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on Utility Models and Prospect Theory |
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Issue of 2024‒01‒01
ten papers chosen by |
| By: | Jacob Smith |
| Abstract: | This paper presents a method for incorporating risk aversion into existing decision tree models used in economic evaluations. The method involves applying a probability weighting function based on rank dependent utility theory to reduced lotteries in the decision tree model. This adaptation embodies the fact that different decision makers can observe the same decision tree model structure but come to different conclusions about the optimal treatment. The proposed solution to this problem is to compensate risk-averse decision makers to use the efficient technology that they are reluctant to adopt. |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2311.07905&r=upt |
| By: | Taisuke Imai (Osaka University, CESifo); Klaus Schmidt (LMU Munich, CESifo) |
| Abstract: | Loss aversion postulates that people prefer avoiding losses over acquiring gains of equal size. It is a central part of prospect theory and, according to Daniel Kahneman, “the most significant contribution of psychology to behavioral economics” (Kahneman, 2011, p. 300). It has powerful implications for decision theory and has been fruitfully applied in many subfields of economics. However, because the reference point is often not well defined and loss aversion interacts with other behavioral biases, there is some controversy about the concept. |
| Keywords: | loss aversion; reference point; prospect theory; endowment effect; decision theory; risk; |
| Date: | 2023–11–21 |
| URL: | http://d.repec.org/n?u=RePEc:rco:dpaper:461&r=upt |
| By: | Maxime Markov; Vladimir Markov |
| Abstract: | In this paper, we explore the portfolio allocation problem involving an uncertain covariance matrix. We calculate the expected value of the Constant Absolute Risk Aversion (CARA) utility function, marginalized over a distribution of covariance matrices. We show that marginalization introduces a logarithmic dependence on risk, as opposed to the linear dependence assumed in the mean-variance approach. Additionally, it leads to a decrease in the allocation level for higher uncertainties. Our proposed method extends the mean-variance approach by considering the uncertainty associated with future covariance matrices and expected returns, which is important for practical applications. |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2311.07478&r=upt |
| By: | Aljoscha Minnich; Andreas Lange |
| Abstract: | This study measures the differences in ambiguity attitudes of groups and individuals in the gain and loss domain. We elicit the ambiguity attitudes and ambiguity-generated insensitivity for natural temperature events. We do not find significant differences between individuals and groups in our main sample, yet higher ambiguity aversion and ambiguity-generated insensitivity results for groups in the gain when constraining the sample to groups and individuals with a better understanding of the experiment. Moreover, the group effect on the ambiguity-generated insensitivity seems domain dependent. |
| Keywords: | ambiguity attitudes, group decision making, gain and loss domain |
| JEL: | C91 C92 D70 D81 D83 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10781&r=upt |
| By: | Yoshiki Ando; Dirk Krueger; Harald Uhlig |
| Abstract: | In this paper we study the neoclassical growth model with idiosyncratic income risk and aggregate risk in which risk sharing is endogenously constrained by one-sided limited commitment. Households can trade a full set of contingent claims that pay off depending on both idiosyncratic and aggregate risk, but limited commitment rules out that households sell these assets short. The model results, under suitable restrictions of the parameters of the model, in partial consumption insurance in equilibrium. With log-utility and idiosyncratic income shocks taking two values one of which is zero (e.g., employment and unemployment) we show that the equilibrium can be characterized in closed form, despite the fact that it features a non-degenerate consumption- and wealth distribution. We use the tractability of the model to study, analytically, inequality over the business cycle and asset pricing, and derive conditions under which our model has identical, as well as conditions under which it has lower/higher risk premia than the corresponding representative agent version of the model. |
| JEL: | D15 D31 E21 E23 |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:31903&r=upt |
| By: | Joseph S. Briggs; David Cesarini; Sean Chanwook Lee; Erik Lindqvist; Robert Östling |
| Abstract: | We investigate the impact of financial windfalls on household portfolio choices and risk exposure. Exploiting the randomized assignment of lottery prizes in three Swedish lotteries, we find a windfall gain of $100K leads to a 5-percentage-point decrease in the risky share of household portfolios. We show theoretically that negative wealth effects are consistent with both constant and decreasing relative risk aversion and analyze how our empirical estimates help distinguish between competing models of portfolio choice. We further show our results are quantitatively aligned with the predictions of a calibrated dynamic portfolio choice model with nontradable human capital and consumption habits. |
| JEL: | G11 G5 |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:31864&r=upt |
| By: | Aljoscha Minnich; Hauke Roggenkamp; Andreas Lange |
| Abstract: | This paper investigates ambiguity attitudes for natural events (temperatures) and how they are updated following new information. Using a general population sample, we first obtain baseline ambiguity attitudes for future weather events based on real temperatures over several past days. Second, we study the influence of different communication types on updating the ambiguity attitudes: participants are given either point estimators, interval estimators, or the combination of both as weather forecasts. We further vary whether the forecast is surprising or in line with the initially received information. In contrast to claims that ambiguity aversion may increase in response to surprising news, we find that ambiguity attitudes are rather robust to new information and variants of their communication. Yet, different variants of communicating new information significantly change the belief updating process and affect the matching probabilities given to specific events. Our sample allows us to analyze sociodemographic correlates of ambiguity attitudes and the updating of ambiguity attitudes to new information. |
| Keywords: | ambiguity attitude, belief updating, expert forecasts, survey experiment |
| JEL: | D81 D83 C93 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10783&r=upt |
| By: | Camille Cornand (CNRS, GATE UMR 5824, F-69130 Ecully, France); Maria Alejandra Erazo Diaz (University of Bologna, Department of Economics); Béatrice Rey (Univ Lyon, Université Lyon 2, GATE UMR 5824, F-69130 Ecully, France); Adam Zylbersztejn (Univ Lyon, Université Lyon 2, GATE UMR 5824, F-69130 Ecully, France; research fellow at Vistula University Warsaw (AFiBV), Warsaw, Poland) |
| Abstract: | In a context-free preference situation, we conduct a laboratory experiment in which we test higher order ambiguity attitudes (order 2, order 3, and order 4) using a simple model with two states of nature (good and bad). We compare ambiguity attitudes when the random variable capturing ambiguity is introduced on the probability associated with the good state of nature versus the bad state of nature. In addition, in the case of order 3, we compare ambiguity attitudes when the random variable capturing ambiguity is presented as two harms (as usual in decision theory) versus one harm and one favor. We first establish the theoretical prediction of a general consistency of ambiguity attitudes. Ceteris paribus, these attitudes should remain invariant with respect to (i) the state of nature to which ambiguity is associated, and to (ii) the type of the change (harm or favor) in the probability to which ambiguity is associated. Our empirical results systematically contradict this formal prediction pointing to the behavioral importance of ambiguity framing. |
| Keywords: | Ambiguity attitudes; Higher order attitudes; Ambiguity aversion; Ambiguity prudence; Ambiguity temperance; Framing |
| JEL: | D81 C91 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:gat:wpaper:2318&r=upt |
| By: | Anusha Chari; Karlye Dilts Stedman; Christian Lundblad |
| Abstract: | This paper defines risk-on risk-off (RORO), an elusive terminology in pervasive use, as the variation in global investor risk aversion. Our high-frequency RORO index captures time-varying investor risk appetite across multiple dimensions: advanced economy credit risk, equity market volatility, funding conditions, and currency dynamics. The index exhibits risk-off skewness and pronounced fat tails, suggesting its amplifying potential for extreme, destabilizing events. Compared with the conventional VIX measure, the RORO index reflects the multifaceted nature of risk, underscoring the diverse provenance of investor risk sentiment. Practical applications of the RORO index highlight its significance for international portfolio reallocation and return predictability. |
| JEL: | F21 F31 F36 G11 G15 G17 |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:31907&r=upt |
| By: | Miguel Risco |
| Abstract: | In today’s world, social networks have a significant impact on information processes, shaping individuals’ beliefs and influencing their decisions. This paper proposes a model to understand how boundedly rational (DeGroot) individuals behave when seeking information to make decisions in situations where both social communication and private learning take place. The model assumes that information is a local public good, and individuals must decide how much effort to invest in costly information sources to improve their knowledge of the state of the world. Depending on the network structure and agents’ positions, some individuals will invest in private learning, while others will free-ride on the social supply of information. The model shows that multiple equilibria can arise, and uniqueness is controlled by the lowest eigenvalue of a matrix determined by the network. The lowest eigenvalue roughly captures how two-sided a network is. Two-sided networks feature multiple equilibria. Under a utilitarian perspective, agents would be more informed than they are in equilibrium. Social welfare would be improved if influential agents increased their information acquisition levels. |
| Keywords: | Information Acquisition, Learning, Public Goods, Network Effects, Information Diffusion, Bounded Rationality |
| JEL: | C72 D61 D83 D85 H41 |
| Date: | 2023–04 |
| URL: | http://d.repec.org/n?u=RePEc:bon:boncrc:crctr224_2023_420v2&r=upt |