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on Utility Models and Prospect Theory |
| By: | Gerrit Meyerheim (University of Munich) |
| Abstract: | This paper integrates tail aversion, implemented via a one-period entropic tilt, with rare disasters in a consumption-based asset pricing model with CRRA utility to jointly address the equity premium and risk-free rate puzzles. The model delivers closed-form expressions for the risk-free rate and asset moments, pushes out the Hansen-Jagannathan bound, implies a low risk-free rate via diffusion and disaster channels, and delivers natural upper and lower bounds of risk aversion. Calibrated to long-run return data and disciplined by disaster evidence, the model matches average returns, volatility, and a low real risk-free rate with very modest risk aversion. |
| Keywords: | equity premium puzzle; risk-free rate puzzle; rare disasters; entropic tilt; multiplier (kl) preferences; robust control; consumption-based asset pricing; |
| JEL: | G12 E44 E43 E21 D81 |
| Date: | 2025–10–30 |
| URL: | https://d.repec.org/n?u=RePEc:rco:dpaper:549 |
| By: | Mateus Joffily (CNRS, Université Lumière Lyon 2, Université Jean Monnet Saint-Etienne, emlyon business school, GATE, 69007 Lyon, France); Thijs van de Laar (Department of Electrical Engineering, Eindhoven University of Technology, Eindhoven, The Netherlands) |
| Abstract: | Variants of the Ellsberg urn experiments introduced by Machina (Am. Econ. Rev., 99(1), 385-392, 2009) have challenged several prominent models of ambiguity aversion. We show that our Bayesian hierarchical model - originally developed to explain Ellsberg-type preferences - also captures the ambiguity preferences observed in Machina's reflection example. Our findings indicate that ambiguity aversion in both the Ellsberg and Machina paradoxes can be attributed to pessimistic prior beliefs about unobserved outcomes. Moreover, the model predicts an asymmetric pattern of preferences across intermediate payoff levels in the reflection example: ambiguity aversion is stronger when the intermediate payoff lies closer to the worst outcome, while the opposite holds for ambiguity-seeking preferences. |
| Keywords: | Machina Paradox; Ambiguity Aversion; Bayesian Modeling |
| JEL: | C63 D81 D91 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:gat:wpaper:2525 |
| By: | Caroline Flammer; Thomas Giroux; Geoffrey Heal; Marcella Lucchetta |
| Abstract: | Does ambiguity (Knightian uncertainty) or risk provide a greater discouragement to investment? There is general agreement in the financial press that uncertainty discourages investment, with uncertainty here meaning any situation where important future policy variables (such as tariffs or tax rates) are not known. And it seems intuitively plausible that situations of ambiguity are “more uncertain” than those of risk: under risk, although the outcome is not known, its expected value is, whereas under ambiguity we have a distribution of possible expected values. In this paper we show that under quite general circumstances it is the case that ambiguity deters investment more than an equivalent risk. An equivalent risk is one characterized by a compound lottery reflecting the ambiguous situation, but without ambiguity aversion. We show that there will always be investments opportunities that are rejected when characterized by ambiguity but are accepted when characterized by risk with an equivalent compound lottery, and that the converse is not true: there are no investments that would be made under ambiguity that would not be made under equivalent risk. We develop the analysis in the context of the emerging field of green finance. |
| JEL: | D81 G11 H23 Q57 |
| Date: | 2025–11 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:34516 |
| By: | Charlotte Cordes; Jana Friedrichsen; Simeon Schudy |
| Abstract: | Experimental studies show that individuals update beliefs about ego-relevant information optimistically when they expect no resolution of uncertainty but neutrally when their ability is revealed immediately. This paper studies belief updating and the role of motivated memory when feedback is delayed but eventually disclosed. In a longitudinal experiment, participants receive noisy signals about their relative performance in a IQ-related task (Raven matrices) and learn their true rank four weeks later. Across subjects, belief updating is asymmetric: unfavorable signals are weighted less than favorable signals. Further, we identify motivated memory among participants who view the task as ego-relevant. |
| Keywords: | motivated beliefs, feedback, memory, Anticipatory utility, motivated cognition, uncertainty |
| JEL: | C91 D03 D81 D83 D84 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:ces:ceswps:_12286 |
| By: | Luigi Ventura (Department of Economics and Law, Sapienza, University of Rome, ITALY); Charles Yuji Horioka (Research Institute for Economics and Business Administration, Kobe University, Institute of Social and Economic Research, Osaka University, Asian Growth Research Institute, JAPAN, and National Bureau of Economic Research, U.S.A.) |
| Abstract: | Previous authors have asserted that precautionary saving will arise only if consumers are not only risk-averse but also prudent, but in this paper, we first show that when saving occurs in the context of a financial economy featuring at least one other asset, prudence is neither necessary, nor sufficient, to generate precautionary saving, i.e. saving induced only by variance in income. Then, simplifying and elaborating on some results presented in Eeckhoudt and Schlesinger (2008), we address a particular form of precautionary saving, which we name “intertemporal precautionary saving” to distinguish it from purely intertemporal and purely precautionary saving, and show that it will inevitably arise in the case of pure (downside) risk as long as consumers are risk-averse, regardless of whether or not they are prudent, and that prudence will affect only its extent. Thus, our paper challenges the conventional wisdom on precautionary saving in at least two ways. |
| Keywords: | Household saving; Precautionary saving; Prudence; Pure risk; Risk aversion; Saving; Speculative risk |
| JEL: | D11 D14 D15 D81 E21 G51 |
| Date: | 2025–12 |
| URL: | https://d.repec.org/n?u=RePEc:kob:dpaper:dp2025-28 |
| By: | Moritz Loewenfeld (Universität Wien = University of Vienna); Jiakun Zheng (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique) |
| Abstract: | Allowing risk preferences to depend on the correlation between lottery outcomes can explain behavioral anomalies, while empirical evidence is limited and mixed. Using the framework of correlation sensitivity, we classify preferences into three types and adapt a choice task to categorize subjects. Experiments show that aggregate choices exhibit correlation sensitivity opposite to regret and salience theory predictions. Clustering analysis reveals that a correlation-sensitive minority drives these patterns, while most subjects display no sensitivity. We further disentangle deliberate within-state comparisons from incidental payoff comparisons, finding that both contribute to correlation sensitivity, with deliberate comparisons exerting slightly stronger effects. |
| Keywords: | regret theory, salience theory, experiment, correlation effects, choice under risk |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:hal:journl:hal-05346525 |
| By: | Fanghella, Valeria; Fezzi, Carlo; Schleich, Joachim; Sebi, Carine |
| Abstract: | This study assesses the incentive compatibility of different elicitation formats for estimating willingness to accept (WTA) in the field. We assess the convergent validity of standard and theorydriven (i.e. based on mechanism-design theory) versions of the double-bounded binary choice (DB) and the open-ended (OE) formats against the single-binary choice (SBC). Our empirical application, developed in collaboration with a major energy company, is based on estimating compensation for the installation of wind farms in respondents' municipalities of residence. We find strong evidence against convergent validity for both versions of the OE format. In comparison, both versions of the DB format, especially the theory-driven version, yield WTA estimates similar to those of the SBC, ranging from near zero for supporters of wind power to €1500-€1800 for opponents. Finally, we introduce a novel econometric approach that allows the utility of compensation to be non-linear when estimating WTA (and WTP) from binary choices. |
| Abstract: | Diese Studie bewertet die Anreizkompatibilität verschiedener Erhebungsformate zur Schätzung der Akzeptanzbereitschaft (WTA) in der Praxis. Wir bewerten die konvergente Validität von standardisierten und theoriegeleiteten (d. h. auf der Mechanismusdesign-Theorie basierenden) Versionen des doppelt begrenzten binären Auswahlformats (DB) und des offenen Formats (OE) im Vergleich zum einfach binären Auswahlformat (SBC). Unsere empirische Anwendung, die in Zusammenarbeit mit einem großen Energieunternehmen entwickelt wurde, basiert auf der Schätzung der Entschädigung für die Installation von Windparks in den Wohnorten der Befragten. Wir finden starke Hinweise gegen die konvergente Validität für beide Versionen des OE-Formats. Im Vergleich dazu liefern beide Versionen des DB-Formats, insbesondere die theoriegeleitete Version, WTA-Schätzungen, die denen des SBC ähneln und von nahezu Null für Befürworter der Windkraft bis zu 1500-1800 € für Gegner reichen. Schließlich stellen wir einen neuartigen ökonometrischen Ansatz vor, der es ermöglicht, den Nutzen der Entschädigung bei der Schätzung der WTA (und WTP) aus binären Entscheidungen nichtlinear zu gestalten. |
| Keywords: | contingent valuation, willingness to accept, wind farm, mechanism design |
| JEL: | C10 C93 D60 H41 Q51 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:rwirep:331884 |
| By: | Ismail Benslimane (USMBA - Université Sidi Mohamed Ben Abdellah [Fès]); Nabil Sifouh (Université Mohammed Premier [Oujda] = Université Mohammed Ier = University of Mohammed First); Sanae Benjelloun (USMBA - Université Sidi Mohamed Ben Abdellah [Fès]); Karim Ameziane (UCD - Université Chouaib Doukkali); Yassire Elotmani (UM5 - Université Mohammed V de Rabat [Agdal]) |
| Abstract: | The objective of this article is to highlight three key concepts in the field of innovation: risk, ambiguity, and uncertainty. To this end, we reviewed the literature to identify the (probability/outcome) pair that helps distinguish these three notions and prevent any confusion. Particular attention is given to the eight types of uncertainty related to innovation, as well as to the various mechanisms available to reduce them. This research also aims to identify the primary source of ambiguity in innovative industries – namely, complexity – while addressing the risks inherent in technological innovation, whether internal or external. Finally, the article proposes an 'uncertainty tree' that synthesizes these various dimensions and situates the three aspects of uncertainty within a process-oriented framework, in order to determine the respective phases in which they emerge. |
| Keywords: | unforeseen uncertainty, radical uncertainty, uncertainty tree, ambiguity, risk |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:hal:journl:hal-05312346 |