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on Utility Models and Prospect Theory |
| By: | Daniel Hernández-Hernández; Alexander Schied |
| Abstract: | We analyze the stochastic control approach to the dynamic maximization of the robust utility of consumption and investment. The robust utility functionals are defined in terms of logarithmic utility and a dynamically consistent convex risk measure. The underlying market is modeled by a diffusion process whose coefficients are driven by an external stochastic factor process. Our main results give conditions on the minimal penalty function of the robust utility functional under which the value function of our problem can be identified with the unique classical solution of a quasilinear PDE within a class of functions satisfying certain growth conditions. |
| Keywords: | Robust utility maximization, optimal consumption, stochastic factor model, stochastic control, convex risk measure, dynamic consistency, Hamilton-Jacobi-Bellman equation |
| JEL: | G11 D81 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:hum:wpaper:sfb649dp2007-030&r=upt |
| By: | Matthias Kräkel |
| Abstract: | everal empirical findings have challenged the traditional trade-off between risk and incentives. By combining risk aversion and limited liability in a standard principal-agent model the empirical puzzle on the positive relationship between risk and incentives can be explained. |
| Keywords: | limited liability; piece rates; risk aversion |
| JEL: | D01 D82 J3 M5 |
| URL: | http://d.repec.org/n?u=RePEc:bon:bonedp:bgse3_2007&r=upt |
| By: | Matthias Kräkel |
| Abstract: | We analyze the optimal choice of risk in a two-stage tournament game between two players that have different concave utility functions. At the first stage, both players simultaneously choose risk. At the second stage, both observe overall risk and simultaneously decide on effort or investment. The results show that those two effects which mainly determine risk taking - an effort effect and a likelihood effect - are strictly interrelated. This finding sharply contrasts with existing results on risk taking in tournament games with symmetric equilibrium efforts where such linkage can never arise. Hence, previous findings based on symmetry at the effort stage turn out to be nongeneric. |
| Keywords: | asymmetric equilibria, rank-order tournaments, risk taking |
| JEL: | C72 J3 L1 M5 |
| URL: | http://d.repec.org/n?u=RePEc:bon:bonedp:bgse4_2007&r=upt |
| By: | José L. B. Fernandes; Juan Ignacio Peña; Benjamin M. Tabak |
| Abstract: | Recent literature has found two behavioral effects - house-money and myopic loss aversion (MLA) - in several experimental designs. We show that although we can find a house-money effect using survey methods this evidence disappears when we study investment decision within a multi-period investment experiment. Loss aversion is found to govern the risk-taking behavior of subjects in dynamic settings, overcoming the house-money effect. These results are robust to experiments conducted in two different countries, Spain and Brazil. |
| Date: | 2006–09 |
| URL: | http://d.repec.org/n?u=RePEc:bcb:wpaper:115&r=upt |
| By: | Calzolari, Giacomo; Scarpa, Carlo |
| Abstract: | We study the regulation of a utility firm which is active in a competitive unregulated sector as well. If the firm jointly operates its activities in the two markets, it enjoys economies of scope, whose size is the firm’s private information and is unknown to the regulator and the rival firms. We jointly characterize the unregulated market outcome (with price and quantity competition) and also optimal regulation. Accounting for the several effects of regulation on the unregulated market, we show the existence of an informational externality, in that regulation provides useful information to the rival firms. Although joint operation of multi-utility’s activities generates scope economies, it also brings about private information to the multi-utility, so that regulation is less efficient and also the unregulated market may be negatively affected. Nevertheless, we show that letting the multi-utility integrate productions is (socially) desirable, unless joint production is instead characterized by dis-economies of scope. |
| Keywords: | asymmetric information; competition; informational externality; multi-utility firms; regulation; scope economies |
| JEL: | L43 L51 L52 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6238&r=upt |
| By: | Sergio A. Lago Alves; Mirta N. S. Bugarin |
| Abstract: | This paper aims to contribute to the research agenda on the sources of price rigidity. Based on broadly accepted assumptions on the behavior of economic agents, we show that firms’ competition can lead to the adoption of sticky prices as a sub-game perfect equilibrium strategy to optimally deal with consumers’ risk aversion, even if firms have no adjustment costs. To this end, we build a model economy based on consumption centers with several complete markets and relax some traditional assumptions used in standard monetary policy models by assuming that households have imperfect information about the inefficient time-varying cost shocks faced by the .rms. Furthermore, we assume that the timing of events is such that, at every period, consumers have access to the actual prices prevailing in the market only after choosing a particular consumption center. Since such choices under uncertainty may decrease the expected utilities of risk-averse consumers, competitive firms adopt some degree of price stickiness in order to minimize the price uncertainty and "attract more customers". |
| Date: | 2006–11 |
| URL: | http://d.repec.org/n?u=RePEc:bcb:wpaper:121&r=upt |
| By: | Caio Ibsen R. Almeida; José Valentim M. Vicente |
| Abstract: | We provide approximation formulas for at-the-money asian option prices to extract volatility risk premium from a joint dataset of bonds and option prices. The dynamic model generates stochastic volatility and a time-varying volatility risk premium, which explicitly depends on the average cross section of bond yields and on the time series behavior of option prices. When estimated using a joint dataset of Brazilian local bonds and asian options, the model generates bond risk premium strongly correlated (89%) with a widely accepted emerging markets benchmark index, and a negative volatility risk premium implying that investors might be using options as insurance in this market. Volatility premium explains a significant portion (32.5%) of bond premium, confirming that options are indeed important to identify risk premium in dynamic term structure models. |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:bcb:wpaper:136&r=upt |
| By: | Daniel S. Hamermesh; Stephen Donald |
| Abstract: | With the American Time Use Survey of 2003 and 2004 we first examine whether additional market work has neutral impacts on the mix of non-market activities. The estimates indicate that fixed time costs of market work alter patterns of non-market activities, reducing leisure time and mostly increasing time devoted to household production. Similar results are found using time-diary data for Australia, Germany and the Netherlands. Direct estimates of the utility derived from goods consumption and two types of non-market time in the presence of these fixed costs indicate that they generate a utility-equivalent of as much as 8 percent of income that must be overcome before market work becomes an optimizing choice. Market work also alters the timing of a fixed amount of non-market activities during the day, away from the schedule chosen when market work imposes no timing constraints. All of these effects are mitigated by higher family income. The results provide a new supply-side explanation for the frequently observed discrete drop from full-time work to complete retirement. |
| JEL: | D13 J22 J26 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13127&r=upt |
| By: | Fedyk, Yuriy (Olin School of Business); Walden, Johan (Haas School of Business) |
| Abstract: | Recent research has suggested that natural selection in financial markets may be a very slow process, taking hundreds of years. We show in a general equilibrium model that it may be much faster in markets with large state spaces. In many cases, the time it takes to wipe out irrational investors is inversely proportional to the number of stocks in the market, i.e., if it takes about 500 years with one stock, it takes about one year with 500 stocks. Thus, theoretically, natural selection can be very efficient even when there is high market uncertainty. The speed of the natural selection process is a known function of irrational investors' sentiment and of the real characteristics of the stock market. According to a calibration to U.S. stock data, it takes about fifty years for an irrational investor to be wiped out. This is in line with studies of individual investor underperformance. |
| Keywords: | Asset pricing; Market selection hypothesis; Natural selection |
| JEL: | G11 G12 |
| Date: | 2007–04–15 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:sifrwp:0052&r=upt |
| By: | Tony Berrada (University of Lausanne and Swiss Finance Institute) |
| Abstract: | We consider a pure exchange economy with incomplete information. Some agents in the economy display learning bias and over- or underreact to the arrival of new information. We study, by simulation, the distribution of irrational agents’ consumption shares. We find that over a reasonable horizon (50 years) under- or over-reaction has little impact on an agent’s consumption share, when parameters of the model are chosen to fit aggregate consumption data in the US. We also show that agents’impact on prices is increasing in their consumption share and conclude that biased agents can significantly influence equilibrium quantities. |
| Keywords: | Bounded rationality, incomplete information, equilibrium |
| JEL: | G12 |
| Date: | 2003–08 |
| URL: | http://d.repec.org/n?u=RePEc:chf:rpseri:rp07&r=upt |