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on Utility Models and Prospect Theory |
| By: | Luigi Guiso; Monica Paiella |
| Abstract: | We use household survey data to construct a direct measure of absolute risk aversion based on the maximum price a consumer is willing to pay for a risky security. We relate this measure to consumers' endowments and attributes and to measures of background risk and liquidity constraints. We find that risk aversion is a decreasing function of the endowment. thus rejecting CARA preferences. We estimate the elasticity of risk aversion to consumption at about 0.7, below the unitary value predicted by CRRA utility. We also find that households. attributes are of little help in predicting their degree of risk aversion, which is characterized by massive unexplained heterogeneity. We show that the consumer's environment affects risk aversion. Individuals who are more likely to face income uncertainty or to become liquidity constrained exhibit a higher degree of absolute risk aversion, consistent with recent theories of attitudes toward risk in the presence of uninsurable risks. |
| Keywords: | Risk aversion, background risk, prudence, heterogeneous preferences |
| JEL: | D1 D8 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2007/47&r=upt |
| By: | Yusuke Osaki (Risk & Sustainable Management Group, School of Economics, University of Queensland); John Quiggin (Risk & Sustainable Management Group, School of Economics, University of Queensland) |
| Abstract: | This note gives a simple, but useful characterization of optimism and pessimism represented by a convex and concave shift of probability weighting functions, and applies it to two comparative static analysis. |
| Keywords: | Optimism, pessimism, rank dependent expected utility, risk–neutral decision weight. |
| JEL: | D81 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:rsm:riskun:r07_3&r=upt |
| By: | Lanteri, Alessandro; Carabelli, Anna |
| Abstract: | Behavioural Economics’ milestones, Endowment Effect and Loss Aversion, have been recognized as ‘well documented,’ ‘robust,’ and ‘important’ even by the critics. But well documented, robust, and important what? Are these stylized facts, theoretical constructs, or psychological truths? Do they express genuine preferences or are they judgement mistakes? We discuss the problems with the nature of these claims in the lights of the goals of Behavioural Economics: to improve economics’ realisticness and to be considered mainstream. We argue that, under sensible interpretations of Loss Aversion and Endowment Effect, Behavioural Economics is neither more realistic than, nor part of the mainstream. |
| Keywords: | Behavioural Economics; Decision-Making; Endowment Effect; Loss Aversion; Uncertainty |
| JEL: | D81 A12 D8 |
| Date: | 2007–11 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:5667&r=upt |
| By: | Yusuke Osaki (Risk & Sustainable Management Group, School of Economics, University of Queensland) |
| Abstract: | We consider an asset market traded three types of assets: the risk–free asset, the market portfolio and derivatives written on the market portfolio return. We determine a sufficient condition to guarantee that noise risk monotonically changes their derivatives. The condition is that Arrow–Pratt absolute risk aversion is decreasing and convex. |
| Keywords: | Derivative price, Noise risk, Nonlineality, Risk aversion |
| JEL: | D51 D81 G12 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:rsm:riskun:r07_2&r=upt |
| By: | Iris Bohnet (Kennedy School of Government, Harvard University); Fiona Greig (Kennedy School of Government, Harvard University); Benedikt Herrmann (School of Economics, University of Nottingham); Richard Zeckhauser (Kennedy School of Government, Harvard University) |
| Abstract: | Due to betrayal aversion, people take risks less willingly when the agent of uncertainty is another person rather than nature. Individuals in six countries (Brazil, China, Oman, Switzerland, Turkey, and the United States) confronted a binary-choice trust game or a risky decision offering the same payoffs and probabilities. Risk acceptance was calibrated by asking individuals their “minimum acceptable probability” (MAP) for securing the high payoff that would make them willing to accept the risky rather than the sure payoff. People’s MAPs are generally higher when another person rather than nature determines the outcome. This indicates betrayal aversion. |
| JEL: | C72 C91 |
| Date: | 2007–10 |
| URL: | http://d.repec.org/n?u=RePEc:cdx:dpaper:2007-08&r=upt |
| By: | Vincent Boucher; Yann Bramoullé |
| Abstract: | We introduce uncertainty and risk aversion to the study of international environmental agreements. We consider a simple model with identical agents and linear payoffs. We show that a stable treaty with positive action always exists. While uncertainty lowers the action of signatories, we find that it may increase participation. In addition, uncertainty may generate multiple equilibria. A treaty with low action and low participation may coexist with one with high action and high participation. Overall, and despite risk aversion, the impact of uncertainty on welfare may be positive. A reduction in uncertainty may hurt international cooperation. |
| Keywords: | International Environmental Agreements, Risk Aversion, Uncertainty |
| JEL: | D62 D80 Q54 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:lvl:lacicr:0739&r=upt |
| By: | Jean-Pierre Drugeon (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I); Bertrand Wigniolle (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I) |
| Abstract: | A basic consumer problem with a unique good is considered, current consumption of this good influencing in a positive manner consumer intertemporal utility, while past consumption exerts a negative influence. Moreover, in the line of Fisher, a specification of preferences is retained so that the rate of time preference, assumes a long-run value – this means for a stationary consumption-path – that is non-monotonic as a function of consumption: impatience increases for low level of consumptions but decreases for higher ones. Such a framework allows for an integrated appraisal of addiction, satiation and the rate of time preference. It is shown that the emergence of an addiction phenomenon in the neighbourhood of an unsatiated long-run position exactly corresponds to letting the rate of time preference be an increasing function of past consumption habits. When addiction becomes sufficiently strong, the unsatiated stationary state becomes unstable and the satiated steady state becomes the only admissible stationary position. |
| Keywords: | Impatience; Consumption habits; Rational addiction; Satiation |
| Date: | 2007–04 |
| URL: | http://d.repec.org/n?u=RePEc:hal:papers:halshs-00185280_v1&r=upt |
| By: | Fosgerau, Mogens; Karlström, Anders |
| Abstract: | We derive the value of reliability in the scheduling of an activity of random duration, such as travel under congested conditions. We show that the minimal expected cost is linear in the mean and standard deviation of duration, regardless of the form of the standardized distribution of durations. This insight provides a unification of the scheduling model and models that include the standard deviation of duration directly as an argument in the cost or utility function. The results generalize approximately to the case where the mean and standard deviation of duration depend on the starting time. Empirical illustration is provided. |
| Keywords: | Welfare; Random duration; Time; Scheduling; Reliability; Variability |
| JEL: | D0 D81 D8 |
| Date: | 2007–11–13 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:5733&r=upt |
| By: | Yesuf, Mahmud; Bluffstone, Randy |
| Abstract: | "Production systems in low-income developing countries are generally poorly diversified, focusing on rainfed staple crop production and raising livestock. These activities are inherently risky and investment and production decisions by farm households are therefore made within environments that are affected by risk. Because of poorly developed or absent credit and insurance markets it is difficult to pass any of these risks to a third party. As a result, it is often found that even when the expected net return is high, households are reluctant to adopt new agricultural technologies when they involve risk. Better understanding risk behavior will be essential for identifying appropriate farm-level strategies for adaptation to climate change by low-income farmers. Despite risk's potentially central role in farm investment decisions, there have been few attempts to estimate the magnitude and nature of risk aversion of farm households in low-income developing countries. To partially close this gap, this paper uses an experimental approach applied to 262 households in the Ethiopian highlands with real payoffs. By incorporating both small and large stakes and gains and losses into the experiment, we test for the presence of low stake risk aversion and loss aversion. We find that more than 50 percent of the households are severely or extremely risk averse. This contrasts with studies in Asia where most household decision-makers exhibit moderate to intermediate risk aversion. We find that households that stand to lose as well as gain something from participation in games are significantly more risk averse than households playing gains-only games. This strongly suggests that agricultural extension efforts involving losses as well as gains may face systematic resistance by farmers in low-income, high-risk environments. Promotion of technologies with downside risks – even if the upside potential is enormous – should therefore be combined with insurance or other support. We also find that even without the possibility of losses households are much more averse to risk when stakes are high. Results indicate that insurance or other support can likely be phased out. After initial successes have convinced farmers that technologies are viable, risk aversion declines. There are also significant differences in risk averting behavior between relatively poorer and wealthier farm households, which is consistent with decreasing absolute risk aversion. This suggests that as wealth is built up households are willing to take on more risk in exchange for higher returns. Both these findings suggest a strong path dependence. Efforts to develop poor rural areas through promotion of risky technologies should take this path dependence into account. Early successes are important, but households should also be allowed to build up wealth before they are challenged or tempted to take on more risky ventures. Furthermore, the finding that even without the possibility of losses households are much more risk averse when stakes are higher, suggests that agricultural extension should start modestly before asking households to take on larger gambles." from Authors' Abstract |
| Keywords: | experimental studies, loss aversion, risk aversion, econometric models, Farm households, |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fpr:ifprid:00715&r=upt |