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on Utility Models and Prospect Theory |
| By: | Rieger, Marc Oliver (Dept. IV, Business Administration, University of Trier); Wang, Mei (WHU - Otto Beisheim School of Management); Hens, Thorsten (Department of Banking and Finance, University of Zurich) |
| Abstract: | We present results from the first large-scale international survey on risk preferences, conducted in 45 countries. We show substantial cross-country differences in risk aversion, loss aversion and probability weighting. Moreover, risk attitudes in our sample depend not only on economic conditions, but also on cultural factors, as measured by the Hofstede dimensions Individuality and Uncertainty Avoidance. The presented data might also serve as an interesting starting point for further research in cultural economics. |
| Keywords: | Risk preferences; prospect theory; cross-cultural comparison |
| JEL: | D90 F40 |
| Date: | 2011–10–31 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:nhhfms:2011_019&r=upt |
| By: | Miryana Grigorova (LPMA - Laboratoire de Probabilités et Modèles Aléatoires - CNRS : UMR7599 - Université Pierre et Marie Curie - Paris VI - Université Paris Diderot - Paris 7) |
| Abstract: | Pursuing our previous work in which the classical notion of increasing convex stochastic dominance relation with respect to a probability has been extended to the case of a normalised monotone (but not necessarily additive) set function also called a capacity, the present paper gives a generalization to the case of a capacity of the classical notion of increasing stochastic dominance relation. This relation is characterized by using the notions of distribution function and quantile function with respect to the given capacity. Characterizations, involving Choquet integrals with respect to a distorted capacity, are established for the classes of monetary risk measures (defined on the space of bounded real-valued measurable functions) satisfying the properties of comonotonic additivity and consistency with respect to a given generalized stochastic dominance relation. Moreover, under suitable assumptions, a "Kusuoka-type" characterization is proved for the class of monetary risk measures having the properties of comonotonic additivity and consistency with respect to the generalized increasing convex stochastic dominance relation. Generalizations to the case of a capacity of some well-known risk measures (such as the Value at Risk or the Tail Value at Risk) are provided as examples. It is also established that some well-known results about Choquet integrals with respect to a distorted probability do not necessarily hold true in the more general case of a distorted capacity. |
| Keywords: | Choquet integral ; stochastic orderings with respect to a capacity ; distortion risk measure ; quantile function with respect to a capacity ; distorted capacity ; Choquet expected utility ; ambiguity ; non-additive probability ; Value at Risk ; Rank-dependent expected utility ; behavioural finance ; maximal correlation risk measure ; quantile-based risk measure ; Kusuoka's characterization theorem |
| Date: | 2011–11–09 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-00639667&r=upt |
| By: | Blake, David; Wright, Douglas; Zhang, Yumeng |
| Abstract: | Assuming loss aversion, stochastic investment and labour income processes, and a path-dependent target fund, we show that the optimal investment strategy for defined contribution pension plan members is a target-driven 'threshold' strategy. With this strategy, the equity allocation is increased if the accumulating fund is below target and decreased if it is above. However, if the fund is sufficiently above target, the optimal investment strategy switches discretely to 'portfolio insurance'. We show that under loss aversion, the risk of failing to attain the target replacement ratio is significantly reduced compared with target-driven strategies derived from maximising expected utility. |
| Keywords: | Defined Contribution Pension Plan; Investment Strategy; Loss Aversion; Target Replacement Ratio; Threshold Strategy; Portfolio Insurance; Dynamic Programming |
| JEL: | G11 C63 G23 D91 |
| Date: | 2011–09 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:34278&r=upt |
| By: | Fourel, V.; Idier, J. |
| Abstract: | Risk aversion and uncertainty are often both at play in market price determination, but it is empirically challenging to disentangle one from the other. In this paper we set up a theoretical model particularly suited for opaque over-the-counter markets that is shown to be empirically tractable. Based on high frequency data, we thus propose an evaluation of risk aversion and uncertainty inherent to the government bond markets in the euro area between 2007 and 2011. We particularly examine the impact of the European Central Bank Securities Markets Programme [SMP] implemented in May 2010 and re- activated in August 2011 to ease the pressure on the European sovereign bond markets. We show how this programme has killed market uncertainty but raised risk aversion for all countries except Greece in a risk-pooling mechanism: this can therefore weaken the impact of market interventions over the long-term. |
| Keywords: | MES, systemic risk, tail correlation, balance sheet ratios, panel. |
| JEL: | D40 D81 E58 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:bfr:banfra:349&r=upt |
| By: | Cipollone, Angela |
| Abstract: | By using data from the latest wave of the Indonesia Life Family Survey, the present work investigates whether and to which extent child time allocation depends on the joint impact of liquidity constraints and risk attitudes. We employ a double selection model of school hours, by adding time preferences, risk attitudes and proxies of risks and shocks among the relevant regressors, and controlling for sample selection and endogeneity of liquidity constraints and school enrolment. To this aim, we exploit measures of time preferences and risk attitudes elicited from individuals’ responses to hypothetical gambles and consider the past occurrence of shocks to proxy the risk profiles of the households under the assumption that households use past income volatility to predict future volatility. It will be shown that, under liquidity constraints, risk averse parents raise a precautionary demand for education as an ex-ante risk coping strategy, so to insure future consumption through higher returns from their children’s work. |
| Keywords: | schooling; risk aversion; liquidity constraints; risks; shocks |
| JEL: | J13 J22 D91 |
| Date: | 2011–11–08 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:34575&r=upt |
| By: | Federica Teppa (De Nederlandsche Bank (DNB) and Netspar) |
| Abstract: | This paper provides new evidence on individual preferences over annuities and lump sum payments based on hypothetical questions posed in the DNB Household Survey in 2005. Contrary to the majority of papers in the annuitization puzzle literature, this study allows to control explicitly for the subjective survival probability (SSP), a key driver of the decision about whether to annuitize or not as a perceived measure of longevity risk. We find that people expecting to live longer do claim to prefer the annuity. This finding is very robust to controlling for bequest motives. The relevance of this paper is twofold. First, it delivers an important empirical result on the role of the SSP that is still not directly tested in the literature. Second and more important, combined with the empirical evidence that on average individuals tend to systematically underestimate their life expectancy, the findings have strong policy implications. The annuitization puzzle may be alleviated by helping individuals in better assessng their longevity risk, rather than forcing their actions. |
| Keywords: | Longevity Risk; Annuitization Puzzle; Survey Data; Hypothetical Choices |
| JEL: | C5 C8 D12 G11 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:inq:inqwps:ecineq2011-223&r=upt |
| By: | Cathleen Johnson; Claude Montmarquette |
| Abstract: | Evidence is presented on whether the willingness to borrow for education varies significantly among some at-risk students: low SES levels, First Nations, and first generation students. 1248 students participated in a survey, a numeracy assessment and took part in experimental decisions. During these sessions, students were presented with a series of paid binary decisions: bursaries vs. cash, loans for postsecondary education studies vs. cash, intertemporal decisions and risky decisions. The paid binary decisions involved trade-offs between cash and various types of student financial aid, allowing us to generate a cost per dollar of educational financing (grants, loans, mixtures of loans and grants). Prices for the various types of educational financing overlapped substantially in order to more clearly distinguish the impact of loan aversion on the decision to take up financial assistance to pursue PSE. Results show that several factors influence the subjects’ decisions about education financing but the most prominent influence was the price of educational subsidies. Participants were marginally sensitive to the form of financing (grant or loan), with no evidence of systematic loan aversion being detected. <P>Cette étude montre que la volonté d'emprunter pour s’instruire varie considérablement chez certains étudiants issus de milieu socio-économique faible, des Premières nations, et les étudiants de première génération. 1248 étudiants ont participé à une enquête, une évaluation de leur niveau de connaissances numériques et ont pris part à des décisions expérimentales. Pendant ces séances, les étudiants ont été confrontés à une série de décisions binaires rémunérées : bourses vs dollars, prêts d’études pour le postsecondaire vs dollars, des décisions intertemporelles et des décisions risquées. Les décisions binaires rémunérées impliquant un arbitrage entre des dollars et divers types d'aide financière, nous ont permis de générer un coût par dollar du financement de l'éducation (bourses, prêts, mélanges de prêts et de bourses). Les prix pour les différents types de financement de l'éducation se chevauchent de manière substantielle pour permettre de distinguer clairement l'impact de l'aversion pour les prêts sur la décision de prendre ou non l’option d’une aide financière pour poursuivre des études postsecondaires. Les résultats montrent que plusieurs facteurs influencent les décisions des sujets sur le financement de leur éducation, mais l'influence la plus importante est le prix en dollars des subventions à l'éducation. Les participants ont été légèrement influencés par la forme de financement (subvention ou prêt), mais aucune preuve d'aversion pour les prêts n’a été décelée. |
| Keywords: | Intertemporal choice, field experiments, risk attitudes, loans aversion, choix intertemporels, expériences sur le terrain, attitudes vis-à-vis des risques, l'aversion aux prêts d’études. |
| Date: | 2011–11–01 |
| URL: | http://d.repec.org/n?u=RePEc:cir:cirwor:2011s-67&r=upt |
| By: | Ian Martin |
| Abstract: | This paper investigates the behavior of asset prices in an endowment economy in which a representative agent with power utility consumes the dividends of multiple assets. The assets are Lucas trees; a collection of Lucas trees is a Lucas orchard. The model generates return correlations that vary endogenously, spiking at times of disaster. Since disasters spread across assets, the model generates large risk premia even for assets with stable fundamentals. Very small assets may comove endogenously and hence earn positive risk premia even if their fundamentals are independent of the rest of the economy. I provide conditions under which the variation in a small asset’s price-dividend ratio can be attributed almost entirely to variation in its risk premium. |
| JEL: | G12 |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17563&r=upt |
| By: | Urs Fischbacher; Verena Utikal |
| Abstract: | We present experimental evidence on the existence of disadvantageous lies. Literature so far assumes that people do not lie to their monetary disadvantage. However, some people have preferences for appearing honest. If the utility gained from appearing honest outweighs the monetary payoff gained from an advantageous lie or the truth, people will tell a disadvantageous lie. |
| Keywords: | Lying, experiment |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:twi:respas:0071&r=upt |
| By: | Dominique Guegan (Centre d'Economie de la Sorbonne); Wayne Tarrant (Department of Mathematics - Wingate University) |
| Abstract: | Regulation and Risk management in banks depend on underlying risk measures. In general this is the only purpose that is seen for risk measures. In this paper, we suggest that the reporting of risk measures can be used to determine the loss distribution function for a financial entity. We demonstrate that a lack of sufficient information can lead to ambiguous risk situations. We give examples, showing the need for the reporting of multiple risk measures in order to determine a bank's loss distribution. We conclude by suggesting a regulatory requirement of multiple risk measures being reported by banks, giving specific recommendations. |
| Keywords: | Risk measure, Value at Risk, Bank capital. |
| JEL: | C16 G18 E52 |
| Date: | 2011–08 |
| URL: | http://d.repec.org/n?u=RePEc:mse:cesdoc:11054&r=upt |
| By: | Wang, Mei (WHU - Otto Beisheim School of Management); Rieger, Marc Oliver (Dept. IV, Business Administration, University of Trier); Hens, Thorsten (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration) |
| Abstract: | We present results from the first large-scale international survey on time discounting, conducted in 45 countries. Cross-country variation cannot simply be explained by economic variables such as interest rates or in ation. In particular, we find strong evidence for cultural differences, as measured by the Hofstede cultural dimensions. For example, high levels of Uncertainty Avoidance or Individualism are both associated with strong hyperbolic discounting. Moreover, as application of our data, we find evidence for an impact of time preferences on the capability of technological innovations in a country and on environmental protection. |
| Keywords: | Time preferences; Intertemporal decision; Endogenous preference; Cross-cultural comparison |
| JEL: | D90 F40 |
| Date: | 2011–10–31 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:nhhfms:2011_018&r=upt |
| By: | Ke Du (School of Finance and Economics, University of Technology, Sydney); Eckhard Platen (School of Finance and Economics, University of Technology, Sydney) |
| Abstract: | The paper discusses the problem of hedging not perfectly replicable contingent claims by using a benchmark, the numerraire portfolio, as reference unit. The proposed concept of benchmarked risk minimization generalizes classical risk minimization, pioneered by Follmer, Sondermann and Schweizer. The latter relies on a quadratic criterion, requesting the square integrability of contingent claims and the existence of an equivalent risk neutral probability measure. The proposed concept of benchmarked risk minimization avoids these restrictive assumptions. It employs the real world probability measure as pricing measure and identifies the minimal possible price for the hedgable part of a contingent claim. Furthermore, the resulting benchmarked profit and loss is only driven by nontraded uncertainty and forms a martingale that starts at zero. Benchmarked profit and losses, when pooled and sufficiently independent, become in total negligible. This property is highly desirable from a risk management point of view. It is making a symptotically benchmarked risk minimization the least expensive method for pricing and hedging for an increasing number of not fully replicable benchmarked contingent claims. |
| Keywords: | incomplete market; pricing; hedging; numeraire portfolio; risk minimization; benchmark approach |
| JEL: | G10 G13 |
| Date: | 2011–08–01 |
| URL: | http://d.repec.org/n?u=RePEc:uts:rpaper:296&r=upt |
| By: | Ravi Bansal; Marcelo Ochoa |
| Abstract: | In this paper we show that temperature is an aggregate risk factor that adversely affects economic growth. Our argument is based on evidence from global capital markets which shows that the covariance between country equity returns and temperature (i.e., temperature betas) contains sharp information about the cross-country risk premium; countries closer to the Equator carry a positive temperature risk premium which decreases as one moves farther away from the Equator. The differences in temperature betas mirror exposures to aggregate growth rate risk, which we show is negatively impacted by temperature shocks. That is, portfolios with larger exposure to risk from aggregate growth also have larger temperature betas; hence, a larger risk premium. We further show that increases in global temperature have a negative impact on economic growth in countries closer to the Equator, while its impact is negligible in countries at high latitudes. Consistent with this evidence, we show that there is a parallel between a country's distance to the Equator and the economy's dependence on climate sensitive sectors; in countries closer to the Equator industries with a high exposure to temperature are more prevalent. We provide a Long-Run Risks based model that quantitatively accounts for cross-sectional differences in temperature betas, its link to expected returns, and the connection between aggregate growth and temperature risks. |
| JEL: | E0 G12 Q0 |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17575&r=upt |
| By: | Paulo Barelli (University of Rochester); Spyros Galanis (University of Southampto) |
| Abstract: | We develop an approach to providing epistemic conditions for admissible behavior in games. Instead of using lexicographic beliefs to capture infinitely less likely conjectures, we postulate that players use tie-breaking sets to help decide among strategies that are outcome-equivalent given their conjectures. A player is event-rational if she best responds to a conjecture and uses a list of subsets of the other players' strategies to break ties among outcome-equivalent strategies. Using type spaces to capture interactive beliefs, we show that common belief of event-rationality (RCBER) implies that players play strategies in S1W, that is, admissible strategies that also survive iterated elimination of dominated strategies (Dekel and Fudenberg (1990)). We strengthen standard belief to validated belief and we show that event-rationality and common validated belief of event-rationality (RCvBER) implies that players play iterated admissible strategies (IA). We show that in complete, continuous and compact type structures, RCBER and RCvBER are nonempty, and hence we obtain epistemic criteria for SinfW and IA. |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:roc:rocher:568&r=upt |
| By: | Parkhurst, Gregory M; Shogren, Jason F |
| Abstract: | We use Vickrey uniform auctions to provide an indirect robustness test of the endowment effect. Our panel data promotes two results: (1) evidence of the endowment effect exists in that risk seeking behavior following losses is less severe for 'out of pocket' losses as opposed to foregone gain. We did not find support for the prediction that bidders recoil from future losses following a realized loss (i.e., become more risk averse); and (2) a form of gamblers fallacy termed the escalation of commitment better explains bidding behavior for inexperienced bidders—risk seeking bidding behavior is observed following a loss. But as bidders gain experience the escalation of commitment is attenuated for “out of pocket” losses but not for foregone gains. |
| Keywords: | Uniform Auction; Vickrey; Losses; opportunity cost; endowment effect; escalation of commitment |
| JEL: | D44 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:34554&r=upt |