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on Utility Models and Prospect Theory |
| By: | Bruno Cara Giovannetti |
| Abstract: | "Focus on the downside, and the upside will take care of itself" is a famous quote among professional investors. By considering an agent who follows this advice, we reproduce the first and second moments of stock returns, risk-free rate and consumption growth. The agent´s behavior towards risk is analogous to a relative risk aversion of about 3 under expected utility, the elasticity of intertemporal substitution is about 0.5 and the time discount factor is below 1. In particular, the proposed model separates time and risk preferences in an innovative way. |
| Keywords: | asset prices, asymmetric preferences, quantile utility |
| JEL: | G11 G12 |
| Date: | 2012–09–10 |
| URL: | http://d.repec.org/n?u=RePEc:spa:wpaper:2012wpecon16&r=upt |
| By: | Quang Nguyen (Nanyang Technological University, 14 Nanyang Drive, Singapore 637332, Singapore); Marie-Claire Villeval (University of Lyon, F-69007, France; GATE, CNRS, 93, Chemin de Mouilles, F-69130, Ecully, France; IZA, Bonn, Germany); Hui Xu (University of Lyon, F-69007, France; GATE, CNRS, 93, Chemin de Mouilles, F-69130, Ecully, France) |
| Abstract: | We study the influence of risk and time preferences on trust and trustworthiness by conducting a field experiment in Vietnamese villages and by estimating the parameters of the Cumulative Prospect Theory and of quasi-hyperbolic time preferences. We find that while probability sensitivity or risk aversion do not affect trust, loss aversion influences trust indirectly by lowering the expectations of return. Also, more risk averse and less present biased participants are found to be trustworthier. The experience of receiving remittances influences behavior and a longer exposure to a collectivist economy tend to reduce trust and trustworthiness. |
| Keywords: | Trust, trustworthiness, risk preferences, time preferences, Cumulative Prospect Theory, Vietnam, field experiment |
| JEL: | C91 C93 D81 D90 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:gat:wpaper:1226&r=upt |
| By: | Glenn W. Harrison; Jimmy MartÃnez-Correa; J. Todd Swarthout |
| Abstract: | We evaluate the binary lottery procedure for inducing risk neutral behavior in a subjective belief elicitation task. Harrison, Martinez-Correa and Swarthout [2013] found that the binary lottery procedure works robustly to induce risk neutrality when subjects are given one risk task defined over objective probabilities. Drawing a sample from the same subject population, we find evidence that the binary lottery procedure induces linear utility in a subjective probability elicitation task using the Quadratic Scoring Rule. We also show that the binary lottery procedure can induce direct revelation of subjective probabilities in subjects with certain Non-Expected Utility preference representations that satisfy weak conditions that we identify. |
| Date: | 2012–09 |
| URL: | http://d.repec.org/n?u=RePEc:exc:wpaper:2012-16&r=upt |
| By: | Thomas Conlon (Smurfit School of Business, University College Dublin); John Cotter (UCD Smurfit School of Business, University College Dublin); Ramazan Gencay (Department of Economics, Simon Fraser University) |
| Abstract: | This paper examines the impact of investor preferences on the optimal futures hedging strategy and associated hedging performance. Explicit risk aversion levels are often overlooked in hedging analysis. Applying a mean-variance hedging objective, the optimal futures hedging ratio is determined for a range of investor preferences on risk aversion, hedging horizon and expected returns. Wavelet analysis is applied to illustrate how investor time horizon shapes hedging strategy. Empirical results reveal substantial variation of the optimal hedge ratio for distinct investor preferences and are supportive of the hedging policies of real firms. Hedging performance is then shown to be strongly dependent on underlying preferences. In particular, investors with high levels of risk aversion and a short horizon reduce the risk of the hedge portfolio but achieve inferior utility in comparison to those with low risk aversion. |
| Keywords: | Commodity Markets, Futures Hedging, Risk Aversion, Hedging Horizon,Wavelet Analysis, Selective Hedging |
| Date: | 2012–09–17 |
| URL: | http://d.repec.org/n?u=RePEc:ucd:wpaper:201218&r=upt |
| By: | Cheung, Stephen L. (University of Sydney) |
| Abstract: | Andreoni and Sprenger (in press) report evidence that distinct utility functions govern choices under certainty and risk. I investigate the robustness of their result to the experimental design. I find that the effect disappears completely when a multiple price list is used instead of a convex time budget design. Also, the effect is reduced by half when sooner and later payment risks are realized using a single lottery instead of two independent lotteries. The result is thus partially driven by intertemporal diversification, suggesting an explanation in terms of concavity of the intertemporal, and not only the atemporal, utility function. |
| Keywords: | intertemporal choice, risk and certainty, convex time budget, multiple price list |
| JEL: | C91 D03 D81 D90 |
| Date: | 2012–07 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp6762&r=upt |
| By: | Philip J. Grossman; Catherine C. Eckel |
| Abstract: | We develop a new protocol, adapted from the Eckel and Grossman (2002, 2008) risk measure, to elicit skewness preferences. The new lottery choices have the same expected payoffs and risk (variance) as the original choices, but with increasing degrees of positive skewness. We find that our subjects are skewness-seekers. More importantly, positive skewness in the payoff structure increases the number of subjects willing to gamble as well as increasing subjects’ risk taking in lottery choices. We conclude that skewed, long-shot payoffs entice decision makers to higher levels of risk taking than they otherwise would prefer. |
| Keywords: | Risk, Skewness, Gambling, Long Shot, Lotteries |
| JEL: | C91 D03 D81 |
| Date: | 2012–09 |
| URL: | http://d.repec.org/n?u=RePEc:mos:moswps:2012-41&r=upt |
| By: | Startz, Richard; Tsang, Kwok Ping |
| Abstract: | Standard models of intertemporal utility maximization assume that agents discount future utility flows at a constant rate—exponential discounting. Euler equations estimated over different time horizons should have equal discount rates but they do not. Rising term yield premia imply discount rates that rise with longer horizons since uncertainty is much too small to account for the difference in interest rates. Such deviations from exponential discounting are large enough to make a significant difference in consumption choices over long horizons. Our results can be viewed as providing estimates of horizon-specific discounts, or as a further puzzle concerning intertemporal substitution and uncertainty. |
| Keywords: | Economics, General, intertemporal consumer choice, discounting, hyperbolic discounting, consumption, portfolio puzzles, CAPM |
| Date: | 2012–07–15 |
| URL: | http://d.repec.org/n?u=RePEc:cdl:ucsbec:qt8pw4h6vk&r=upt |
| By: | Cameron, Lisa A. (Monash University); Shah, Manisha (University of California, Irvine) |
| Abstract: | We study whether natural disasters affect risk-taking behavior exploiting geographic variation in exposure to natural disasters. We conduct standard risk games (using real money) with randomly selected individuals in Indonesia and find that individuals who recently suffered a flood or earthquake exhibit more risk aversion than individuals living in otherwise like villages. The impact persists for several years, particularly if the disaster was severe. Some, but not all, of this effect is due to income losses. While we cannot rule out fundamental changes in risk preferences, data on subjective beliefs of the probability of a disaster occurring and the expected severity of such a disaster suggest that changes in perceptions of background risk are driving the more risk-averse behavior we observe. We show that access to insurance can partly offset this effect. Finally, we relate the observed experimental behavior to the propensity of respondents to take risks in their daily lives and show that an increase in risk-aversion has important implications for economic development. |
| Keywords: | natural disasters, risk aversion, development |
| JEL: | Q54 O12 D81 |
| Date: | 2012–07 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp6756&r=upt |
| By: | Anmol Ratan |
| Abstract: | In this paper, we relax the hard closure property of experiments that have been used to study endowment effect in laboratory. We study differences in benchmark environments (hard closure) and an environment that allows participants to reverse the decisions taken in the laboratory (soft closure). We find that “endowment effect†is not observed in the soft closure treatment. The procedures in our experiment allow us to circumvent the critique of altered expectations. Our results call for a careful interpretation of experiments that suggest “endowment effect†in laboratory conditions. Other implications pertain to external validity of experiments with hard closure. |
| Keywords: | prospect-theory, endowment effect, reference-dependence, loss aversion, lab experiments,field experiments, external validity |
| JEL: | C91 C93 D81 |
| Date: | 2012–09 |
| URL: | http://d.repec.org/n?u=RePEc:mos:moswps:2012-22&r=upt |