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on Utility Models and Prospect Theory |
| By: | Ulrich Schmidt; Zank Horst |
| Abstract: | We present a preference foundation for Chance Theory (CT), a model of decision making under uncertainty where the evaluation of an act depends distinctively on its lowest outcome. This outcome is evaluated with the riskless value function u and the potential increments over it are evaluated by subjective expected utility with a risky utility function u. In contrast to earlier approaches with models that aimed at separating riskless and risky utility, CT does not violate basic rationality principles like first-order stochastic dominance or transitivity. Decision makers with CT-preferences always prefer the expected value of a lottery to the latter, so they are weakly risk averse. Besides explaining behavioral irregularities like the expected utility paradoxes of Allais and Rabin, CT also separates risk attitude in the strong sense from attitude towards wealth. Risk attitude is completely determined by the curvature of vuand is independent of the value function v. Conversely, attitude towards wealth is reflected solely through the curvature of v without imposing constraints on u |
| Keywords: | decision theory, expected utility, riskless utility for wealth, risky utility for money, preference, foundation, prudence |
| JEL: | D81 |
| Date: | 2013–10 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1874&r=upt |
| By: | Nicky Nicholls (Department of Economics, University of Pretoria); Aylit Romm (School of Economic and Business Sciences, University of the Witwatersrand, Johannesburg, South Africa); Alexander Zimper (Department of Economics, University of Pretoria) |
| Abstract: | This paper experimentally tests whether violations of Savage's (1954) subjective expected utility theory decrease if the ambiguity of an uncertain decision situation is reduced through statistical learning. Because our data does not show such a decrease, existing models which formalize ambiguity within an Anscombe-Aumann (1963) framework--thereby reducing to expected utility theory in the absence of ambiguity--are violated. In contrast, axiomatic models of prospect theory can accommodate our experimental findings because they allow for violations of von Neumann and Morgenstern's (1947) independence axiom whenever uncertain decision situations transform into risky decision situations for which probabilities are known. |
| Keywords: | Prospect Theory, Choquet Expected Utility Theory, Multiple Priors Expected Utility Theory, Sure Thing Principle, Independence Axiom |
| JEL: | C91 D81 |
| Date: | 2013–10 |
| URL: | http://d.repec.org/n?u=RePEc:pre:wpaper:201364&r=upt |
| By: | Anna Conte (Westminster Business School, University of Westminster, London, and Strategic Interaction Group, Max Planck Institute of Economics, Jena); M. Vittoria Levati (Strategic Interaction Group, Max Planck Institute of Economics, Jena, and Department of Economics, University of Verona); Chiara Nardi (Department of Economics, University of Verona) |
| Abstract: | In the last decades, there has been a large volume of research showing that emotions do have relevant effects on decision-making. We contribute to this literature by experimentally investigating the impact of four specific emotional states - joviality, sadness, fear, and anger - on risk attitudes. In order to do so, we fit two models of behaviour under risk: the Expected Utility model (EU) and the Rank Dependent Expected Utility model (RDEU), assuming several functional forms of the weighting function. Our results indicate that all emotional states instigate risk-seeking behaviour. Furthermore, we show that there are some differences across gender and across participants' experience in lab experiments. |
| Keywords: | Risk aversion, Emotions, Structural models |
| JEL: | D81 C91 D00 |
| Date: | 2013–10–29 |
| URL: | http://d.repec.org/n?u=RePEc:jrp:jrpwrp:2013-046&r=upt |
| By: | Vieider, Ferdinand M.; Lefebvre, Mathieu; Bouchouicha, Ranoua; Chmura, Thorsten; Hakimov, Rustamdjan; Krawczyk, Michal; Martinsson, Peter |
| Abstract: | Attitudes towards uncertainty have been indicated to be highly context-dependent, and to be sensitive to the measurement technique employed. We present data collected in controlled experiments with 2939 subjects in 30 countries measuring uncertainty attitudes through incentivized measures as well as survey questions. Our data show clearly that measures correlate not only within decision context or measurements methods, but also across contexts and methods. This points to the existance of one underlying 'risk preference', which influences attitudes independently of the measurement method or choice domain. We furthermore find that answers to a general survey question correlate with incentivized lottery choices in most countries. Much more surprisingly, incentivized and survey measures also correlate significantly between countries. This opens the possibility to conduct cultural comparisons on risk attitudes using survey instruments. -- |
| Keywords: | risk attitudes,uncertainty attitudes,context-specificity,experimental methodology |
| JEL: | D0 D81 C90 J10 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:wzbrad:spii2013402&r=upt |
| By: | Jouini, Elyès; Napp, Clotilde; Nocetti, Diego |
| Abstract: | In this paper we analyse the risk attitude of a group of heterogenous agents and we develop a theory of comparative collective risk tolerance. In particular, we characterize how shifts in the distribution of individual levels of risk tolerance affect the representative agent's degree of risk tolerance. In the model with efficient risk – sharing and two agents (e.g. a household) with isoelastic preferences we show that an increase of the level of risk tolerance of one of the agents might have an ambiguous impact on the aggregate level of risk tolerance; the latter increases for some levels of aggregate wealth while it decreases for other levels of aggregate wealth. Specifically, there are two possible shapes for aggregate risk tolerance as a function of the risk tolerance level of one of the agents: increasing curve or increasing then decreasing curve. For more general populations we characterize the effect of first order like shifts (individual levels of risk tolerance more concentrated on high values) and second order like shifts (more dispersion on individual levels of risk tolerance) on the collective level of risk tolerance. We also evaluate how shifts in the distribution of individual levels of risk tolerance impact the collective level of risk tolerance in a framework with exogenous egalitarian sharing rules. Our results permit to better characterize differences in risk taking behavior between groups and individuals and among groups with different distribution of risk preferences. |
| Keywords: | collective risk; heterogenous agents; risk tolerance; isoelastic preferences; aggregate wealth; risk preferences; |
| JEL: | D1 D81 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:dau:papers:123456789/5673&r=upt |
| By: | Vieider, Ferdinand M.; Truong, Nghi; Martinsson, Peter; Pham Khanh Nam; Martinsson, Peter |
| Abstract: | We obtain rich measures of risk preferences of poor farmers in Vietnam, and estimate structural models that capture risk preferences over different probability levels and across different domains (gains and losses). The results break radically with the previous literature on risk preferences, in developed and developing countries alike. Far from being particularly risk averse, our Vietnamese farmers are on average risk neutral. At the same time, we find our preference measures to perform well at predicting behavior, from the purchase of lottery tickets to risk management on the farm. We also find strong direct evidence of a risk-income paradox. While risk aversion is strongly decreasing in income within our farmer subject population, our Vietnamese farmers are significantly less risk averse than subjects in Western countries according to measurements obtained using the same decision tasks and procedures. -- |
| Keywords: | risk preferences,development,external validity |
| JEL: | C93 D03 D80 O12 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:wzbrad:spii2013403&r=upt |
| By: | Elaine M. Liu; Juanjuan Meng; Joseph Tao-yi Wang |
| Abstract: | This paper investigates how Confucianism affects individual decision making in Taiwan and in China. We found that Chinese subjects in our experiments became less accepting of Confucian values, such that they became significantly more risk loving, less loss averse, and more impatient after being primed with Confucianism, whereas Taiwanese subjects became significantly less present-based and were inclined to be more trustworthy after being primed by Confucianism. Combining the evidence from the incentivized laboratory experiments and subjective survey measures, we found evidence that Chinese subjects and Taiwanese subjects reacted differently to Confucianism. |
| JEL: | C91 Z10 |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:19615&r=upt |
| By: | Lubomir Cingl (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic); Jana Cahlikova (CERGE-EI, a joint workplace of Charles University and the Economics Institute of the Academy of Sciences of the Czech Republic) |
| Abstract: | Many important decisions are made under stress and they often involve risky alternatives. There has been ample evidence that stress influences decision making in cognitive as well as in affective domains, but still very little is known about whether individual attitudes to risk change with exposure to acute stress. To directly evaluate the causal effect of stress on risk attitudes, we adopt an experimental approach in which we randomly expose participants to a psychosocial stressor in the form of a standard laboratory stress-induction procedure: the Trier Social Stress Test for Groups. Risk preferences are elicited using an incentive compatible task, which has been previously shown to predict risk-oriented behavior out of the laboratory. Using three different measures (salivary cortisol levels, heart rate and multidimensional mood questionnaire scores), we show that stress was successfully induced on the treatment group. Our main result is that acute psychosocial stress significantly increases risk aversion. The effect is mainly driven by males; men in our control group are less risk-averse than women, which is a standard result in the literature, but this difference almost disappears when under psychosocial stress. |
| Keywords: | risk preferences, stress, Trier Social Stress Test, cortisol |
| JEL: | C90 C91 D03 D81 D87 |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:fau:wpaper:wp2013_17&r=upt |
| By: | Kocher, Martin; Krawczyk, Michal; Le Lec, Fabrice |
| Abstract: | This paper investigates experimentally whether risk attitudes are stable across social contexts. In particular, it focuses on situations where some resource (for instance, a position, decision power, a bonus) has to be allocated between two parties: the decision maker can either opt for sharing the resource or for using a random device that allocates the entire prize to one of the two parties. By varying the relative situation of the decision maker with respect to the other party, we show that risk attitude is strongly affected by social contexts: participants in the experiment seem to be relatively risk seeking when they possess a relatively weaker position than the other party and risk averse when the opposite is true. Our main average results seem to be driven by the behavior of around a quarter of subjects whose choices appear to be fully determined by social comparisons. Various interpretations of the behavior are provided linking our results to preferences under risk with a social reference point and on status-seeking preferences. |
| Keywords: | risk attitudes; risk preferences in social context; social reference point; status-seeking preferences; social preferences under risk |
| JEL: | A13 C65 C72 D63 D03 |
| Date: | 2013–10–24 |
| URL: | http://d.repec.org/n?u=RePEc:lmu:muenec:17383&r=upt |
| By: | Alexander Ludwig (CMR, University of Cologne; Albertus-Magnus-Platz; 50923 Koln; Germany); Alexander Zimper (Department of Economics, University of Pretoria) |
| Abstract: | Based on the axiomatic framework of Choquet decision theory, we develop a closed-form model of Bayesian learning with ambiguous beliefs about the mean of a normal distribution. In contrast to rational models of Bayesian learning the resulting Choquet Bayesian estimator results in a long-run bias that reflects the agent's ambiguity attitudes. By calibrating the standard equilibrium conditions of the consumption based asset pricing model we illustrate that our approach contributes towards a resolution of the risk-free rate puzzle. For a plausible parameterization we obtain a risk-free rate in the range of 3.5-5 percent. This is 1-2.5 percent closer to the empirical risk-free rate than according calibrations of the rational expectations model. |
| Keywords: | Ambiguity, Non-additive probability measures, Bayesian learning, Truncated normal distribution, Risk-free rate puzzle |
| JEL: | C79 D83 |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:pre:wpaper:201366&r=upt |
| By: | Napp, Clotilde; Viossat, Yannick; Jouini, Elyès |
| Abstract: | Why do investors keep different opinions even though they learn from their own failures and successes? Why do investors keep different opinions even though they observe each other and learn from their relative failures and successes? We analyze beliefs dynamics when beliefs result from a very general learning process that favors beliefs leading to higher absolute or relative utility levels. We show that such a process converges to the Nash equilibrium in a game of strategic belief choices. The asymptotic beliefs are subjective and heterogeneous across the agents. Optimism (respectively overconfidence) as well as pessimism (respectively doubt) emerge from the learning process. Furthermore, we obtain a positive correlation between pessimism (respectively doubt) and risk tolerance. Under reasonable assumptions, beliefs exhibit a pessimistic bias and, as a consequence, the risk premium is higher than in a standard setting. |
| Keywords: | heterogeneous beliefs; Beliefs formation; evolutionary game theory; risk premium; pessimism; |
| JEL: | D81 D53 D03 G12 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:dau:papers:123456789/5772&r=upt |
| By: | Stefanescu, Razvan; Dumitriu, Ramona |
| Abstract: | This paper approaches the risk management as a decision making process in which the best solution to an exposure is found and implemented. Such a process includes five stages: identifying the risk, assessment of exposure, analysis of the alternatives to deal with the exposure, adopting the optimum alternative and the implementation of the adopted solution. |
| Keywords: | Risk Management, Uncertainty, Business Environment, Decision Making Process |
| JEL: | D81 D89 G32 |
| Date: | 2013–10–17 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:50754&r=upt |
| By: | Sigrid Kallblad; Jan Obloj; Thaleia Zariphopoulou |
| Abstract: | We combine forward investment performance processes and ambiguity averse portfolio selection. We introduce the notion of robust forward criteria which addresses the issues of ambiguity in model specification and in preferences and investment horizon specification. It describes the evolution of time-consistent ambiguity averse preferences. We first focus on establishing dual characterizations of the robust forward criteria. This offers various advantages as the dual problem amounts to a search for an infimum whereas the primal problem features a saddle-point. Our approach is based on ideas developed in Schied (2007) and Zitkovic (2009). We then study in detail non-volatile criteria. In particular, we solve explicitly the example of an investor who starts with a logarithmic utility and applies a quadratic penalty function. The investor builds a dynamical estimate of the market price of risk $\hat \lambda$ and updates her stochastic utility in accordance with the so-perceived elapsed market opportunities. We show that this leads to a time-consistent optimal investment policy given by a fractional Kelly strategy associated with $\hat \lambda$. The leverage is proportional to the investor's confidence in her estimate $\hat \lambda$. |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1311.3529&r=upt |
| By: | Gigi Foster; Paul Frijters; Markus Schaffner; Benno Torgler |
| Abstract: | We examine the nature of stated subjective probabilities in a complex, evolving context in which true event probabilities are not within subjects' explicit information set. Specically, we collect information on subjective expectations in a car race wherein participants must bet on a particular car but cannot influence the odds of winning once the race begins. In our setup, the actual probability of the good outcome (a win) can be determined based on computer simulations from any point in the process. We compare this actual probability to the subjective probability participants provide at three dierent points in each of 6 races. We find that the S-shaped curve relating subjective to actual probabilities found in prior research when participants have direct access to actual probabilities also emerges in our much more complex situation, and that there is only a limited degree of learning through repeated play. We show that the model in the S-shaped function family that provides the best fit to our data is Prelec's (1998) conditional invariant model. |
| Keywords: | behavioural economics, expected utility theory, experiments, expectations, probabilities |
| JEL: | D40 L10 |
| Date: | 2013–11–01 |
| URL: | http://d.repec.org/n?u=RePEc:qut:qubewp:wp022&r=upt |
| By: | Stefania Minardi; Andrei Savochkin |
| Abstract: | Departing from the traditional approach to modeling an agent who finds it difficult to make clear-cut comparisons between alternatives, we introduce the notion of graded preferences: Given two alternatives, the agent reports a number between 0 and 1, which reflects her inclination to prefer the first option over the second or, put differently, how confident she is about the superiority of the first one. In the classical framework of uncertainty, we derive a representation of a graded preference by a measure of the set of beliefs that rank one option better than the other. Our model is a refinement of Bewley’s (1986) model of Knightian uncertainty: It is based on the same object of representation — the set of beliefs — but provides more information about how the agent compares alternatives. We also define and characterize, in terms of the representation, the notion of one agent being “more decisive” than another. |
| Keywords: | incomplete preferences, Knightian uncertainty, graded preferences, confidence, decisiveness |
| JEL: | D81 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:cca:wpaper:309&r=upt |
| By: | Fang Yang; Xuan Liu; Zongwu Cai |
| Abstract: | In this article, we explore whether relative risk aversion varies with wealth. First, we derive theoretical predictions on how risky shares respond to wealth uctuations in a portfolio choice model with both external habits and time-varying labor income. Our analytical results indicate that: (1) for each household, there are two channels through which the risky share responds to wealth uctuations, the habit channel and the income channel; (2) across households, there are heterogeneous responses through the habit channel: those who experience large negative income shocks reduce their share of risky assets; and (3) two potential mis-identication problems arise when both the heterogeneity in responses through the habit channel and the income channel are ignored. We then test the theoretical predictions with data from the Panel Study of Income Dynamics. Contrary to the existing literature, our empirical ndings show evidences of relative risk aversion varying with wealth over time after correcting those two mis-identication problems. |
| URL: | http://d.repec.org/n?u=RePEc:lsu:lsuwpp:2013-09&r=upt |
| By: | Tomasz Gerard Czekaj (Department of Food and Resource Economics, University of Copenhagen); Arne Henningsen (Department of Food and Resource Economics, University of Copenhagen) |
| Abstract: | We apply nonparametric panel data kernel regression to investigate production risk, out-put price uncertainty, and risk attitudes of Polish dairy farms based on a firm-level unbalanced panel data set that covers the period 2004–2010. We compare different model specifications and different approaches for obtaining firm-specific measures of risk attitudes. We found that Polish dairy farmers are risk averse regarding production risk and price uncertainty. According to our results, Polish dairy farmers perceive the production risk as being more significant than the risk related to output price uncertainty. |
| Keywords: | production risk, price uncertainty, nonparametric econometrics, panel data, Polish dairy farms |
| JEL: | C14 C23 D24 Q12 |
| Date: | 2013–10 |
| URL: | http://d.repec.org/n?u=RePEc:foi:wpaper:2013_6&r=upt |
| By: | Paolo Delle Site (DICEA Dept. of Civil Architectural and Environmental Engineering, CTL Centre of Research on Transport and Logistics, University of Rome La Sapienza) |
| Abstract: | We provide the discrete choice, random utility counterparts of some basic results of consumer theory. For the primal problem and related Marshallian probabilities, we provide a new, simpler proof of Roy's identity at aggregate level and investigate price and income effects. For the dual problem and related Hicksian probabilities, we extend Shepard's lemma at aggregate level to unbound expenditure and investigate compensated price effects. We establish a primal-dual equivalence result and provide the counterpart of the Slutsky equation. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:rcr:wpaper:05_13&r=upt |
| By: | Guo, Xu; Wong, Wing-Keung; Zhu, Lixing |
| Abstract: | This paper investigates the impact of multiplicative background risk on an investor's portfolio choice in a mean-variance framework. We also study the efficient boundary frontiers with and without risk-free security. |
| Keywords: | Background risk; Portfolio selection; VaR; CVaR |
| JEL: | C02 G11 |
| Date: | 2013–11–08 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:51331&r=upt |
| By: | Werner Güth (Max Planck Institute of Economics, Strategic Interaction Group); Matteo Ploner (DEM-University of Trento); Ivan Soraperra (Max Planck Institute of Economics, Strategic Interaction Group) |
| Abstract: | Experimental studies of the WTP-WTA gap avoid social trading by implementing an incentive compatible mechanism for each individual trader. We compare a traditional random price mechanism and a novel elicitation mechanism preserving social trading, without sacrificing mutual incentive compatibility. Furthermore, we focus on risky goods - binary monetary lotteries - for which asymmetries in evaluations are more robust with respect to experimental procedures. For both elicitation mechanisms, the usual asymmetry in evaluation by sellers and buyers is observed. An econometric estimation sheds new light on its causes: potential buyers are over-pessimistic and systematically underweight the probability of a good outcome. |
| Keywords: | WTP-WTA gap, Risk, Elicitation Mechanisms, Probability Weighting |
| JEL: | D81 D03 C91 |
| Date: | 2013–11–05 |
| URL: | http://d.repec.org/n?u=RePEc:jrp:jrpwrp:2013-047&r=upt |
| By: | Alessandro Innocenti; Tommaso Nannicini; Roberto Ricciuti |
| Abstract: | We evaluate the impact of timing on decision outcome, when both the timing and the relevant decision are chosen under uncertainty. Betting markets provide the testing ground, as we exploit an original dataset containing more than one million online bets on games of the Italian Major Soccer League. We find that individuals perform systematically better when they place their bets farther away from the game day. The better performance of early bettors holds controlling for (time-invariant) unobservable ability, learning during the season, and timing of the odds. We attribute this result to the increase of noisy information on game day, which hampers the capacity of late (non-professional) bettors to use very simple prediction methods, such as team rankings or last game results. We also find that more successful bettors tend to bet in advance,focus on a smaller set of events, and prefer events associated with smaller betting odds. JEL codes: D81, D83. Keywords: decision timing, information overload, betting, sports forecasting. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:igi:igierp:502&r=upt |
| By: | V. A. Kalyagin; A. P. Koldanov; P. A. Koldanov; P. M. Pardalos; V. A. Zamaraev |
| Abstract: | Statistical uncertainty of different filtration techniques for market network analysis is studied. Two measures of statistical uncertainty are discussed. One is based on conditional risk for multiple decision statistical procedures and another one is based on average fraction of errors. It is shown that for some important cases the second measure is a particular case of the first one. Statistical uncertainty for some popular market network structures is analyzed. Results of numerical evaluation of statistical uncertainty for minimum spanning tree, market graph, maximum cliques and maximum independent sets are given. The most stable structures are derived. |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1311.2273&r=upt |
| By: | Czajkowski, Mikolaj; Hanley, Nicholas; LaRiviere, Jacob |
| Abstract: | This paper develop and estimates a model of demand estimation for environmental public goods which allows for consumers to learn about their preferences through consumption experiences. We develop a theoretical model of Bayesian updating, perform comparative statics over the model, and show how the theoretical model can be consistently incorporated into a reduced form econometric model. We then estimate the model using data collected for two environmental goods. We find that the predictions of the theoretical exercise that additional experience makes consumers more certain over their preferences in both mean and variance are supported in each cas e. |
| Keywords: | scale variance; scale; generalized multinomial logit; Bayesian updating; stated preferences; preference learning; discrete choice experiment |
| Date: | 2013–10 |
| URL: | http://d.repec.org/n?u=RePEc:stl:stledp:2013-11&r=upt |
| By: | Li, Xiaogu; Clark, Christopher D; Jensen, Kimberly L; Yen, Steven T |
| Abstract: | This study examines how a $50 mail-in rebate influences consumer willingness-to-pay for an ENERGY STAR-certified refrigerator. Data collected from a 2009 U.S. online survey containing a hypothetical choice experiment. Results suggest that a rebate induces uncertainty about the quality of ENERGY STAR-certified refrigerators and, thus, could actually reduce willingness-to-pay. |
| Keywords: | Choice Experiment, Eco-label, Energy Star, Generalized Multinomial Logit, Ordered Probit, Rebate, Refrigerator, Willingness-to-Pay, Environmental Economics and Policy, Q58, D12, |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:ags:saea14:159795&r=upt |