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on Utility Models and Prospect Theory |
| By: | David Dillenberger (Department of Economics, University of Pennsylvania); Andrew Postlewaite (Department of Economics, University of Pennsylvania); Kareen Rozen (Department of Economics, Yale University) |
| Abstract: | Maximizing subjective expected utility is the classic model of decision-making under uncertainty. Savage (1954) provides axioms on preference over acts that are equivalent to the existence of a subjective expected utility representation, and further establishes that such a representation is essentially unique. We show that there is a continuum of other "expected utility" representations in which the probability distributions over states used to evaluate acts depend on the set of possible outcomes of the act and suggest that these alternate representations can capture pessimism or optimism. We then extend the DM's preferences to be defined over both subjective acts and objective lotteries, allowing for source-dependent preferences. Our result permits modeling ambiguity aversion in Ellsberg's two-urn experiment using a single utility function and pessimistic probability assessments over prizes for lotteries and acts, while maintaining the axioms of Savage and von Neumann-Morganstern on the appropriate domains. |
| Keywords: | Subjective expected utility, optimism, pessimism, stake-dependent probability |
| JEL: | D80 D81 |
| Date: | 2011–10–01 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:13-068&r=upt |
| By: | Tomasz Strzalecki; Jan Werner |
| Abstract: | An important implication of the expected utility model under risk aversion is that if agents have the same probability belief, then the efficient allocations under uncertainty are comonotone with the aggregate endowment, and if their beliefs are concordant, then the efficient allocations are measurable with respect to the aggregate endowment. We study these two properties of efficient allocations for models of preferences that exhibit ambiguity aversion using the concept of conditional belief, which we introduce in this paper. We provide characterizations of such conditional beliefs for the standard models of preferences used in applications. ∗ |
| URL: | http://d.repec.org/n?u=RePEc:qsh:wpaper:8325&r=upt |
| By: | Matthew Polisson; John K.-H. Quah |
| Abstract: | Consider a finite data set where each observation consists of a bundle of contingent consumption chosen from a constraint set of contingent consumption bundles. We develop a general procedure for testing the consistency of such a data set with a broad class of models of choice under risk or uncertainty. Unlike previous tests, we do not require that the agent has a concave Bernoulli utility function. |
| Keywords: | expected utility, rank dependent expected utility, maxmin expected util- ity, revealed preference |
| JEL: | C14 C60 D11 D12 D81 |
| Date: | 2013–12 |
| URL: | http://d.repec.org/n?u=RePEc:lec:leecon:13/24&r=upt |
| By: | Jean Desrochers; J. Francois Outreville |
| Abstract: | The purpose of this paper is to examine whether people treat all forms of uncertainty in the same way. Studies investigating known-risk gambles and ambiguous gambles have systematically used the urn context. Little systematic research has investigated differences in expressed attitude as a function of the manner in which vague probability information is communicated to a decision maker. The experiments reported in this paper examine the behavior of people when faced with different situations with and without an insurance context: a risky situation (the probability of loss is known), an uncertain situation (there is no prior information on the probability of loss) or an ambiguous (the information provided is vague). |
| Keywords: | Risk behavior; ambiguity aversion; insurance purchase |
| JEL: | C90 D81 D83 G22 |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:icr:wpicer:10-2013&r=upt |
| By: | Laurie Bréban (LED - Laboratoire d'Economie Dionysien - Université Paris VIII - Vincennes Saint-Denis : EA3391); André Lapidus (PHARE - Pôle d'Histoire de l'Analyse et des Représentations Economiques - CNRS : FRE2541 - Université Paris I - Panthéon-Sorbonne - Université Paris X - Paris Ouest Nanterre La Défense) |
| Abstract: | The few pages that Adam Smith devoted to lotteries, mainly in the Wealth of Nations (1776) did not receive much attention. They nonetheless constituted an opportunity to introduce a sophisticated analysis of individual decision under risk. Through various examples, Smith pointed out a risk-seeking attitude, figured out in the paper in terms of inverse stochastic dominance. However, it is well-known that a contradiction occurs between such an attitude and the principle of an asymmetric sensitivity to favorable and unfavorable events, expressed by a concave function, introduced in the Theory of Moral Sentiments (1759). We argue that an appropriate solution to this difficulty should rest on Smith's emphasis on a universal tendency to overestimate the chance of gain, which leads to favor a rank-dependent utility approach within which optimism toward risk can compensate asymmetric sensibility in order to produce some kind of risk-seeking. The question raised by the coexistence of various attitudes toward risk illustrated by the figures of the entrepreneur (typically, the "projector" and the "sober man") gives rise to an extensive analysis, which aims at explaining, on moral grounds, how an initial attitude of risk-seeking can generate prudence before being transformed into risk-aversion. |
| Keywords: | Adam Smith; decision; risk; lotteries; stochastic dominance; rank-dependent utility; asymmetric sensitivity; prudence |
| Date: | 2013–12–05 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-00914222&r=upt |
| By: | Tomasz Strzalecki |
| Abstract: | This paper shows that in the class of variational preferences the notion of probabilistic sophistication is equivalent to expected utility as long as there exists at least one event such that the independence axiom holds for bets on that event. This extends a result of Marinacci (2002) and provides a novel interpretation of his result. |
| URL: | http://d.repec.org/n?u=RePEc:qsh:wpaper:8337&r=upt |
| By: | Svenja Hector() |
| Abstract: | The paper clarifies the link between changes in risk aversion and the effect on the consumption discount rate. In a general framework that can cope with various forms of uncertainty, it is shown that the response of the consumption discount rate to a change in risk aversion depends on some fundamental properties of the considered uncertainties. The application of this general result to specific forms of uncertainty extends existing results to more general forms of risk and yields a new result on preference uncertainty. |
| Keywords: | discount rate, risk aversion, Kreps-Porteus-Selden, Risk-Sensitive preferences, uncertain preferences, climate change |
| URL: | http://d.repec.org/n?u=RePEc:stz:wpaper:eth-rc-13-007&r=upt |
| By: | John Quah; Hiroki Nishimura; Efe A. Ok |
| Abstract: | The theoretical literature on (non-random) choice largely follows the route of Richter (1966) by working in abstract environments and by stipulating that we see all choices of an agent from a given feasible set.� On the other hand, empirical work on consumption choice using revealed preference analysis is done following the approach of Afriat (1967), which assumes that we observe only one (and not necessarily all) of the potential choices of an agent.� These two approaches are structurally different and they are treated in the literature in isolation from each other.� This paper introduces a framework in which both approaches can be formulated in tandem.� We prove a rationalizability theorem in this framework that simultaneously generalizes the fundamental results of Afriat and Richter, along with many of their variants. � � |
| Keywords: | Revealed Preference, Rational Choice, Afriat's Theorem, Richter's Theorem |
| JEL: | D11 D81 |
| Date: | 2013–12–06 |
| URL: | http://d.repec.org/n?u=RePEc:oxf:wpaper:686&r=upt |
| By: | Roman Kraussl; Carmen Lee; Leo Paas (LSF) |
| Abstract: | This paper investigates the effect of anticipated/experienced regret and pride on individual investors decisions to hold or sell a winning or losing investment, in the form of the disposition effect. As expected the results suggest that in the loss domain, low anticipated regret predicts a greater probability of selling a losing investment. While in the gain domain, high anticipated pride indicates a greater probability of selling a winning investment. The effects of high experienced regret/pride on the selling probability are found as well. An unexpected finding is that regret (pride) seems to be not only relevant for the loss (gain) domain, but also for the gain (loss) domain. In addition, this paper presents evidence of interconnectedness between anticipated and experienced emotions. The authors discuss the implications of these findings and possible avenues for further research. |
| Keywords: | Regret, pride, the disposition effect, risky decision |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:crf:wpaper:13-5&r=upt |
| By: | Rindone, Fabio; Greco, Salvatore; Di Gaetano, Luigi |
| Abstract: | The aim of this paper is to introduce prospect theory in a game theoretic framework. We address the complexity of the weighting function by restricting the object of our analysis to a 2-player 2-strategy game, in order to derive some core results. We find that dominant and indifferent strategies are preserved under prospect theory. However, in absence of dominant strategies, equilibrium may not exist depending on parameters. We also discuss a different approach presented by Metzger and Rieger (2009) and give some interesting interpretations of the two approaches. |
| Keywords: | Game theory, Prospect theory, Nash equilibrium, Behavioural economics. |
| JEL: | C7 C70 D03 |
| Date: | 2013–06–06 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:52131&r=upt |
| By: | Natalia Montinari (University of Lund, Department of Economics); Michela Rancan (Robert Schuman Centre for Advanced Studies, European University Institute) |
| Abstract: | In many different contexts individuals take decisions on the behalf of others. However, little is known about how this circumstance affects the decision making process and influences the ultimate individuals' choices. In this paper, we focus on the context of investment decisions and study if (and how) lottery-type investment decisions made on behalf of another person differ i) compared to decisions which do not affect anyone else, and ii) depending on the social distance between who makes the decision and who is affected by it. Our results shows that social distance (i.e., whether the person affected by one's decision is an unknown stranger or a friend) is an important determinant when people decide on the behalf of others. Individuals are heterogeneous in their individual investment strategies but, on average, when deciding on behalf of a friend rather than only for themselves or a stranger, their behavior is closer to expected value maximization, exhibiting less risk taking. We interpret these findings as evidence of other regarding preferences affecting the decision making process in lottery-type decisions when the social distance is shortened. |
| Keywords: | Risk seeking, Other Regarding Preferences, Social Distance, Friends, Lottery-type investment |
| JEL: | A13 C91 D64 D81 |
| Date: | 2013–12–04 |
| URL: | http://d.repec.org/n?u=RePEc:jrp:jrpwrp:2013-050&r=upt |
| By: | Glimcher, Paul; Tymula, Agnieszka; Woelbert, Eva |
| Abstract: | Economists have long been interested in mechanisms that lead to truthful revelation of the relative values individuals place on diff erent goods. In this paper we take one of the most popular of such mechanisms, and show that valuations obtained using the Becker-DeGroot-Marschak (BDM) procedure depend on the distribution of prices presented to subjects when the mechanism is implemented. We show that this eff ect of price distribution occurs quite frequently, significantly impacts reported valuations, and that it is unlikely to be caused by misconceptions about BDM. This eff ect is the largest when pricing distributions show a large peak just above or just below an individual's average valuation of the good being considered. We also show that a simple non-incentive compatible subject rating of the desirability of goods can be used to predict the likelihood that pricing distributions will influence BDM valuations. Valuations for goods subjects report that they most want to purchase are most likely to be influenced by distributional structure. Our results challenge some of the dominant theoretical models of how BDM-like valuation procedures relate to standard notions of utility. |
| Keywords: | valuation; reference; utility |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:syd:wpaper:2123/9732&r=upt |
| By: | Fabian Irek; Thorsten Lehnert (LSF) |
| Abstract: | Previous research suggests that investor sentiment has an influence on the market s risk-return trade-off. Noise traders demand for assets is considered to be risk independent and, as a result, risky assets do not offer a risk premium when demand is high. We show that market risk is only a priced factor of expected fund returns when investor sentiment is low. Furthermore, fund investors seem aware that risk is sometimes not priced. During high sentiment periods, (smart) investors buy safe funds that subsequently outperform and sell risky funds that subsequently underperform. Our results are statistically and economically significant. |
| JEL: | G11 G12 G23 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:crf:wpaper:13-1&r=upt |