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on Utility Models and Prospect Theory |
| By: | Masako Ikefuji (University of Southern Denmark, Denmark); Roger Laeven (University of Amsterdam, the Netherlands); Jan Magnus (VU University Amsterdam, the Netherlands); Chris Muris (Simon Fraser University, Canada) |
| Abstract: | An expected utility based cost-benefit analysis is in general fragile to its distributional assumptions. We derive necessary and sufficient conditions on the utility function of the expected utility model to avoid this. The conditions ensure that expected (marginal) utility remains finite also under heavy-tailed distributional assumptions. Our results are context-free and are relevant to many fields encountering catastrophic risk analysis, such as, perhaps most noticeably, insurance and risk management. |
| Keywords: | Expected utility, Catastrophe, Cost-benefit analysis, Risk management, Power utility, Exponential utility, Heavy tails |
| JEL: | D61 D81 G10 G20 |
| Date: | 2014–10–14 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:uvatin:20140133&r=upt |
| By: | Malakhov, Sergey |
| Abstract: | When the increase in income reduces the time of search and increases prices of purchases, the increase in price can be presented as the increase in the willingness to pay for insurance. The optimal consumer decision represents the trade-off between the propensity to search for proficient insurance and marginal savings on insurance policy. Under price dispersion the indirect utility function takes the form of cubic parabola, where the saddle point represents the comprehensive insurance. The comparative static analysis of the saddle point of the utility function discovers the ambiguity of the departure from risk-neutrality. This ambiguity can produce the ordinary risk seeking behavior as well as mathematical catastrophes of Veblen-effect’s imprudence and over prudence of family altruism. The comeback to risk aversion is also ambiguous and it results either in increasing or in decreasing relative risk aversion. The paper argues that the decreasing risk aversion results in the optimum quantity of money. |
| Keywords: | consumer search, risk, insurance, real balances, Veblen effect, family altruism, mathematical catastrophe |
| JEL: | D11 D81 |
| Date: | 2014–10–28 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:59530&r=upt |
| By: | Eric Danan (THEMA - Université Cergy-Pontoise); Thibault Gajdos (GREQAM - Université d'Aix Marseille); Brian Hill (GREGHEC - HEC Paris); Jean-Marc Tallon (Centre d'Economie de la Sorbonne - Paris School of Economics) |
| Abstract: | We provide possibility results on the aggregation of beliefs and tastes for Monotone, Bernoullian and Archimedian preferences of Cerreia-Vioglio, Ghirardato, Maccheroni, Marinacci and Siniscalchi (2011). We propose a new axiom, Unambiguous Pareto Dominance, which requires that if the unambiguous part of individuals' preferences over a pair of acts agree, then society should follow them. We characterize the resulting social preferences and show that it is enough that individuals share a prior to allow non dictatorial aggregation. A further weakening of this axiom on common-taste acts, where cardinal preferences are identical, is also characterized. It gives rise to a set of relevant priors at the social level that can be any subset of the convex hull of the individuals' sets of relevant priors. We then apply these general results to the Maxmin Expected Utility model, the Choquet Expected Utility model and the Smooth Ambiguity model. We end with a characterization of the aggregation of ambiguity attitudes. |
| Keywords: | Preferences aggregation, social choice, uncertainty. |
| JEL: | D71 D81 |
| Date: | 2014–07 |
| URL: | http://d.repec.org/n?u=RePEc:mse:cesdoc:14063&r=upt |
| By: | Max Groneck (CMR, University of Cologne; Netspar; Albertus-Magnus-Platz; 50923 Köln; Germany); Alexander Ludwig (SAFE, Goethe University Frankfurt; MEA; Netspar; House of Finance; Grüneburgplatz 1; 60323 Frankfurt am Main; Germany; Department of Economics; University of Pretoria; Private Bag X20; Hatfield 0028; South Africa) |
| Abstract: | On average, ``young" people underestimate whereas ``old" people overestimate their chances to survive into the future. We adopt a Bayesian learning model of ambiguous survival beliefs which replicates these patterns. The model is em- bedded within a non-expected utility model of life-cycle consumption and saving. Our analysis shows that agents with ambiguous survival beliefs (i) save less than originally planned, (ii) exhibit undersaving at younger ages, and (iii) hold larger amounts of assets in old age than their rational expectations counterparts who correctly assess their survival probabilities. Our ambiguity-driven model therefore simultaneously accounts for three important empirical findings on household saving behavior. |
| Keywords: | Cumulative prospect theory; Choquet expected utility; Dynamic inconsistency; Life-cycle hypothesis; Saving puzzles |
| JEL: | D91 D83 E21 |
| Date: | 2014–10 |
| URL: | http://d.repec.org/n?u=RePEc:pre:wpaper:201465&r=upt |
| By: | Heyen, Daniel |
| Abstract: | Epstein and Schneider (2007) develop a framework of learning under ambiguity, generalizing maxmin preferences of Gilboa and Schmeidler (1989) to intertemporal settings. The specific belief dynamics in Epstein and Schneider (2007) rely on the rejection of initial priors that have become implausible over the learning process. I demonstrate that this feature of ex-post rejection of theories gives rise to choices that are in sharp contradiction with ambiguity aversion. Concrete, the intertemporal maxmin decision-maker equipped with such belief dynamics prefers, under prevalent conditions, a bet in an ambiguous urn over the same bet in a risky urn. I offer two modifications of their framework, each of which is capable of avoiding this anomaly. |
| Keywords: | learning under ambiguity; multiple prior; maxmin; ambiguity aversion |
| Date: | 2014–10–21 |
| URL: | http://d.repec.org/n?u=RePEc:awi:wpaper:0573&r=upt |
| By: | Steffen Ahrens; Inske Pirschel; Dennis J. Snower; |
| Abstract: | We present a new partial equilibrium theory of price adjustment, based on consumer loss aversion. In line with prospect theory, the consumers’ perceived utility losses from price increases are weighted more heavily than the perceived utility gains from price decreases of equal magnitude. Price changes are evaluated relative to an endogenous reference price, which depends on the consumers’ rational price expectations from the recent past. By implication, demand responses are more elastic for price increases than for price decreases and thus firms face a downward-sloping demand curve that is kinked at the consumers’ reference price. Firms adjust their prices flexibly in response to variations in this demand curve, in the context of an otherwise standard dynamic neoclassical model of monopolistic competition. The resulting theory of price adjustment is starkly at variance with past theories. We find that - in line with the empirical evidence - prices are more sluggish upwards than downwards in response to temporary demand shocks, while they are more sluggish downwards than upwards in response to permanent demand shocks. |
| Keywords: | price sluggishness, loss aversion, state-dependent pricing |
| JEL: | D03 D21 E31 E50 |
| Date: | 2014–11 |
| URL: | http://d.repec.org/n?u=RePEc:hum:wpaper:sfb649dp2014-065&r=upt |
| By: | Masaaki Fukasawa |
| Abstract: | We construct an utility-based dynamic asset pricing model for a limit order market. The price is nonlinear in volume and subject to market impact. We solve an optimal hedging problem under the market impact and derive the dynamics of the efficient price, that is, the asset price when a representative liquidity demander follows an optimal strategy. We show that a Pareto efficient allocation is achieved under a completeness condi- tion. We give an explicit representation of the efficient price for several examples. In particular, we observe that the volatility of the asset depends on the convexity of an initial endowment. Further, we observe that an asset price crash is invoked by an endowment shock. We establish a dynamic programming principle under an incomplete framework. |
| Date: | 2014–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1410.8224&r=upt |
| By: | Christian Wolff; Thorsten Lehnert; Yuehao Lin (LSF) |
| Abstract: | Using an equilibrium asset and option pricing model in a production economy under jump diffusion, we derive an analytical link between the equity premium, risk aversion and the systematic variance and skewness risk premium. In an empirical application of the model using more than 20 years of data on S&P500 index options, we find that, in line with theory, risk-averse investors demand risk-compensation for holding equity when the systematic skewness risk premium is high. However, when we differentiate between market conditions proxied by investor sentiment, we find that in up-markets (high sentiment) risk aversion is low, while in down-markets (low sentiment) risk aversion is high. We show that in line with theory, the skewness-risk-premium-return relationship only holds when risk aversion is high. In periods of low risk aversion, investors demand lower risk compensation, thus substantially weakening the skewness-risk premium-return trade off. Therefore, we also provide new evidence that helps to disentangle sentiment from risk aversion. |
| Keywords: | Asset Pricing, Skewness Risk Premium, Option Markets, Central Moments Risk Compensation, Risk Aversion |
| JEL: | G12 C15 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:crf:wpaper:14-05&r=upt |
| By: | Boschini, Anne (Linköping University); Dreber, Anna (Stockholm School of Economics); von Essen, Emma (Aarhus University); Muren, Astri (Dept. of Economics, Stockholm University); Ranehill, Eva (University of Zurich) |
| Abstract: | We explore gender differences in preferences related to altruism, fairness, cooperation, trust, coordination, risk and competitiveness in an experiment with a large random sample of the Swedish population. In addition to a baseline treatment, we have treatments where participants are primed with their gender or know the counterpart’s gender. We find no behavioral differences between treatments, but some gender differences within specific treatments: men are in some instances less generous, more trusting, and more competitive than women. Aside from a lack of gender differences in risk taking, our results are roughly in line with previous literature. |
| Keywords: | Gender differences; Random sample; Social preferences; Risk-taking; Competitiveness; Dictator games; Priming; Experiment |
| JEL: | C91 C93 J16 |
| Date: | 2014–10–23 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:sunrpe:2014_0006&r=upt |
| By: | Hu Lu (Applied Research and Analysis Directorate, Health Canada); Yuntong Wang (Department of Economics, University of Windsor) |
| Abstract: | This paper considers a trading problem on a network with incomplete information. We consider a simple water trading problem in which three agents are located in a linear order along a river. Upper stream agents can sell some amount of the water to their downstream but not the other way around. The middle agent can be both a seller and a buyer. Agents have private information on their utility of water, which we assume is non- linear. We ask if there is an efficient trading mechanism for the allocation of water. We show that if agents have highly asymmetric initial endowments of water, incentive-compatible, individually rational, budget-balanced mechanisms exist that are also ex-post efficient. |
| Keywords: | Network; Incomplete Information; Water Trading; Mechanism Design. |
| JEL: | C72 D82 |
| Date: | 2014–10–27 |
| URL: | http://d.repec.org/n?u=RePEc:wis:wpaper:1405&r=upt |
| By: | Luo, Yulei; Nie, Jun; Wang, Gaowang; Young, Eric |
| Abstract: | This paper derives the general equilibrium effects of rational inattention (or RI; Sims 2003, 2010) in a model of incomplete income insurance (Huggett 1993, Wang 2003). We show that, under the assumption of CARA utility with Gaussian shocks, the Permanent Income Hypothesis (PIH) arises in equilibrium, as in models with full information-rational expectations, due to a balancing of precautionary savings and impatience. We then explore how RI affects the equilibrium joint dynamics of consumption, income and wealth, and find that elastic attention can make the model fit the data better. We finally show that the welfare costs of incomplete information are even smaller due to general equilibrium adjustments in interest rates. |
| Keywords: | Rational Inattention; Permanent Income Hypothesis; General Equilibrium; Consumption and Income Volatility. |
| JEL: | C61 D83 E21 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:59182&r=upt |
| By: | Meinhardt, Holger Ingmar |
| Abstract: | To determine correctly a non-convex pre-kernel for TU games with more than 4 players can be a challenge full of possible pitfalls, even to the experienced researcher. Parts of the pre-kernel can be easily overlooked. In this note we discuss a method to present the full shape of the pre-kernel for a permutation game as discussed by Solymosi (2014). By using the property in which the pre-kernel is located in the least core for permutation games, the least core can be covered by a small collection of payoff equivalence classes as identified by Meinhardt (2013d) to finally establish the correct shape of the pre-kernel. |
| Keywords: | Transferable Utility Game: Non-Convex Pre-Kernel: Pre-Kernel Catcher: Convex Analysis: Fenchel-Moreau Conjugation: Indirect Function |
| JEL: | C63 C71 D63 D74 |
| Date: | 2014–10–18 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:59365&r=upt |
| By: | Rossi, Fabrizio; Cebula, Richard |
| Abstract: | The Board of Directors plays an important role in corporate governance. It is an internal mechanism that controls and monitors the actions of managers and aligns the utility functions between corporate owners and managers. The board of directors performs multiple functions that concern, for example, the replacement of the managers, financial policy, the preparation of strategic plans, and other actions that affect the performance of the firm. The board plays an important role since on the one hand it controls the actions of management and on the other it advises management regarding the strategies to be adopted. In this study, 100 announcements for the appointment to the board of directors of 100 Italian listed public companies during the period 2012-2014 are investigated. The results show a positive reaction within 20 days around the announcement date of the appointments. In four of the six study periods, Cumulative Abnormal Returns (CARs) are positive and statistically significant. The difference between the sub-sample composed of a higher presence of women, non-executives, and independents on the Board of Directors does not seem to perform better than the one composed of a smaller presence of women, non-executives, and independents. |
| Keywords: | stock market reactions; rates of return; announcements of boards of directors |
| JEL: | G10 G30 G32 |
| Date: | 2013–09–05 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:58403&r=upt |