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on Utility Models and Prospect Theory |
| By: | Fortin, Ines (Financial Markets and Econometrics, Institute for Advanced Studies, Vienna, Austria); Hlouskova, Jaroslava (Financial Markets and Econometrics, Institute for Advanced Studies, Vienna, Austria and Department of Economics, Thompson Rivers University, Kamloops, Canada); Tsigaris, Panagiotis (Department of Economics, Thompson Rivers University, Kamloops, Canada) |
| Abstract: | This study extends the literature on portfolio choice under prospect theory preferences by introducing a two-period life cycle model, where the household decides on optimal consumption and investment in a portfolio with one risk-free and one risky asset. The optimal solution depends primarily on the household’s choice of the present value of the consumption reference levels relative to the present value of its endowment income. If the present value of the consumption reference levels is set below the present value of endowment income, then the household behaves in such a way to avoid relative losses in consumption in any present or future state of nature (good or bad). As a result the degree of loss aversion does not directly affect optimal consumption and risk taking activity. However, it must be sufficiently high in order to rule out outcomes with relative losses. On the other hand, if the present value of the consumption reference levels is set exactly equal to the present value of the endowment income, i.e., the household sets its reference levels such that they are in balance with its income, then the household’s optimal consumption is the reference consumption in both periods and the household will not invest in the risky asset. Finally, if the present value of the household’s consumption reference levels is set above the present value of its endowment income, then the household cannot avoid experiencing a relative loss in consumption, either now or in the future. As a result, loss aversion directly affects consumption and risky investment. Reference levels play a significant role in consumption and risk taking activity. In most cases the household will “follow the Joneses” if the reference levels are set equal to the consumption levels of the Joneses. Independent of how consumption reference levels are set, being more ambitious, i.e., increasing one’s reference levels, will result in less happiness. The only case when this is not true is when reference levels increase with growing income (and the present value of reference levels is set below the present value of endowment income). |
| Keywords: | prospect theory, loss aversion, consumption-savings decision, portfolio allocation, happiness |
| JEL: | G02 G11 E20 |
| Date: | 2016–06 |
| URL: | http://d.repec.org/n?u=RePEc:ihs:ihsesp:322&r=upt |
| By: | Nicolas Lampach; Kene Boun My; Sandrine Spaeter |
| Abstract: | We conduct experiments to study the incentive effects of strict liability by comparing both regimes, unlimited and limited liability in the domain of risk and ambiguity. We assume that the firm’s activities cause a risk of technological disaster and can invest in prevention to reduce the likelihood of accident. We assess Lampach and Spaeter’s theoretical predictions. We find on average high levels of investment under limited liability in the domain of risk, consistent with the theory, but lower level of investment in prevention in the domain of ambiguity. We do not find that subjects’ degree of optimism affect the decision choice albeit we demonstrate strong evidence in favor of inequity aversion, fairness and risk preferences. |
| Keywords: | Strict liability; Technological disaster; Experiment; Risk; Ambiguity; Optimism. |
| JEL: | K13 C91 D81 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:ulp:sbbeta:2016-30&r=upt |
| By: | Fajardo, José; Corcuera, José Manuel; Menouken Pamen, Olivier |
| Abstract: | In 1988 Dybvig introduced the payoff distribution pricing model (PDPM) as an alternative to the capital asset pricing model (CAPM). Under this new paradigm agents preferences depend on the probability distribution of the payoff and for the same distribution agents prefer the payoff that requires less investment. In this context he gave the notion of efficient payoff. Both approaches run parallel to the theory of choice of von Neumann -Morgenstern (1947), known as the Expected Utility Theory and posterior axiomatic alternatives. In this paper we consider the notion of optimal payoff as that maximizing the terminal position for a chosen preference functional and we investigate the relationship between both concepts, optimal and efficient payoffs, as well as the behavior of the efficient payoffs under different market dynamics. We also show that path-dependent options can be efficient in some simple models. |
| Keywords: | Expected Utility, Prospect Theory, Risk Aversion, Law invariant preferences, Growth Optimal Portfolio, Portfolio Numeraire. |
| JEL: | D03 D11 G02 G11 |
| Date: | 2016–06–06 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:71901&r=upt |
| By: | Bayrak, Oben; Hey, John |
| Abstract: | This paper presents a new theory, called Preference Cloud Theory, of decision-making under uncertainty. This new theory provides an explanation for empirically-observed Preference reversals. Central to the theory is the incorporation of preference imprecision which arises because of individuals’ vague understanding of numerical probabilities. We combine this concept with the use of the Alpha model (which builds on Hurwicz’s criterion) and construct a simple model which helps us to understand various anomalies discovered in the experimental economics literature that standard models cannot explain. |
| Keywords: | Imprecise Preferences; Preference Reversals; Decision under Uncertainty; Anomalies in Expected Utility Theory |
| JEL: | D0 D00 D01 D02 D03 D04 D8 D80 D81 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:71782&r=upt |
| By: | Jeremy Fox (Institute for Fiscal Studies and University of Michigan) |
| Abstract: | I explore the estimation of transferable utility matching games, encompassing many-to-many matching, marriage and matching with trading networks (trades). I introduce a matching maximum score estimator that does not suffer from a computational curse of dimensionality in the number of agents in a matching market. I apply the estimator to data on the car parts supplied by automotive suppliers to estimate the returns from different portfolios of parts to suppliers and automotive assemblers. |
| Date: | 2016–03–24 |
| URL: | http://d.repec.org/n?u=RePEc:ifs:cemmap:14/16&r=upt |
| By: | Yola Engler; Rudolf Kerschbamer; Lionel Page |
| Abstract: | For the trust game, recent models of belief-dependent motivations make opposite predictions regarding the correlation between back-transfers and secondorder beliefs of the trustor: While reciprocity models predict a negative correlation, guilt-aversion models predict a positive one. This paper tests the hypothesis that the inconclusive results in previous studies investigating the reaction of trustees to their beliefs are due to the fact that reciprocity and guilt-aversion are behaviorally relevant for different subgroups and that their impact cancels out in the aggregate. We find little evidence in support of this hypothesis and conclude that type heterogeneity is unlikely to explain previous results. |
| JEL: | C25 C70 C91 D63 D64 |
| Date: | 2016–06–07 |
| URL: | http://d.repec.org/n?u=RePEc:qut:qubewp:wp039&r=upt |
| By: | Schweizer, Nikolaus; Szech, Nora |
| Abstract: | Information about the future may be instrumentally useful, yet scary. For example, many patients shy away from precise genetic tests about their dispositions for severe diseases. They are afraid that a bad test result could render them desperate due to anticipatory feelings. We show that partially revealing tests are typically optimal when anticipatory utility interacts with an instrumental need for information. The same result emerges when patients rely on probability weighting. Optimal tests provide only two signals, which renders them easily implementable. While the good signal is typically precise, the bad one remains coarse. This way, patients have a substantial chance to learn that they are free of the genetic risk in question. Yet even if the test outcome is bad, they do not end in a situation of no hope. |
| Keywords: | Test Design,Revelation of Information,Design of Beliefs,Medical Tests,Anticipatory Utility,Huntington's Disease |
| JEL: | D81 D82 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:kitwps:90&r=upt |
| By: | Villanueva, Anastasio J.; Glenk, Klaus; Rodriguez-Entrena, M. |
| Abstract: | The incidence of serial non-participation and protest responses has largely been ignored in willingness to accept (WTA) applications. This paper analyses serial non-participation with a focus on choice experiment applications using a WTA format to investigate preferences of ecosystem services providers towards incentive-based schemes. The paper addresses two main objectives. First, a review of the literature on WTA for participation in incentive-based schemes is used to identify and discuss a range of possible motives for protest responses that emerge in a WTA context. Second, drawing on choice experiment data on olive farmers’ preferences for agri-environmental scheme participation in Southern Spain, we analyse the impact on WTA estimates of censoring serial non-participation resulting from protest or high compensation requirements (very high takers) from further analysis. Using a random parameter logit model in WTA space, we find that the inclusion or exclusion of serial non-participants in the analysis can have a significant impact on marginal and total WTA estimates. Based on the findings, the paper makes recommendations on how to minimise the incidence of protest responses through survey design, regarding the identification of protesters as opposed to very high takers, and regarding the treatment of both for WTA estimation. |
| Keywords: | Protest response, Willingness to accept, Payments for ecosystem services, Agri-environmental schemes, Choice experiment, Agricultural and Food Policy, Environmental Economics and Policy, Q18, Q58, |
| Date: | 2016–04 |
| URL: | http://d.repec.org/n?u=RePEc:ags:aesc16:236348&r=upt |