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on Utility Models and Prospect Theory |
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Issue of 2022‒01‒03
seventeen papers chosen by |
| By: | Bin Wei |
| Abstract: | I generalize the long-run risks (LRR) model of Bansal and Yaron (2004) by incorporating recursive smooth ambiguity aversion preferences from Klibanoff et al. (2005, 2009) and time-varying ambiguity. Relative to the Bansal-Yaron model, the generalized LRR model is as tractable but more flexible due to its separation of ambiguity aversion from both risk aversion and the intertemporal elasticity of substitution. This three-way separation allows the model to further account for the variance premium puzzle besides the puzzles of the equity premium, the risk-free rate, and the return predictability. Specifically, the model matches reasonably well key asset-pricing moments with risk aversion under 5. Model calibration shows that the ambiguity aversion channel accounts for 77 percent of the variance premium and 40 percent of the equity premium. |
| Keywords: | smooth ambiguity aversion; long-run risks; equity premium puzzle; risk-free rate puzzle; variance premium puzzle; return predictability |
| JEL: | G12 G13 D81 E44 |
| Date: | 2021–09–08 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedawp:93476&r= |
| By: | Biljana Meiske |
| Abstract: | This paper studies the consequences of productivity shocks on conflict behavior in the presence of loss aversion. In a first step, I incorporate expectation based loss preferences `a la KË oszegi and Rabin (2006, 2007) into a Hirshleifer-Skaperdas conflict game and show that negative productivity shocks entail larger conflict investments if agents are loss averse (and smaller investments if agents are gain-seeking); the reverse holds in case of a positive productivity shock. In a second step, a lab experiment (N=496) was conducted with participants playing repeated guns-and-butter conflict game under changing productivity regimes. The experimental results reveal that while negative productivity shocks (channeled through loss aversion) have the predicted effects, positive productivity shocks lead to the predicted increase in conflict investment among gain-seeking, but fail to reduce conflict investment among loss-averse participants. Furthermore, absent any changes in productivity level, conflict investments are shown to increase in the level of loss aversion. |
| Keywords: | conflict rent-seeking loss aversion reference dependence productivity shocks |
| JEL: | D91 C92 D72 D74 |
| Date: | 2021–11 |
| URL: | http://d.repec.org/n?u=RePEc:mpi:wpaper:tax-mpg-rps-2021-18&r= |
| By: | Christoph Görtz (Department of Economics, University of Birmingham, UK; Rimini Centre for Economic Analysis); Mallory Yeromonahos (Department of Economics, University of Birmingham, UK) |
| Abstract: | A large literature suggests that the expected equity risk premium is countercyclical. Using a variety of different measures for this risk premium, we document that it also exhibits growth asymmetry, i.e. the risk premium rises sharply in recessions and declines much more gradually during the following recoveries. We show that a model with recursive preferences, in which agents cannot perfectly observe the state of current productivity, can generate the observed asymmetry in the risk premium. Key for this result are endogenous fluctuations in uncertainty which induce procyclical variations in agent's nowcast accuracy. In addition to matching moments of the risk premium, the model is also successful in generating the growth asymmetry in macroeconomic aggregates observed in the data, and in matching the cyclical relation between quantities and the risk premium. |
| Keywords: | Risk Premium, Business cycles, Bayesian Learning, Asymmetry, Uncertainty, Nowcasting |
| JEL: | E2 E3 G1 |
| Date: | 2021–12 |
| URL: | http://d.repec.org/n?u=RePEc:rim:rimwps:21-25&r= |
| By: | Heinzel Christoph; Richard Peter |
| Abstract: | Using a unified approach, we show how precautionary saving, self-protection and self-insurance are jointly determined by risk preferences and the preference over the timing of uncertainty resolution. We cover higher-order risk effects and examine both risk averters and risk lovers. When decision-makers use several instruments simultaneously to respond to income risk, substitutive interaction effects arise. We quantify precautionary and substitution effects numerically and discuss the role of instrument interaction for the inference of preference parameters from precautionary motives. Instruments can differ substantially in the size of the precautionary motive and in the susceptibility to substitution effects. This affects their suitability for the identification of precautionary preferences. |
| Keywords: | Préférences récursives, prudence, comportement de précaution, effets d’interaction, statique comparative. |
| JEL: | D11 D80 D81 G22 |
| Date: | 2021 |
| URL: | http://d.repec.org/n?u=RePEc:rae:wpaper:202109&r= |
| By: | Michail Anthropelos (University of Piraeus - Department of Banking and Financial Management); Paul Schneider (University of Lugano - Institute of Finance; Swiss Finance Institute) |
| Abstract: | We consider portfolio selection under nonparametric alpha-maxmin ambiguity in the neighbourhood of a reference distribution. We show strict concavity of the portfolio problem under ambiguity aversion.Implied demand functions are nondifferentiable, resemble observed bid-ask spreads, and are consistent with existing parametric limiting participation results under ambiguity. Ambiguity seekers exhibit a discontinuous demand function, implying an empty set of reservation prices. If agents have identical, or sufficiently similar prior beliefs, the first best equilibrium is no trade. Simple sufficient conditions yield the existence of a Pareto-efficient second-best equilibrium which reconciles many observed phenomena in financial markets, such as liquidity dry-ups, portfolio inertia, and negative risk premia. |
| Keywords: | ambiguity,equilibrium,asset pricing |
| JEL: | G11 G12 G41 C62 D84 |
| Date: | 2021–11 |
| URL: | http://d.repec.org/n?u=RePEc:chf:rpseri:rp2178&r= |
| By: | Yulei Luo; Jun Nie; Xiaowen Wang; Eric R. Young |
| Abstract: | We propose a production-cost smoothing model with Knightian uncertainty due to ambiguity aversion to study the joint behavior of production, inventories, and sales. Our model can explain four facts that previous studies find difficult to account for simultaneously: (i) the high volatility of production relative to sales, (ii) the low ratio of inventory-investment volatility to sales volatility, (iii) the positive correlation between sales and inventories, and (iv) the negative correlation between the inventory-to-sales ratio and sales. We find that the stock-out avoidance motive (Kahn 1987) emerges endogenously in our model, reconciling the long debate in the inventory literature over the production- cost smoothing and the stock-out avoidance models. |
| Keywords: | Ambiguity Aversion; Robustness; Knightian Uncertainty; Inventories; Production Cost Smoothing |
| JEL: | D83 E21 F41 G15 |
| Date: | 2021–08–02 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedkrw:93094&r= |
| By: | Pablo Garcés (Pontifical Catholic University of Ecuador) |
| Abstract: | Behavioral economics offers an account of actual human behavior. Contrasting with the conventional normative approach to rationality, rational choice theory, describes the deviations from optimal decision making. These are attributed to failures in two systems, one in charge of automatic behavior (System 1) and the other responsible for reflective one (System 2). As important as this is, an elaboration of the interaction between them seems to be lacking. Philosophical pragmatism can contribute to address this want. It provides an evolutionary explanation of how people act accounting for the continuity of behavior including habitual and reflective action. The former is captured by habits and the latter directed towards objects. Additionally, it proposes a dialogical self, consisting of an interaction between the 'I', denoting impulse, and the 'me', referring to reflective action. As such, pragmatism can provide fertile ground on which to cultivate behavioral insights. |
| Keywords: | behavioral economics,pragmatism,rationality,agency,transaction |
| Date: | 2021 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-03426533&r= |
| By: | Georgios Gerasimou |
| Abstract: | This paper contributes to the elicitation of a decision maker's strict preferences and their possible indifference or incomparability/indecisiveness. Every subject in both treatments of an incentivized lab experiment could choose multiple alternatives from each of the 50 distinct menus of popular gift-card pairs that they saw. Subjects in the non-forced-choice treatment could, in addition, avoid/delay making an active choice at those menus. Applying a non-parametric optimization method on data collected from 273 subjects, we find that nearly 60% of them are well-approximated by an indifference-permitting model of complete- or incomplete-preference maximization. Most recovered preferences are unique, have a non-trivial indifference part and, where relevant, a distinct indecisiveness part. The two kinds of distinctions between indifference and indecisiveness uncovered by this method are theory-guided and documented empirically for the first time. These findings suggest that accounting for possible indifferences and/or incomparabilities in the data-collection process and analysis can be useful in eliciting transitive weak preferences. Two aspects of the experimental design, finally, allow for interpreting an additional 10% of subjects as revealing a systematic preference for randomization or satisficing. |
| Date: | 2021–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2111.14431&r= |
| By: | Gu, Tao; Nakagawa, Masayuki; Saito, Makoto; Yamaga, Hisaki |
| Abstract: | This paper proposes a simple method to estimate a nonlinear function using only coarsely discrete explanatory variables in panel data. The basic premise is to distinguish carefully between two types of discrete variables by assuming that if the variable changes between two points in time, it increases (decreases) marginally from near the upper (lower) bound one rank below (above). The dynamic pricing behavior at the boundary between two consecutive ranks is then properly approximated. Applying the proposed method, we estimate the nonlinear relationship between land prices and earthquake risk, with the latter being assessed over only five ranks. The panel datasets used comprise some two thousand fixed places over time in the Tokyo Metropolitan District. We interpret the estimated nonlinear land pricing functions using prospect theory from behavioral economics. |
| JEL: | R14 R30 D91 |
| Date: | 2021–12 |
| URL: | http://d.repec.org/n?u=RePEc:hit:hituec:729&r= |
| By: | Subhasish M. Chowdhury (University of Bath); Sang-Hyun Kim (Yonsei University) |
| Abstract: | We analyze a spatial voting contest without the “one person, one vote” restriction. Players exert continuous influence effort and incurs cost accordingly. They can be heterogeneous in terms of position, disutility function, and cost function. In equilibrium, two groups endogenously emerge: players in one group try to implement more leftist policy, while those in the other group more rightist one. Since the larger group suffers more severe free-riding problem, the equilibrium policy does not converge to the center if the larger group does not have a cost advantage. We demonstrate how the location of the center (i.e., the steady-state point) depends the convexities of the utility and cost functions. We extend the model to a dynamic setting. |
| Keywords: | Spatial Competition; Contest; Lobbying; Median Voter Theorem |
| JEL: | C72 D72 D74 D78 |
| Date: | 2021–12 |
| URL: | http://d.repec.org/n?u=RePEc:yon:wpaper:2021rwp-193&r= |
| By: | Indrajit Mitra; Taeuk Seo; Yu Xu |
| Abstract: | Ljungqvist and Sargent (2017) (LS) show that unemployment fluctuations can be understood in terms of a quantity they call the “fundamental surplus.” However, their analysis ignores risk premia, a force that Hall (2017) shows is important in understanding unemployment fluctuations. We show how the LS framework can be adapted to incorporate risk premia. We derive an equivalence result that relates parameters in economies with risk premia to those of an artificial economy without risk premia. We show how to use properties of the artificial economy to deduce how risk premia affect unemployment dynamics in the original economy. |
| Keywords: | risk premia; fundamental surplus; time-varying discounts; unemployment fluctuations |
| JEL: | E23 E24 E32 E44 J23 J24 J31 J41 J63 |
| Date: | 2021–09–24 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedawp:93477&r= |
| By: | Georgios Piliouras; Ryann Sim; Stratis Skoulakis |
| Abstract: | In this paper we solve the problem of no-regret learning in general games. Specifically, we provide a simple and practical algorithm that achieves constant regret with fixed step-sizes. The cumulative regret of our algorithm provably decreases linearly as the step-size increases. Our findings depart from the prevailing paradigm that vanishing step-sizes are a prerequisite for low regret as championed by all state-of-the-art methods to date. We shift away from this paradigm by defining a novel algorithm that we call Clairvoyant Multiplicative Weights Updates (CMWU). CMWU is Multiplicative Weights Updates (MWU) equipped with a mental model (jointly shared across all agents) about the state of the system in its next period. Each agent records its mixed strategy, i.e., its belief about what it expects to play in the next period, in this shared mental model which is internally updated using MWU without any changes to the real-world behavior up until it equilibrates, thus marking its consistency with the next day's real-world outcome. It is then and only then that agents take action in the real-world, effectively doing so with the ``full knowledge" of the state of the system on the next day, i.e., they are clairvoyant. CMWU effectively acts as MWU with one day look-ahead, achieving bounded regret. At a technical level, we establish that self-consistent mental models exist for any choice of step-sizes and provide bounds on the step-size under which their uniqueness and linear-time computation are guaranteed via contraction mapping arguments. Our arguments extend well beyond normal-form games with little effort. |
| Date: | 2021–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2111.14737&r= |
| By: | Peter Reinhard Hansen; Zhuo Huang; Chen Tong; Tianyi Wang |
| Abstract: | We show that the Realized GARCH model yields close-form expression for both the Volatility Index (VIX) and the volatility risk premium (VRP). The Realized GARCH model is driven by two shocks, a return shock and a volatility shock, and these are natural state variables in the stochastic discount factor (SDF). The volatility shock endows the exponentially affine SDF with a compensation for volatility risk. This leads to dissimilar dynamic properties under the physical and risk-neutral measures that can explain time-variation in the VRP. In an empirical application with the S&P 500 returns, the VIX, and the VRP, we find that the Realized GARCH model significantly outperforms conventional GARCH models. |
| Date: | 2021–12 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2112.05302&r= |
| By: | Zongmin Liu |
| Abstract: | The probabilistic linguistic term has been proposed to deal with probability distributions in provided linguistic evaluations. However, because it has some fundamental defects, it is often difficult for decision-makers to get reasonable information of linguistic evaluations for group decision making. In addition, weight information plays a significant role in dynamic information fusion and decision making process. However, there are few research methods to determine the dynamic attribute weight with time. In this paper, I propose the concept of double fuzzy probability interval linguistic term set (DFPILTS). Firstly, fuzzy semantic integration, DFPILTS definition, its preference relationship, some basic algorithms and aggregation operators are defined. Then, a fuzzy linguistic Markov matrix with its network is developed. Then, a weight determination method based on distance measure and information entropy to reducing the inconsistency of DFPILPR and obtain collective priority vector based on group consensus is developed. Finally, an aggregation-based approach is developed, and an optimal investment case from a financial risk is used to illustrate the application of DFPILTS and decision method in multi-criteria decision making. |
| Date: | 2021–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2111.15255&r= |
| By: | Christoph Carnehl; Johannes Schneider |
| Abstract: | We study the tradeoff between fundamental risk and time. A time-constrained agent has to solve a problem. She dynamically allocates effort between implementing a risky initial idea and exploring alternatives. Discovering an alternative implies progress that has to be converted to a solution. As time runs out, the chances of converting it in time shrink. We show that the agent may return to the initial idea after having left it in the past to explore alternatives. Our model helps explain so-called false starts. The agent takes risks early on to quickly arrive at a solution, sacrificing the prospects of alternatives. |
| Date: | 2021–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2111.07451&r= |
| By: | Ferdinand M. Vieider (-) |
| Abstract: | I present a model generating delay-discounting from noisy mental representations of time delays. The optimal combination of noisy signals about time delays with prior information results in a stochastic model predicting discounting to exhibit present-bias, but to be stationary and delaydependent once up-front delays are introduced. The derivation from an optimal encoding-decoding process sidesteps arbitrariness concerns voiced about earlier models. Data collected in an experiment support the need for separate but interacting parameters to capture present-bias and delaydependence. The account explains why non-trivial discounting is routinely observed in experiments using monetary rewards instead of consumption. |
| Date: | 2021–12 |
| URL: | http://d.repec.org/n?u=RePEc:rug:rugwps:21/1036&r= |
| By: | Xiaohui Bei; Xinhang Lu; Warut Suksompong |
| Abstract: | The classic cake cutting problem concerns the fair allocation of a heterogeneous resource among interested agents. In this paper, we study a public goods variant of the problem, where instead of competing with one another for the cake, the agents all share the same subset of the cake which must be chosen subject to a length constraint. We focus on the design of truthful and fair mechanisms in the presence of strategic agents who have piecewise uniform utilities over the cake. On the one hand, we show that the leximin solution is truthful and moreover maximizes an egalitarian welfare measure among all truthful and position oblivious mechanisms. On the other hand, we demonstrate that the maximum Nash welfare solution is truthful for two agents but not in general. Our results assume that mechanisms can block each agent from accessing parts that the agent does not claim to desire; we provide an impossibility result when blocking is not allowed. |
| Date: | 2021–12 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2112.05632&r= |