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on Utility Models and Prospect Theory |
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Issue of 2022‒10‒03
ten papers chosen by |
| By: | Marcos Escobar-Anel; Yevhen Havrylenko; Rudi Zagst |
| Abstract: | We solve an expected utility-maximization problem with terminal-wealth constraints via dynamic programming in a setting of incomplete markets due to stochastic volatility. We demonstrate that the value function in the constrained problem can be represented as an expected modified utility of a vega-neutral financial derivative on the optimal unconstrained wealth. The optimal wealth and the optimal investment strategy in the constrained problem follow similarly. The case of a power utility and a Value-at-Risk constraint is treated theoretically in details. In numerical studies, we substantiate the impact of risk aversion levels, and investment horizons on the optimal investment strategy. We find a 20% relative difference between constrained and unconstrained allocations for average parameters in a low risk-aversion, short-horizon setting. |
| Date: | 2022–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2208.14152&r= |
| By: | Suen, Richard M. H. |
| Abstract: | This paper analyses a two-period model in which a consumer faces a future income risk but is uncertain about its probability distribution. We derive three sets of sufficient conditions under which a consumer with generalised recursive smooth ambiguity (GRSA) preferences will save more under ambiguity than in a deterministic environment. Our results show how precautionary saving is jointly determined by attitudes toward atemporal risk, ambiguity and intertemporal substitution. We also find a close connection between risk prudence under non-expected utility and precautionary saving under GRSA preferences. |
| Keywords: | Precautionary Saving; Risk Aversion; Intertemporal Substitution; Smooth Ambiguity Preferences. |
| JEL: | D81 E21 |
| Date: | 2022–08–02 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:114382&r= |
| By: | Schäfers, Sebastian (University of Basel) |
| Abstract: | Product lotteries are a sales strategy where companies hide features of differentiated products from consumers until the purchase is complete. I identify loss aversion as an important factor explaining the existence of vertical product lotteries. I consider a profit-maximizing monopolist serving loss-averse consumers with rational expectations about the lottery. I find that the optimal strategy consists of offering a premium product with high and deterministic quality and a lottery with stochastic and lower expected quality. When consumers are reasonably loss averse, I show that the profit increase from adding a quality lottery exceeds 10% compared to the case without a lottery. |
| Keywords: | Product lotteries, Probabilistic selling, Reference-dependent preferences, Loss aversion |
| JEL: | D42 D81 D91 L12 |
| Date: | 2022–08–22 |
| URL: | http://d.repec.org/n?u=RePEc:bsl:wpaper:2022/06&r= |
| By: | Victor H. Aguiar (University of Western Ontario); Per Hjertstrand (Research Institute of Industrial Economics, Sweden); Roberto Serrano (Brown University) |
| Abstract: | Samuelson’s (1938) weak (generalized) axiom of revealed preference– WGARP–is a minimal and appealing consistency condition of choice. We offer a rationalization of WGARP in general settings. Our main result is an exact analog of the celebrated Afriat’s theorem, but for WGARP. Its ordinal rationalization is in terms of an asymmetric and locally nonsatiated preference function. Its cardinal rationalization uses a coalitional multi-utility (CMU) maxmin representation with a coherency restriction on the coalition structure. Effectively, the CMU representation aggregates piecemeal preferences within the decision maker (multiple rationales without preference reversals that allow for transitivity violations). Basic consumer theory and welfare analysis are also developed. Extensions to the weak axiom of revealed preference–WARP–and choices obeying the law of demand are included. |
| Keywords: | abstract consumer choice; weak axiom of revealed preference; Afriat’s theorem; asymmetric preference function; coalitional multi-utility rationalization; welfare analysis |
| JEL: | C60 D10 |
| Date: | 2022 |
| URL: | http://d.repec.org/n?u=RePEc:uwo:uwowop:20229&r= |
| By: | Sarah Auster; Yeon-Koo Che; Konrad Mierendorff |
| Abstract: | This paper studies sequential information acquisition by an ambiguity-averse decision maker (DM), who decides how long to collect information before taking an irreversible action. The agent optimizes against the worst-case belief and updates prior by prior. We show that the consideration of ambiguity gives rise to rich dynamics: compared to the Bayesian DM, the DM here tends to experiment excessively when facing modest uncertainty and, to counteract it, may stop experimenting prematurely when facing high uncertainty. In the latter case, the DM’s stopping rule is non-monotonic in beliefs and features randomized stopping. |
| Keywords: | Wald Problem, Ambiguity Aversion |
| JEL: | C61 D81 D83 D91 |
| Date: | 2022–09 |
| URL: | http://d.repec.org/n?u=RePEc:bon:boncrc:crctr224_2022_366&r= |
| By: | Francesc Dilmé (University of Bonn); Daniel Garrett (University of Essex) |
| Abstract: | Work on relational employment agreements often predicts low payments or termination for poor performance. The possibility of saving can, however, limit the e˙ectiveness of mone-tary incentives in motivating an employee with diminishing marginal utility for consump-tion. We study the role of savings and their observability in optimal relational contracts. We focus on the case where players are not too patient, and hence the constant first-best e˙ort cannot be implemented. If savings are hidden, the relationship eventually deterio-rates over time. In particular, both payments and e˙ort decline. On the other hand, if savings are public, consumption is initially high, so the agent’s savings fall over time, and e˙ort and payments to the agent increase. The findings thus suggest how tacit agreements on consumption can forestall the deterioration of dynamic relationships in which the agent can save. |
| Keywords: | relational contracts, consumption smoothing preferences, private savings |
| JEL: | C73 J30 |
| Date: | 2022–08 |
| URL: | http://d.repec.org/n?u=RePEc:ajk:ajkdps:192&r= |
| By: | Dimitris Christelis (University of Glasgow, CSEF, CFS, CEPR and Netspar); Dimitris Georgarakos (European Central Bank and CFS); Tullio Jappelli (Università di Napoli Federico II, CSEF, CFS, CEPR and Netspar); Geoff Kenny (European Central Bank) |
| Abstract: | We use new euro area representative data from the Consumer Expectations Survey (CES) to elicit household-specific propensities to invest and consume out of positive wealth shocks. Using a randomized assignment of hypothetical lottery gains ranging from 5,000 to 50,000 euros and a realistic menu of consumption, saving and asset choices, we estimate the causal effect of wealth shocks on risky asset ownership and conditional asset shares. Wealth shocks have a positive effect on stockholding (about a 10 percentage points increase for the largest wealth shock). The majority of households in the sample do not participate in the stock market, even after a large increase in wealth. The conditional asset share invested in stocks does not depend on the size of wealth shocks, with the small exception of very high values of the latter, for which the conditional risky asset share slightly increases. This result is consistent with the notion that preferences are characterized by constant relative risk aversion for the vast majority of risky asset investors. |
| Keywords: | Household finance; Stock market participation; Risk aversion; Consumer Expectations Survey. |
| JEL: | D14 G11 G51 |
| Date: | 2022–09–13 |
| URL: | http://d.repec.org/n?u=RePEc:sef:csefwp:652&r= |
| By: | Sara Cecchetti (Bank of Italy); Adriana Grasso (European Central Bank); Marcello Pericoli (Bank of Italy) |
| Abstract: | We study euro-area risk-adjusted expected inflation and the inflation risk premium at different maturities, leveraging inflation swaps, inflation options and survey-based forecasts. We introduce a model that features time-varying long-term average inflation and time-varying inflation volatility and we anchor market-based risk-adjusted measures of expected inflation to survey-based inflation forecasts. The results show that medium-term risk-adjusted expected inflation was close to the ECB's aim from 2010 to mid-2014, has since fallen to a low in March 2020 and has risen significantly since the second half of 2021. The medium-term inflation risk premium was positive until 2014 and turned negative since 2015 despite a sharp rise at the end of 2021. The risk-adjusted probabilities of exceeding the ECB's inflation aim and of seeing deflation over the medium term have been low on average. |
| Keywords: | inflation density, inflation risk premium, objective probability |
| JEL: | C22 C58 G12 E31 E44 |
| Date: | 2022–07 |
| URL: | http://d.repec.org/n?u=RePEc:bdi:wptemi:td_1380_22&r= |
| By: | Francesc Dilmé (University of Bonn); Daniel Garrett (Toulouse School of Economics) |
| Abstract: | A seller with commitment power sets prices over time. Risk-averse buyers arrive to the market and decide when to purchase. We obtain that the optimal price path is a “regular” price, with occasional episodes of sequential discounts that occur at random times. The optimal price path has the property that the price a buyer ends up paying is independent of his arrival and purchase times, and only depends on his valuation. Our theory accommodates empirical findings on the timing of discounts. |
| Keywords: | dynamic pricing, sales, random mechanisms |
| JEL: | D82 |
| URL: | http://d.repec.org/n?u=RePEc:ajk:ajkdps:191&r= |
| By: | Geir B Asheim (UiO - University of Oslo); Kohei Kamaga (Sophia University [Tokyo]); Stéphane Zuber (PSE - Paris School of Economics - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique) |
| Keywords: | utilitarianism,intergenerational equity,population ethics |
| Date: | 2022 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-03760324&r= |