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on Utility Models and Prospect Theory |
| By: | Keigo Inukai; Yuta Shimodaira; Kohei Shiozawa |
| Abstract: | While the constant elasticity of substitution (CES) utility function is widely used in the modified dictator game, a well-known shortcoming is that the distribution parameter loses its interpretation in the limit of the substitution parameter. This paper shows that previously proposed solutions for this problem necessarily have a similar mathematical shortcoming. Hence, we propose a new CES specification to address this problem and demonstrate its usefulness. Our results clarified empirical inconsistencies in the conventional analysis of measuring subjects' preferences. In particular, the conventional interpretation of the substitution parameter, “the equality–efficiency trade-off, ” is not based on subjects' behavior. |
| Date: | 2022–10 |
| URL: | https://d.repec.org/n?u=RePEc:dpr:wpaper:1195r |
| By: | Mika Akesaka; Ryo Mikami; Yoshiyasu Ono |
| Abstract: | This study theoretically considers household behavior with wealth preference and empirically investigates the validity of insatiable wealth preference using a nationally representative survey. With wealth preference, the marginal rate of substitution of asset holdings for consumption depends on the nominal interest rates of assets at each point in time. From this property, we derive a reduced-form model and estimate it to find that the marginal utility of holding financial assets remains strictly positive as asset holdings increase and has a strictly positive lower bound; that is the insatiability of wealth preference. We also show that this property plays a crucial role in creating secular demand stagnation and expanding asset price bubbles. |
| Date: | 2024–04 |
| URL: | https://d.repec.org/n?u=RePEc:dpr:wpaper:1241rr |
| By: | Wing Fung Chong; Gechun Liang |
| Abstract: | This paper studies robust forward investment and consumption preferences and optimal strategies for a risk-averse and ambiguity-averse agent in an incomplete financial market with drift and volatility uncertainties. We focus on non-zero volatility and constant relative risk aversion (CRRA) forward preferences. Given the non-convexity of the Hamiltonian with respect to uncertain volatilities, we first construct robust randomized forward preferences through endogenous randomization in an auxiliary market. We derive the corresponding optimal and robust investment and consumption strategies. Furthermore, we show that such forward preferences and strategies, developed in the auxiliary market, remain optimal and robust in the physical market, offering a comprehensive framework for forward investment and consumption under model uncertainty. |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2410.01378 |
| By: | Martin Browning (Department of Economics, University of Copenhagen); Laurens Cherchye (Faculty of Economics and Business, KU Leuven); Thomas Demuynck (Faculty of Economics and Business, KU Leuven); Bram de Rock (Faculty of Economics and Business, KU Leuven); Frederic Vermeulen (Faculty of Economics and Business, KU Leuven) |
| Abstract: | We model the interaction between the marriage market and the intrahousehold allocation of resources. We do this within a setting that accountsfor both economic gains to marriage (through public consumption) and unobserved non-material match quality, without relying on the transferable utility assumption. We adopt an axiomatic approach that leads to the empirically tractable “Additive Quantity Shifting†(AQS) model. We develop a revealed preference methodology that is able to identify individuals’ heterogeneous match qualities and to quantify them in money metric terms. The methodology can include both preference factors, affecting individuals’ preferences over private and public goods, and match quality factors, driving differences in unobserved match quality. We demonstrate the practical usefulness of our methodology through an application to the Belgian MEqIn data. Our results reveal intuitive patterns of match quality that allow us to rationalise both the observed matches and the within-household allocations of time and money. |
| Keywords: | household consumption; marital stability; unobserved match quality; revealed preference analysis; intrahousehold allocation. |
| JEL: | C14 D11 C78 |
| Date: | 2024–09–20 |
| URL: | https://d.repec.org/n?u=RePEc:kud:kucebi:2414 |
| By: | Tizié Bene (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique); Yann Bramoullé (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique); Frédéric Deroïan (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique) |
| Abstract: | We study how altruism networks affect the demand for formal insurance. Agents with CARA utilities are connected through a network of altruistic relationships. Incomes are subject to a common shock and to a large individual shock, generating heterogeneous damages. Agents can buy formal insurance to cover the common shock, up to a coverage cap. We find that ex-post altruistic transfers induce interdependence in ex-ante formal insurance decisions. We characterize the Nash equilibria of the insurance game and show that agents act as if they are trying to maximize the expected utility of a representative agent with average damages. Altruism thus tends to increase demand of low-damage agents and to decrease demand of high-damage agents. Its aggregate impact depends on the interplay between demand homogenization, the zero lower bound and the coverage cap. We find that aggregate demand is higher with altruism than without altruism at low prices and lower at high prices. Nash equilibria are constrained Pareto efficient. |
| Keywords: | Formal insurance, Informal transfers, Altruism networks |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:hal:journl:hal-04717990 |
| By: | Gaurab Aryal; Isabelle Perrigne; Quang Vuong; Haiqing Xu |
| Abstract: | In this paper, we address the identification and estimation of insurance models where insurees have private information about their risk and risk aversion. The model includes random damages and allows for several claims, while insurers choose from a finite number of coverages. We show that the joint distribution of risk and risk aversion is nonparametrically identified despite bunching due to multidimensional types and a finite number of coverages. Our identification strategy exploits the observed number of claims as well as an exclusion restriction, and a full support assumption. Furthermore, our results apply to any form of competition. We propose a novel estimation procedure combining nonparametric estimators and GMM estimation that we illustrate in a Monte Carlo study. |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2410.08416 |
| By: | Pierre Collin-Dufresne; Kent D. Daniel; Mehmet Sağlam |
| Abstract: | A number of papers have solved for the optimal dynamic portfolio strategy when expected returns are time-varying and trading is costly, but only for agents with myopic utility. Non-myopic agents benefit from hedging against future shocks to the investment opportunity set even when transaction costs are zero (Merton, 1969, 1971). In this paper, we propose a solution to the dynamic portfolio allocation problem for non-myopic agents faced with a stochastic investment opportunity set when trading is costly. We show that the agent’s optimal policy is to trade toward an “aim” portfolio, the makeup of which depends both on transaction costs and on each asset’s correlation with changes in the investment opportunity set. The speed at which the agent should trade towards the aim portfolio depends both on the shock’s persistence and on the extent to which the shock can be effectively hedged. We illustrate the differences in portfolio makeup that result from considering hedging demands of a long-horizon investor using a set of simplified examples, and using a daily trading strategy based on the estimated relation between retail order imbalance and future returns. |
| JEL: | G11 G12 |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:33058 |
| By: | Masashi Sekine |
| Abstract: | This paper studies an asset pricing model in a partially observable market with a large number of heterogeneous agents using the mean field game theory. In this model, we assume that investors can only observe stock prices and must infer the risk premium from these observations when determining trading strategies. We characterize the equilibrium risk premium in such a market through a solution to the mean field backward stochastic differential equation (BSDE). Specifically, the solution to the mean field BSDE can be expressed semi-analytically by employing an exponential quadratic Gaussian framework. We then construct the risk premium process, which cannot be observed directly by investors, endogenously using the Kalman-Bucy filtering theory. In addition, we include a simple numerical simulation to visualize the dynamics of our market model. |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2410.01352 |
| By: | Heifetz, Stephen |
| Abstract: | As the U.S. government has become increasingly intolerant of national security risks sometimes attendant to foreign investment, Stephen Heifetz suggests the government should consider the costs of that risk avoidance and should alter its approach. |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:colfdi:303496 |
| By: | Motte, Edouard (Université catholique de Louvain, LIDAM/ISBA, Belgium); Hainaut, Donatien (Université catholique de Louvain, LIDAM/ISBA, Belgium) |
| Abstract: | This paper investigates the hedging of equity-linked life insurance portfolio for loss-averse insurers. We consider a general arbitrage-free financial market and an actuarial market composed of n−independent policyholders. As the combined market is incomplete, perfect hedging of any actuarial-financial payoff is not possible. Instead, we study the efficient hedging of n−size equity-linked life insurance portfolio for insurers who are only concerned with their losses. To this end, we consider stochastic control problems (under the real-world measure) in order to determine the optimal hedging strategies that either maximize the probability of successful hedge (called quantile hedging) or minimize the expectation for a class of shortfall loss functions (called shortfall hedging). We show that the optimal strategies depend both on actuarial and financial risks. Moreover, these strategies adapt not only to the size of the insurance portfolio but also to the risk-aversion of the insurer. Under the additional assumption of complete financial market, we derive the explicit forms of the optimal hedging strategies. The numerical results show that, for loss-averse insurers, the optimal strategies outperform the optimal mean-variance hedging strategy, demonstrating the relevance of adopting the optimal strategy according to the insurers' risk aversion and portfolio size. |
| Keywords: | Efficient hedging ; Super hedging ; Incomplete market ; Insurance portfolio ; Loss-averse |
| Date: | 2024–04–15 |
| URL: | https://d.repec.org/n?u=RePEc:aiz:louvad:2024013 |