Showing papers on "Certainty effect published in 2016"
TL;DR: In this paper, the authors analyzed the impact of the trading model of Vlcek and Hens (2011) on Prospect Theory parameters using an adopted maximum likelihood approach for a dataset of 656 individual investors from a large German discount brokerage firm and found evidence that investors in their dataset are moderately averse to large losses and display high risk sensitivity.
Abstract: Shortcomings revealed by experimental and theoretical researchers such as Allais (1953), Rabin (2000) and Rabin and Thaler (2001) that put the classical expected utility paradigm von Neumann and Morgenstern (1947) into question, led to the proposition of alternative and generalized utility functions, that intend to improve descriptive accuracy. The perhaps best known among those alternative preference theories, that has attracted much popularity among economists, is the so called Prospect Theory by Kahneman and Tversky (1979) and Tversky and Kahneman (1992). Its distinctive features, governed by its set of risk parameters such as risk sensitivity, loss aversion and decision weights, stimulated a series of economic and financial models that build on the previously estimated parameter values by Tversky and Kahneman (1992) to analyze and explain various empirical phenomena for which expected utility doesn't seem to offer a satisfying rationale. In this paper, after providing a brief overview of the relevant literature, we take a closer look at one of those papers, the trading model of Vlcek and Hens (2011) and analyze its implications on Prospect Theory parameters using an adopted maximum likelihood approach for a dataset of 656 individual investors from a large German discount brokerage firm. We find evidence that investors in our dataset are moderately averse to large losses and display high risk sensitivity, supporting the main assumptions of Prospect Theory.
12 citations
TL;DR: In this article, a simple, parameter-free method was proposed to measure the utility of prospect theory under ambiguity and risk and ambiguity, as assumed by prospect theory and sign-comonotonic trade-off consistency.
Abstract: We propose a simple, parameter‐free method that, for the first time, makes it possible to completely observe Tversky and Kahneman’s (1992) prospect theory. While methods existed to measure event weighting and the utility for gains and losses separately, there was no method to measure loss aversion under ambiguity. Our method allows this and thereby it can measure prospect theory’s entire utility function. Consequently, we can properly identify properties of utility and perform new tests of prospect theory. We implemented our method in an experiment and obtained support for prospect theory. Utility was concave for gains and convex for losses and there was substantial loss aversion. Both utility and loss aversion were the same for risk and ambiguity, as assumed by prospect theory, and sign‐comonotonic trade‐off consistency, the central condition of prospect theory, held.
11 citations
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TL;DR: For example, this paper found that the certainty and possibility effects are reduced but not eliminated in multiple-play decisions, and that the majority choice patterns almost always remained the modal or majority patterns.
Abstract: textPeople often make more rational choices between monetary prospects when their choices will be played out many times rather than just once. For example, previous research has shown that the certainty effect and the possibility effect (two common-ratio effects that violate expected utility theory) are eliminated in multiple-play decisions. This finding is challenged by seven new studies (N = 2391) and two small meta-analyses. Results indicate that, on average, certainty and possibility effects are reduced but not eliminated in multiple-play decisions. Moreover, in our within-participants studies, the certainty and possibility choice patterns almost always remained the modal or majority patterns. Our primary results were not reliably affected by prompts that encouraged a long-run perspective, by participants’ insight into long-run payoffs, or by participants’ numeracy. The persistence of common-ratio effects suggests that the oft-cited benefits of multiple plays for the rationality of decision makers’ choices may be smaller than previously realized.
4 citations
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TL;DR: In this article, the authors established a tight relation between non-standard behaviors in the domains of risk and time by considering a decision maker with non-expected utility preferences who believes that only present consumption is certain while any future consumption is uncertain.
Abstract: The paper establishes a tight relation between non-standard behaviors in the domains of risk and time by considering a decision maker with non-expected utility preferences who believes that only present consumption is certain while any future consumption is uncertain. We provide the first complete characterization of the two-way relations between i) certainty effect and present bias, and, ii) common ratio effect and the common difference effect. A corollary to our results is that hyperbolic discounting implies the Common Ratio Effect and that quasi-hyperbolic discounting implies the Certainty Effect.
4 citations
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TL;DR: In this paper, regret-risk-averse and elation-riskseeking people behave as if they had rank-dependent utility preferences with an inverse-S shaped probability weighting function that reproduces estimates existing in the literature.
Abstract: We assume that the ex-post utility of an agent facing a menu of lotteries depends upon the actual payoff together with its forgone best alternative, thereby allowing for the expost emotion of regret. An increase in the risk of regret is obtained when the actual payoff and its forgone best alternative are statistically less concordant in the sense of Tchen (1980). The aversion to any such risk of regret is thus equivalent to the supermodularity of the bivariate utility function. We show that more regret-risk-averse agents are more willing to choose the risky act in a one-risky-one-safe menu, in particular when the payoff of the risky choice is highly skewed. This is compatible with the "possibility effect" that is well documented in prospect theory. Symmetrically, we define the aversion to elationrisk that can prevail when the ex-post utility is alternatively sensitive to the forgone worst payoff. We show that elation-risk-seeking is compatible with the "certainty effect". We finally show that regret-risk-averse and elation-risk-seeking people behave as if they had rank-dependent utility preferences with an inverse-S shaped probability weighting function that reproduces estimates existing in the literature.
1 citations
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TL;DR: In this article, regret-risk aversion is defined as the supermodularity of the bivariate utility function, which is characterized by the sensitivity of an agent to regret when her ex-post utility depends upon the forgone best payoff.
Abstract: We fill a gap in the literature by formally defining the notion of aversion to risk of regret. An agent is sensitive to regret when her ex-post utility depends upon the forgone best payoff. An increase in the risk of regret occurs when the actual payoff and this best alternative become statistically less concordant. Accordingly, regret-risk aversion is characterized by the supermodularity of the bivariate utility function. We define a measure of regret-risk aversion in the small and in the large. We show that more regretrisk- averse agents are more willing to choose the risky act in a one-risky-one-safe menu, and that this bias is increasing in the skewness of the risky choice. This can explain the "possibility effect" that is well documented in decision theory. Symmetrically, we define the aversion to elation-risk that can prevail when the ex-post utility is alternatively sensitive to the forgone worst payoff. We show that elation-risk-seeking can explain the "certainty effect". We also show that a regret-risk-averse and elation-risk-seeking people behave as if they would have rank-dependent utility preferences with an inverse-S shaped probability weighting function that reproduces estimations existing in the literature.