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Some properties of subjective probabilities induced by optimal expectations

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  • Iwaki, Hideki
  • Osaki, Yusuke
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    Abstract

    In this paper, we examine the properties of subjective probabilities induced by optimal expectations. We show that investors who follow optimal expectations underweigh small probabilities and overweigh large probabilities in a simple binary economy. This indicates that the subjective probabilities induced by optimal expectations are incompatible with experimentally observed results under the rank dependent probability assumption.

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    File URL: http://www.sciencedirect.com/science/article/B7CPP-4Y6453D-1/2/494a3e1e231650a6b4d56f9aa6dce5b7
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    Bibliographic Info

    Article provided by Elsevier in its journal Finance Research Letters.

    Volume (Year): 7 (2010)
    Issue (Month): 2 (June)
    Pages: 98-102

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    Handle: RePEc:eee:finlet:v:7:y:2010:i:2:p:98-102

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    Web page: http://www.elsevier.com/locate/frl

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    Keywords: Optimal expectation Portfolio choice Subjective probability;

    References

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    1. Markus K. Brunnermeier & Jonathan A. Parker, 2002. "Optimal Expectations," Working Papers 146, Princeton University, Woodrow Wilson School of Public and International Affairs, Discussion Papers in Economics..
    2. Nicholas Barberis & Ming Huang, 2008. "Stocks as Lotteries: The Implications of Probability Weighting for Security Prices," American Economic Review, American Economic Association, vol. 98(5), pages 2066-2100, December.
    3. Brunnermeier, Markus & Gollier, Christian & Parker, Jonathan, 2007. "Optimal Beliefs, Asset Prices, and the Preference for Skewed Returns," IDEI Working Papers 429, Institut d'Économie Industrielle (IDEI), Toulouse.
    4. Christian Gollier, 2005. "Optimal Illusions and Decisions under Risk," CESifo Working Paper Series 1382, CESifo Group Munich.
    5. Drazen Prelec, 1998. "The Probability Weighting Function," Econometrica, Econometric Society, vol. 66(3), pages 497-528, May.
    6. Quiggin, John, 1982. "A theory of anticipated utility," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 323-343, December.
    7. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
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