Advanced Search
MyIDEAS: Login

Theories of choice under risk: Insights from financial markets

Contents:

Author Info

  • Kliger, Doron
  • Levy, Ori

Abstract

To date, the plausibility of theories of choice under risk hinges are mainly on experimental evidence. This paper devises and implements an approach amenable of assessing the performance of three families of models (expected utility, rank-dependent expected utility, and the cumulative prospect theory) using information from financial asset markets. Our findings unequivocally support reference-point dependence, diminishing marginal sensitivity, loss aversion, and nonlinear weighting of (gain and loss) physical probabilities. The empirical observations are found to be robust to, inter alia, the parameterization of the utility and probability weighting functions, "day-of-the-week effects", the choice of a reference point, and the introduction of possible, low-probability market crashes (peso component).

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.sciencedirect.com/science/article/B6V8F-4VNKGPT-1/2/6f9a3152cc28bb42764b6825c81ee230
Download Restriction: Full text for ScienceDirect subscribers only

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Behavior & Organization.

Volume (Year): 71 (2009)
Issue (Month): 2 (August)
Pages: 330-346

as in new window
Handle: RePEc:eee:jeborg:v:71:y:2009:i:2:p:330-346

Contact details of provider:
Web page: http://www.elsevier.com/locate/jebo

Related research

Keywords: Cumulative prospect theory Expected utility Market data Rank-dependent expected utility;

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Han Bleichrodt & Jose Luis Pinto, 2000. "A Parameter-Free Elicitation of the Probability Weighting Function in Medical Decision Analysis," Management Science, INFORMS, vol. 46(11), pages 1485-1496, November.
  2. Pamela K. Lattimore & Joanna R. Baker & A. Dryden Witte, 1992. "The Influence Of Probability on Risky Choice: A parametric Examination," NBER Technical Working Papers 0081, National Bureau of Economic Research, Inc.
  3. Bowman, David & Minehart, Deborah & Rabin, Matthew, 1999. "Loss aversion in a consumption-savings model," Journal of Economic Behavior & Organization, Elsevier, vol. 38(2), pages 155-178, February.
  4. Donkers, A.C.D. & Melenberg, B. & Soest, A.H.O. van, 1999. "Estimating Risk Attitudes Using Lotteries; A Large Sample Approach," Discussion Paper 1999-12, Tilburg University, Center for Economic Research.
  5. Terrance Odean, 1998. "Volume, Volatility, Price, and Profit When All Traders Are Above Average," Journal of Finance, American Finance Association, vol. 53(6), pages 1887-1934, December.
  6. Nygren, Thomas E. & Isen, Alice M. & Taylor, Pamela J. & Dulin, Jessica, 1996. "The Influence of Positive Affect on the Decision Rule in Risk Situations: Focus on Outcome (and Especially Avoidance of Loss) Rather Than Probability," Organizational Behavior and Human Decision Processes, Elsevier, vol. 66(1), pages 59-72, April.
  7. Genesove, David & Mayer, Christopher, 2001. "Loss Aversion and Seller Behaviour: Evidence from the Housing Market," CEPR Discussion Papers 2813, C.E.P.R. Discussion Papers.
  8. George Wu & Richard Gonzalez, 1996. "Curvature of the Probability Weighting Function," Management Science, INFORMS, vol. 42(12), pages 1676-1690, December.
  9. Cook, Philip J & Clotfelter, Charles T, 1993. "The Peculiar Scale Economies of Lotto," American Economic Review, American Economic Association, vol. 83(3), pages 634-43, June.
  10. Jens Carsten Jackwerth., 1996. "Recovering Risk Aversion from Option Prices and Realized Returns," Research Program in Finance Working Papers RPF-265, University of California at Berkeley.
  11. Christensen, B. J. & Prabhala, N. R., 1998. "The relation between implied and realized volatility," Journal of Financial Economics, Elsevier, vol. 50(2), pages 125-150, November.
  12. Jackwerth, Jens Carsten & Rubinstein, Mark, 1996. " Recovering Probability Distributions from Option Prices," Journal of Finance, American Finance Association, vol. 51(5), pages 1611-32, December.
  13. Bruno Jullien & Bernard Salanie, 2000. "Estimating Preferences under Risk: The Case of Racetrack Bettors," Journal of Political Economy, University of Chicago Press, vol. 108(3), pages 503-530, June.
  14. Rubinstein, Mark, 1994. " Implied Binomial Trees," Journal of Finance, American Finance Association, vol. 49(3), pages 771-818, July.
  15. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  16. Camerer, Colin & Babcock, Linda & Loewenstein, George & Thaler, Richard, 1996. "Labor Supply of New York City Cab Drivers: One Day At A time," Working Papers 960, California Institute of Technology, Division of the Humanities and Social Sciences.
  17. Arkes, Hal R. & Herren, Lisa Tandy & Isen, Alice M., 1988. "The role of potential loss in the influence of affect on risk-taking behavior," Organizational Behavior and Human Decision Processes, Elsevier, vol. 42(2), pages 181-193, October.
  18. Shlomo Benartzi & Richard H. Thaler, 1993. "Myopic Loss Aversion and the Equity Premium Puzzle," NBER Working Papers 4369, National Bureau of Economic Research, Inc.
  19. Dalia Gilad & Doron Kliger, 2008. "Priming the Risk Attitudes of Professionals in Financial Decision Making," Review of Finance, European Finance Association, vol. 12(3), pages 567-586.
  20. Camerer, Colin F & Ho, Teck-Hua, 1994. "Violations of the Betweenness Axiom and Nonlinearity in Probability," Journal of Risk and Uncertainty, Springer, vol. 8(2), pages 167-96, March.
  21. Drazen Prelec, 1998. "The Probability Weighting Function," Econometrica, Econometric Society, vol. 66(3), pages 497-528, May.
  22. 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.
  23. Yaari, Menahem E, 1987. "The Dual Theory of Choice under Risk," Econometrica, Econometric Society, vol. 55(1), pages 95-115, January.
  24. Quiggin, John, 1982. "A theory of anticipated utility," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 323-343, December.
  25. Bechara, Antoine & Damasio, Antonio R., 2005. "The somatic marker hypothesis: A neural theory of economic decision," Games and Economic Behavior, Elsevier, vol. 52(2), pages 336-372, August.
  26. French, Kenneth R., 1980. "Stock returns and the weekend effect," Journal of Financial Economics, Elsevier, vol. 8(1), pages 55-69, March.
  27. Rietz, Thomas A., 1988. "The equity risk premium a solution," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 117-131, July.
  28. Chip Heath & Steven Huddart & Mark Lang, 1999. "Psychological Factors And Stock Option Exercise," The Quarterly Journal of Economics, MIT Press, vol. 114(2), pages 601-627, May.
  29. Nicholas Barberis & Ming Huang & Tano Santos, 2001. "Prospect Theory And Asset Prices," The Quarterly Journal of Economics, MIT Press, vol. 116(1), pages 1-53, February.
  30. Hey, John D & Orme, Chris, 1994. "Investigating Generalizations of Expected Utility Theory Using Experimental Data," Econometrica, Econometric Society, vol. 62(6), pages 1291-1326, November.
  31. Nicholas Barberis, 2001. "Mental Accounting, Loss Aversion, and Individual Stock Returns," Journal of Finance, American Finance Association, vol. 56(4), pages 1247-1292, 08.
  32. Terrance Odean, 1998. "Volume, Volatility, Price and Profit When All Traders Are Above Average," Finance 9803001, EconWPA.
  33. Mark Rubinstein., 1994. "Implied Binomial Trees," Research Program in Finance Working Papers RPF-232, University of California at Berkeley.
  34. George Loewenstein, 2000. "Emotions in Economic Theory and Economic Behavior," American Economic Review, American Economic Association, vol. 90(2), pages 426-432, May.
  35. Nicholas Barberis & Ming Huang, 2001. "Mental Accounting, Loss Aversion, and Individual Stock Returns," NBER Working Papers 8190, National Bureau of Economic Research, Inc.
  36. Mohammed Abdellaoui, 2000. "Parameter-Free Elicitation of Utility and Probability Weighting Functions," Management Science, INFORMS, vol. 46(11), pages 1497-1512, November.
  37. Constantinides, George M, 1982. "Intertemporal Asset Pricing with Heterogeneous Consumers and without Demand Aggregation," The Journal of Business, University of Chicago Press, vol. 55(2), pages 253-67, April.
  38. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
  39. Lattimore, Pamela K. & Baker, Joanna R. & Witte, Ann D., 1992. "The influence of probability on risky choice: A parametric examination," Journal of Economic Behavior & Organization, Elsevier, vol. 17(3), pages 377-400, May.
  40. Dubois, M. & Louvet, P., 1996. "The day-of-the-week effect: The international evidence," Journal of Banking & Finance, Elsevier, vol. 20(9), pages 1463-1484, November.
  41. Gibbons, Michael R & Hess, Patrick, 1981. "Day of the Week Effects and Asset Returns," The Journal of Business, University of Chicago Press, vol. 54(4), pages 579-96, October.
  42. Ait-Sahalia, Yacine & Wang, Yubo & Yared, Francis, 2001. "Do option markets correctly price the probabilities of movement of the underlying asset?," Journal of Econometrics, Elsevier, vol. 102(1), pages 67-110, May.
  43. Brad M. Barber & Terrance Odean, 2001. "Boys Will Be Boys: Gender, Overconfidence, And Common Stock Investment," The Quarterly Journal of Economics, MIT Press, vol. 116(1), pages 261-292, February.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Barseghyan, Levon & Molinari, Francesca & O'Donoghue, Ted & Teitelbaum, Joshua C., 2011. "The Nature of Risk Preferences: Evidence from Insurance Choices," Working Papers 11-03, Cornell University, Center for Analytic Economics.
  2. Mohammed Abdellaoui & Han Bleichrodt & Hilda Kammoun, 2013. "Do financial professionals behave according to prospect theory? An experimental study," Theory and Decision, Springer, vol. 74(3), pages 411-429, March.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:eee:jeborg:v:71:y:2009:i:2:p:330-346. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.