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Cognitive biases and the representative agent

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  • Elyès Jouini

    ()
    (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS : UMR7534 - Université Paris Dauphine - Paris IX)

  • Clotilde Napp

    (DRM - Dauphine Recherches en Management - CNRS : UMR7088 - Université Paris Dauphine - Paris IX)

Abstract

In this paper, we show that behavioral features can be obtained at a group level when the individuals of the group are heterogeneous enough. Starting from a standard model of Pareto optimal allocations, with expected utility maximizers and exponential discounting, but allowing for heterogeneity among individual beliefs and individual time preference rates, we show that the representative agent has an inverse S-shaped probability distortion function and hyperbolic discount rates. As an application of this result, we show that an agent with a probability weighting function as in Cumulative Prospect Theory (resp. an ambiguity averse agent, resp. an hyperbolic discounting agent) may be represented as a collection of agents with noisy beliefs (resp. heterogeneous beliefs, resp. heterogeneous constant discount rates).

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Bibliographic Info

Paper provided by HAL in its series Working Papers with number halshs-00488570.

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Date of creation: 2009
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Handle: RePEc:hal:wpaper:halshs-00488570

Note: View the original document on HAL open archive server: http://halshs.archives-ouvertes.fr/halshs-00488570/en/
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Related research

Keywords: behavioral agent; hyperbolic discounting; probability weighting function; representative agent; neurofinance; ambiguity aversion.;

References

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  1. Jouini, Elyès & Napp, Clotilde & Nocetti, Diego, 2008. "Properties of the Social Discount Rate in a Benthamite Framework with Heterogeneous Degrees of Impatience," Economics Papers from University Paris Dauphine 123456789/260, Paris Dauphine University.
  2. Gollier, Christian, 1997. "A Note on Portfolio Dominance," Review of Economic Studies, Wiley Blackwell, vol. 64(1), pages 147-50, January.
  3. Isabelle Brocas & Juan D. Carrillo, 2008. "The Brain as a Hierarchical Organization," American Economic Review, American Economic Association, vol. 98(4), pages 1312-46, September.
  4. Mohammed Abdellaoui, 2000. "Parameter-Free Elicitation of Utility and Probability Weighting Functions," Management Science, INFORMS, vol. 46(11), pages 1497-1512, November.
  5. Landsberger, Michael & Meilijson, Isaac, 1990. "Demand for risky financial assets: A portfolio analysis," Journal of Economic Theory, Elsevier, vol. 50(1), pages 204-213, February.
  6. David Schmeidler, 1989. "Subjective Probability and Expected Utility without Additivity," Levine's Working Paper Archive 7662, David K. Levine.
  7. Diecidue, E. & Wakker, P.P., 2000. "On the Intuition of Rank-Dependent Utility," Discussion Paper 2000-74, Tilburg University, Center for Economic Research.
  8. Clotilde Napp & Elyès Jouini, 2007. "Consensus consumer and intertemporal asset pricing with heterogeneous beliefs," Post-Print halshs-00152348, HAL.
  9. Abel, Andrew B., 2002. "An exploration of the effects of pessimism and doubt on asset returns," Journal of Economic Dynamics and Control, Elsevier, vol. 26(7-8), pages 1075-1092, July.
  10. Elyès Jouini & Jean-Michel Marin & Clotilde Napp, 2010. "Discounting and Divergence of Opinion," Post-Print halshs-00176636, HAL.
  11. Thaler, Richard H & Shefrin, H M, 1981. "An Economic Theory of Self-Control," Journal of Political Economy, University of Chicago Press, vol. 89(2), pages 392-406, April.
  12. Drazen Prelec, 1998. "The Probability Weighting Function," Econometrica, Econometric Society, vol. 66(3), pages 497-528, May.
  13. Kenneth F. Reinschmidt, 2002. "Aggregate Social Discount Rate Derived from Individual Discount Rates," Management Science, INFORMS, vol. 48(2), pages 307-312, February.
  14. 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.
  15. Yvan Lengwiler, 2005. "Heterogeneous Patience and the Term Structure of Real Interest Rates," American Economic Review, American Economic Association, vol. 95(3), pages 890-896, June.
  16. Loewenstein, George & Prelec, Drazen, 1992. "Anomalies in Intertemporal Choice: Evidence and an Interpretation," The Quarterly Journal of Economics, MIT Press, vol. 107(2), pages 573-97, May.
  17. Fox, Craig R & Tversky, Amos, 1995. "Ambiguity Aversion and Comparative Ignorance," The Quarterly Journal of Economics, MIT Press, vol. 110(3), pages 585-603, August.
  18. Chateauneuf, Alain & Cohen, Michele, 1994. "Risk Seeking with Diminishing Marginal Utility in a Non-expected Utility Model," Journal of Risk and Uncertainty, Springer, vol. 9(1), pages 77-91, July.
  19. Shefrin, Hersh M & Thaler, Richard H, 1988. "The Behavioral Life-Cycle Hypothesis," Economic Inquiry, Western Economic Association International, vol. 26(4), pages 609-43, October.
  20. Christian Gollier & Richard Zeckhauser, 2005. "Aggregation of Heterogeneous Time Preferences," Journal of Political Economy, University of Chicago Press, vol. 113(4), pages 878-896, August.
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