the realization effect risk taking after realized versus paper losses abstract understanding how prior outcomes affect risk attitudes is critical for the study of choice under uncertainty a large literature documents the significant influence of prior losses on risk attitudes the findings appear contradictory some studies find greater risk taking after a loss whereas others show the opposite that people take on less risk i reconcile these seemingly inconsistent findings by distinguishing between realized versus paper losses using new and existing data i replicate prior findings and demonstrate that following a realized loss individuals avoid risk if the same loss is not realized a paper loss individuals take on greater risk jel d11 d14 d81 g11

risk neutral firms can extract unbounded profits from consumers with prospect theory preferences this paper considers the problem of a risk neutral firm offering a gamble to consumers with preferences given by prospect theory under conditions satisfied by virtually all functional forms used in the literature firms can extract arbitrarily high expected values from consumers moreover for any given lottery there exists another lottery that makes both the firm and the consumer better off as a consequence equilibria and pareto optimal allocations do not exist in standard monopolistic or competitive models

the duality of a dynamic model of equilibrium and an optimal growth model the heterogeneous capital goods case the equivalence between optimal growth solutions and solutions of decentralized models of intertemporal allocation is explored in a one consumer heterogeneous capital goods framework the decentralized economy follows a perfect foresight path the main result is that the decentralized economy will impose on itself a transversality condition this yields the interpretation of equilibrium prices as prices consistent with a certainty version of the efficient markets hypothesis the results rest on the recent contribution by benveniste and scheinkman providing sufficient conditions for infinite horizon concave programs to exhibit capital value transversality as a necessary condition for optimality

skewness preference and the popularity of technical analysis abstract we propose a simple model of how investors evaluate a trading rule and show that the market timing of technical trading rules induces lottery like trading profits therefore investors preference for positive skewness caters to the popularity of technical analysis since prospect theory implies strong skewness preference it can explain why investors trade extensively on chart patterns that are meaningless in light of the efficient market hypothesis technicians often invoke behavioral finance as its theoretical foundation contrary to this view we show that ideas from behavioral finance explain why technical analysis is popular despite the lack of theoretical foundation and empirical success

prospect theory liquidation and the disposition effect there is a well known intuition linking prospect theory with the disposition effect the tendency of investors to sell assets that have risen in value rather than fallen recently several authors have studied rigorous models in an attempt to formalize the intuition however some have found it difficult to predict a disposition effect while others produce a more extreme prediction where investors never voluntarily sell at a loss we solve a model of asset liquidation where investors realize utility over gains and losses and utility is concave over gains and convex over losses under the preferences of tversky and kahneman tversky a d kahneman 1992 advances in prospect theory cumulative representation of uncertainty j risk uncertainty5 4 297 323 and lognormal asset prices investors exhibit a disposition effect as gains are realized at a greater rate than losses nonetheless in contrast to the extant literature we find that the investor will give up and sell at a loss when the asset has a sufficiently low sharpe ratio this paper was accepted by brad barber teck ho and terrance odean special issue editors

cumulative prospect theory option returns and the variance premium the variance premium and the pricing of out of the money otm equity index options are major challenges to standard asset pricing models we develop a tractable equilibrium model with cumulative prospect theory cpt preferences that can overcome both challenges the key insight is that the variance premium can be written as the expected return on a portfolio of otm call and put options and the probability weighting feature of cpt can explain the puzzlingly low returns observed for these options using gmm on a sample of u s index option returns between 1996 and 2010 we show that the cpt model ts well observed option prices and therefore the variance premium in a dynamic setting probability weighting and time varying equity return volatility combine to match the observed time series pattern of the variance premium

on skewed risks in economic models and experiments many of the most significant risks that people face in their lives are left skewed i e imply large losses with only small probability i characterize skewness in binary risks which are widely applied in both economic models and experiments moreover i provide an explicit re parametrization of binary risks in terms of their first three moments these results allow for the conducting of comparative statics analysis with regard to skewness and provide a useful tool for the calibration of lotteries in experiments i apply them to show that left skewed background risks give rise to a very strong precautionary saving motive and to collect additional laboratory evidence on skewness preference and risk seeking behavior

a theory of anticipated utility abstract a new theory of cardinal utility with an associated set of axioms is presented it is a generalization of the von neumann morgenstern expected utility theory which permits the analysis of phenomena associated with the distortion of subjective probability

a utility and cpt based comparison of life insurance contracts with guarantees abstract some recent literature studies whether contracts including financial guarantees can be preferred by a utility maximizing investor the main result for contracts exposed solely to financial risk e g doskeland and nordahl 2008 dichtl and drobetz 2011 is that expected utility theory eut fails to interpret demand for guarantees while cumulative prospect theory cpt is able to support the demand while the development of the financial market has a significant impact on the portfolio choice some other non financial risk might play an important role too in the present paper we take life insurance products as an example where the long term nature of these contracts places a special emphasis on the uncertain lifetime of the investor we incorporate the mortality risk and investigate its effect on the attractiveness of contracts offering minimum interest rate guarantees to eut and cpt investors for this purpose we introduce two approaches for the consideration of multiple risk sources within cpt we illustrate the theoretical framework with numerous simulations and our numerical results show that a long term risk averse eut investor prefers products with guarantees

until the bitter end on prospect theory in a dynamic context many economic and financial decisions depend crucially on their timing people decide when to invest in a project when to liquidate assets or when to stop gambling in a casino we provide a general result on prospect theory decision makers who are unaware of the time inconsistency induced by probability weighting if a market offers a sufficiently rich set of investment strategies then such naive investors postpone their stopping decisions indefinitely we illustrate the drastic consequences of this never stopping result and conclude that probability distortion in combination with naivete leads to unrealistic predictions for a wide range of dynamic setups

risk aversion in the theory of expected utility with rank dependent probabilities expected utility with rank dependent probability theory is a model of decision making under risk where the preference relations on the set of probability distributions is represented by the mathematical expectation of a utility function with respect to a transformation of the probability distributions on the set of outcomes this paper defines based on g teaux differentiability measures of risk aversion for such preferences which characterize the relation more risk averse and applies these measures to the analysis of unconditional and conditional portfolio choice problems

technical note path dependent and randomized strategies in barberis casino gambling model we consider the dynamic casino gambling model initially proposed by barberis 2012 and study the optimal stopping strategy of a precommitting gambler with cumulative prospect theory cpt preferences we illustrate how the strategies computed in barberis 2012 barberis n 2012 a model of casino gambling management sci 58 1 35 51 can be strictly improved by reviewing the betting history or by tossing an independent coin and we explain that the improvement generated by using randomized strategies results from the lack of quasi convexity of cpt preferences moreover we show that any path dependent strategy is equivalent to a randomization of path independent strategies

prospect theory and liquidation decisions we solve a liquidation problem for an agent with preferences consistent with the prospect theory of kahneman and tversky econometrica 47 1979 263 291 we find that the agent is willing to hold a risky project with a relatively inferior sharpe ratio if the project is currently making losses and intends to liquidate it when it breaks even on the other hand the agent may liquidate a project with a relatively superior sharpe ratio if its current profits rise or drop to the break even point our results capture the spirit of the disposition effect and the break even effect documented in empirical and experimental studies

testing for prudence and skewness seeking numerous theoretical predictions such as precautionary saving or preventive behavior have been derived for prudent decision makers further prudence can be characterized as downside risk aversion and plays a key role in preference for skewness we use a simple experimental method to test for prudence and skewness preference in the laboratory and compare the two to this end we introduce a novel graphical representation of compound lotteries that is easily accessible to subjects and test it for robustness using a factorial design prudence is observed on the aggregate and individual level we find that prudence does not boil down to skewness seeking we further provide some theoretical explanations for this result this paper was accepted by peter wakker decision analysis

an index of loss aversion to a considerable extent risk aversion as it is commonly observed is caused by loss aversion several indexes of loss aversion have been proposed in the literature the one proposed in this paper leads to a clear decomposition of risk attitude into three distinct components basic utility probability weighting and loss aversion the index is independent of the unit of payment the main theorem shows how the indexes of different decision makers can be compared through observed choices

on the impossibility of protecting risk takers risk neutral sellers can extract high profits from risk loving buyers by oering them lotteries to limit risk taking gambling is heavily regulated in most countries i show that protecting risk loving buyers is essentially impossible even if buyers are risk loving only asymptotically the seller can construct a nonrandom winner pays auction that ensures unbounded profits buyers are asymptotically risk loving for example when their preferences satisfy savage s axioms or they have prospect theory preferences the profits are unbounded even if the seller cannot use any mechanism that resembles a lottery

a model of casino gambling we show that prospect theory offers a rich theory of casino gambling one that captures several features of actual gambling behavior first we demonstrate that for a wide range of preference parameter values a prospect theory agent would be willing to gamble in a casino even if the casino offers only bets with no skewness and with zero or negative expected value second we show that the probability weighting embedded in prospect theory leads to a plausible time inconsistency at the moment he enters a casino the agent plans to follow one particular gambling strategy but after he starts playing he wants to switch to a different strategy the model therefore predicts heterogeneity in gambling behavior how a gambler behaves depends on whether he is aware of the time inconsistency and if he is aware of it on whether he can commit in advance to his initial plan of action this paper was accepted by brad barber teck ho and terrance odean special issue editors

reference dependent risk attitudes we use koszegi and rabin s 2006 model of reference dependent utility and an extension of it that applies to decisions with delayed consequences to study preferences over monetary risk because our theory equates the reference point with recent probabilistic beliefs about outcomes it predicts specific ways in which the environment influences attitudes toward modest scale risk it replicates classical prospect theory including the prediction of distaste for insuring losses when exposure to risk is a surprise but implies first order risk aversion when a risk and the possibility of insuring it are anticipated a prior expectation to take on risk decreases aversion to both the anticipated and additional risk for large scale risk the model allows for standard consumption utility to dominate reference dependent gain loss utility generating nearly identical risk aversion across situations

patent statistics in the age of globalisation new legal procedures new analytical methods new economic interpretation abstract patent analysis seems to become more difficult in the age of globalisation starting from microlevel observations it is evident that multinational enterprises pursue different technological marketing and strategic aims in effect they cover world markets in a distinctly different manner with patent intellectual property this article in good economic tradition starts with consideration of recent microlevel patent behaviour in telecommunications before new macroeconomic procedures to measure technical change are outlined the new challenges to patent statistics comprise the assignment of countries to patent documents of multinational firms the appropriate use of economic filters in comparing patent statistics from various patent offices the fitting of the new international patent procedures offered by the amended patent cooperation treaty pct to national statistics the assignment of patent applications in case of withdrawn country destinations and the estimation of time series if most recent data sets are incomplete we propose consistent workable adjustments to patent statistics that overcome the above mentioned biases which we denote the triad patent model for measuring technical progress in the proper economic sense first applications deal with the assessment of the pace of technical change in major countries up until 1995 in conclusion we discuss problems for future research the main policy implication is that macroeconomic patent statistics can correct for the effects of global knowledge production indeed as these are not disruptive but rather limited and well accountable