Preferences under risk: content-dependent behavior and psychological processing

A common view in economics and psychology is that decision agents achieve their choices and express their respective preferences by computing probabilistic properties (probabilities and money) from a decisionmaking context (e.g., von Neumann and Morgenstern, 1947; Tversky and Kahneman, 1992; Starmer, 2000). In this computational processing, the main psychological mechanism requires that decision agents are able to integrate economic (contextual) attributes such as money and probabilities into subjective values; in other words people are able to construct and employ psycho-economic scales. Subsequently, when making a choice, decision agents are supposed to perform tradeoffs between the computed outputs (psycho-economic variables such as expected values) and certain monetary alternatives (see Kahneman and Tversky, 1979; Tversky and Kahneman, 1992

Illusory Losses

Recent empirical work demonstrates that people's self-reported happiness is surprisingly resilient to many large changes in life conditions. Apparently significant adverse events and conditions often inflict little or no hedonic damage because those who suffer losses do not focus on them on a daily basis. These findings have important implications for the legal system, especially for awards for pain, suffering, and hedonic losses, as juries overestimate the effect of injuries on happiness. There are two qualifications. First, some injuries do inflict significant hedonic losses because people cannot help focusing on them, such as chronic pain. Second, people may suffer 'capability loss' without suffering hedonic loss, and that should be compensable. These considerations suggest that the legal system might be improved by a set of Civil Damages Guidelines to correct these errors. There are also broader implications, involving the appropriate priorities for governments attempting to improve the welfare of their citizens.

Conditional Value-at-Risk Constraint and Loss Aversion Utility Functions

We provide an economic interpretation of the practice consisting in incorporating risk measures as constraints in a classic expected return maximization problem. For what we call the infimum of expectations class of risk measures, we show that if the decision maker (DM) maximizes the expectation of a random return under constraint that the risk measure is bounded above, he then behaves as a ``generalized expected utility maximizer'' in the following sense. The DM exhibits ambiguity with respect to a family of utility functions defined on a larger set of decisions than the original one; he adopts pessimism and performs first a minimization of expected utility over this family, then performs a maximization over a new decisions set. This economic behaviour is called ``Maxmin under risk'' and studied by Maccheroni (2002). This economic interpretation allows us to exhibit a loss aversion factor when the risk measure is the Conditional Value-at-Risk

Conditional Value-at-Risk Constraint and Loss Aversion Utility Functions

We provide an economic interpretation of the practice consisting in incorporating risk measures as constraints in a classic expected return maximization problem. For what we call the infimum of expectations class of risk measures, we show that if the decision maker (DM) maximizes the expectation of a random return under constraint that the risk measure is bounded above, he then behaves as a ``generalized expected utility maximizer'' in the following sense. The DM exhibits ambiguity with respect to a family of utility functions defined on a larger set of decisions than the original one; he adopts pessimism and performs first a minimization of expected utility over this family, then performs a maximization over a new decisions set. This economic behaviour is called ``Maxmin under risk'' and studied by Maccheroni (2002). This economic interpretation allows us to exhibit a loss aversion factor when the risk measure is the Conditional Value-at-Risk.Risk measures; Utility functions; Nonexpected utility theory; Maxmin; Conditional Value-at-Risk; Loss aversion

Causes, consequences, and cures of myopic loss aversion - An experimental investigation

Myopic loss aversion (MLA) has been established as one prominent explanation for the equity premium puzzle. In this paper we address two issues related to the effects of MLA on risky investment decisions. First, we assess the relative impact of feedback frequency and investment flexibility (via the investment horizon) on risky investments. Second, given that we observe higher investments with a longer investment horizon, we examine conditions under which investors might endogenously opt for a longer investment horizon in order to avoid the negative effects of MLA on investments. We find in our experimental study that investment flexibility seems to be at least as relevant as feedback frequency for the effects of myopic loss aversion. When subjects are given the choice to opt for a long or short investment horizon, there is no clear preference for either. Yet, if subjects face a default horizon (either long or short), there is rather little switching from the one to the other horizon, showing that a default might work to attenuate the effects of MLA. However, if subjects switch, they are more often willing to switch from the long to the short horizon than vice versa, suggesting a preference for higher investment flexibility

The Value of Reunification in Germany: An Analysis of Changes in Life Satisfaction

We quantify the value of changes in life circumstances in Germany following reunification. To this end, we develop and implement a fixed-effect estimator for ordinal life satisfaction in the German Socio-Economic Panel. We find strong negative effects on life satisfaction from being recently fired, losing a spouse through either death or separation and time spent in hospital, whilst we find strong positive effects from income and marriage. Using a new casual decomposition technique, we find that East Germans experienced a continued improvement in life satisfaction after 1990 to which increased household incomes contributed around 12%. Most of the increase is explained by improved average circumstances, such as public services. For West Germans, we find virtually no change in satisfaction between 1991 and 1999.Life satisfaction, German Reunification, Random and Fixed-Effects Panel Models, Causal Decomposition

Why do we invest ethically?

Analysis in this paper has proposed three potential motives for ethical investment - financial returns, non-wealth returns and social change. The motives are developed from the literature and illustrated in the context of a 'best of sector' fund and a socially screened fund. We find that the proposed motives are neither exhaustive nor exclusive and one single motive will not explain the behaviour of all ethical investors. There may be a trade-off between financial and psychic returns for some investors. The trade-off for consumption-investors is expected to be close to zero (total utility is maximised with small levels of ethical investment in the fun of participation model) and is expected to vary with the ethical intensity of investment-investors, as shown when we include ethical intensity into the investor's utility function. Psychic return can also be viewed as an increase in happiness and this approach would lend itself to empirical testing to increase our understanding of why we invest ethically

Measuring subjective wellbeing: recommendations on measures for use by national governments

Governments around the world are now beginning to seriously consider the use of measures of subjective wellbeing (SWB) – ratings of thoughts and feelings about life – for monitoring progress and for informing and appraising public policy. The mental state account of wellbeing upon which SWB measures are based can provide useful additional information about who is doing well and badly in life when compared to that provided by the objective list and preference satisfaction accounts. It may be particularly useful when deciding how best to allocate scarce resources, where it is desirable to express the benefits of intervention in a single metric that can be compared to the costs of intervention. There are three main concepts of SWB in the literature – evaluation (life satisfaction), experience (momentary mood) and eudemonia (purpose) – and policy-makers should seek to measure all three, at least for the purposes of monitoring progress. There are some major challenges to the use of SWB measures. Two related and well-rehearsed issues are the effects of expectations and adaptation on ratings. The degree to which we should allow wellbeing to vary according to expectations and adaptation are vexing moral problems but information on SWB can highlight what difference allowing for these considerations would have in practice (e.g. in informing prioiritisation decisions), which can then be fed into the normative debate. There are also questions about precisely what attention should be drawn to in SWB questions and how to capture the ratings of those least inclined to take part in surveys, but these can be addressed through more widespread use of SWB. We also provide some concrete recommendations about precisely what questions should be asked in large-scale surveys, and these recommendations have been taken up by the Office of National Statistics in the UK and are being looked at closely by the OECD