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Utility theory front to back - inferring utility from agents' choices
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Cox, Alexander M. G., Hobson, David (David G.) and Obloj, Jan (2014) Utility theory front to back - inferring utility from agents' choices. International Journal of Theoretical and Applied Finance, Volume 17 (Number 3). doi:10.1142/S0219024914500186 ISSN 0219-0249.
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Official URL: http://dx.doi.org/10.1142/S0219024914500186
Abstract
We pursue an inverse approach to utility theory and associated consumption and investment problems. Instead of specifying a utility function and deriving the actions of an agent, we assume that we observe the actions of the agent (i.e. consumption and investment strategies) and ask if it is possible to derive a utility function for which the observed behavior is optimal. We work in continuous time both in a deterministic and stochastic setting. In the deterministic setup, we find that there are infinitely many utility functions generating a given consumption pattern. In the stochastic setting of a geometric Brownian motion market it turns out that the consumption and investment strategies have to satisfy a consistency condition (PDE) if they are to come from a classical utility maximization problem. We show further that important characteristics of the agent such as risk attitudes (e.g., DARA) can be deduced directly from the agent's consumption and investment choices.
Item Type: | Journal Article | ||||||||
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Divisions: | Faculty of Science, Engineering and Medicine > Science > Statistics | ||||||||
Journal or Publication Title: | International Journal of Theoretical and Applied Finance | ||||||||
Publisher: | World Scientific Publishing Co. Pte. Ltd. | ||||||||
ISSN: | 0219-0249 | ||||||||
Official Date: | 12 May 2014 | ||||||||
Dates: |
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Volume: | Volume 17 | ||||||||
Number: | Number 3 | ||||||||
DOI: | 10.1142/S0219024914500186 | ||||||||
Status: | Peer Reviewed | ||||||||
Publication Status: | Published | ||||||||
Access rights to Published version: | Restricted or Subscription Access | ||||||||
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