Abstract

(This talk is based on two related papers – abstracts below):

RICH MIXTURE SET, PROCESS PREFERENCE, AND HOME BIAS

Abstract: Decision making often involves compounding of risks from different sources. Building on the Herstein-Milnor mixture set axiomatization of expected utility theory, we employ multiple mixture operators each modeling a source of risk to arrive at the definition of a rich mixture set, elements of which are rich lotteries. Our modeling framework enables a source-dependent weakening of the independence axiom as well as the reduction of compound lottery axiom. This yields a representation for preference over rich lotteries called source recursive expected utility (SREU). When there is consistent preference for the “same” lottery arising from different sources, SREU implies a preference for risk being resolved more decisively by the preferred source. We further show that an SREU investor always exhibits home bias when she consistently prefers risks arising from the domestic stock market over identically distributed risks from the foreign stock market.

EXPERIMENTAL EVIDENCE OF SOURCE PREFERENCE: FAMILIARITY AND HOME BIAS

Abstract: This paper experimentally tests the Fox-Tversky (1995) source preference hypothesis as axiomatized in Chew and Sagi (2008) where people may have preference between equally distributed risks depending on the underlying sources of uncertainty. We study two forms of source preference. One is based on familiarity of risks arising from the trailing digit of stock prices in the home city exchange. Another is based on the trailing digit of the market index of the home city versus that of a foreign city. We find a familiarity-based source preference in portfolios comprising strictly dominated bets associated with more familiar stocks and in valuation of bets elicited using an ascending-price auction. Complementarily, we find a home bias in terms of Shanghai (Hong Kong) subjects preferring to bet on the trailing digit of the Shanghai Stock Exchange Index (Hang Seng Index) even though the same bets based on Dow Jones Industrial Average would pay more. Taken together, our study suggests that home bias is driven mainly by source preference rather than ambiguity aversion.

About the Speaker

Prof. CHEW Soo Hong is Chief Professor at the Southwestern University of Finance and Economics, where he directs its China Center for Behavioral Economics and Finance. He is a fellow of the Econometric Society (2011), which awarded him the Leonard J. Savage thesis prize, and of the Society for the Advancement of Economic Theory. Chew is an Emeritus Professor at NUS and has previously taught at HKUST, UC lrvine, Johns Hopkins, and the University of Arizona. He has published in well regarded journals such as Econometrica, Journal of Political Economy, Journal of Economic Theory, Review of Economic Studies, International Economic Review as well as PNAS, Management Science, PRSB, Neuron, PLoS ONE, among many other top-tier journals.