Testing theories of financial decision making.

Area of Science:

• Behavioral Economics
• Decision Theory
• Econometrics

Background:

• Models of decision under uncertainty are crucial for understanding economic behavior.
• Translation invariant preference models are widely used but their observable implications require characterization.
• Specific utility models like variational, maxmin, constant absolute risk aversion (CARA), and constant relative risk aversion (CRRA) lack clear empirical tests.

Purpose of the Study:

• To characterize the observable content of widely used translation invariant preference models.
• To derive revealed preference axioms for variational, maxmin, CARA, and CRRA utility models.
• To empirically test these axioms using experimental financial decision data.

Main Methods:

• Theoretical derivation of revealed preference axioms for specific utility models.
• Formulation of conditions for dataset consistency with each utility representation.
• Empirical testing of the derived axioms using data from a financial decision experiment.

Main Results:

• Each model (variational, maxmin, CARA, CRRA) is associated with a unique, testable revealed preference axiom.
• The axioms provide necessary and sufficient conditions for data to be consistent with the respective utility models.
• Experimental data is used to demonstrate the application and validation of these axioms.

Conclusions:

• The study successfully translates theoretical models of decision under uncertainty into empirically testable propositions.
• Revealed preference axioms offer a robust framework for identifying the observable content of various utility functions.
• The findings contribute to a better empirical understanding of financial decision-making and economic preferences.