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General stopping behaviors of naïve and noncommitted sophisticated agents, with application to probability distortion

Yu‐Jui Huang, Adrien Nguyen‐Huu and Xun Yu Zhou
Authors registered in the RePEc Author Service: Adrien Nguyen-Huu

Mathematical Finance, 2020, vol. 30, issue 1, 310-340

Abstract: We consider the problem of stopping a diffusion process with a payoff functional that renders the problem time‐inconsistent. We study stopping decisions of naïve agents who reoptimize continuously in time, as well as equilibrium strategies of sophisticated agents who anticipate but lack control over their future selves' behaviors. When the state process is one dimensional and the payoff functional satisfies some regularity conditions, we prove that any equilibrium can be obtained as a fixed point of an operator. This operator represents strategic reasoning that takes the future selves' behaviors into account. We then apply the general results to the case when the agents distort probability and the diffusion process is a geometric Brownian motion. The problem is inherently time‐inconsistent as the level of distortion of a same event changes over time. We show how the strategic reasoning may turn a naïve agent into a sophisticated one. Moreover, we derive stopping strategies of the two types of agent for various parameter specifications of the problem, illustrating rich behaviors beyond the extreme ones such as “never‐stopping” or “never‐starting.”

Date: 2020
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Citations: View citations in EconPapers (14)

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https://doi.org/10.1111/mafi.12224

Related works:
Working Paper: General Stopping Behaviors of Naive and Non-Committed Sophisticated Agents, with Application to Probability Distortion (2019) Downloads
Working Paper: General stopping behaviors of naive and non-committed sophisticated agents, with application to probability distortion (2019)
Working Paper: General stopping behaviors of naïve and non-committed sophisticated agents, with application to probability distortion (2018) Downloads
Working Paper: General stopping behaviors of naïve and non-committed sophisticated agents, with application to probability distortion (2018) Downloads
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