S-shaped Utility Functions and the Puzzles of the Financial Market

Through thorough statistical analysis and analytic calculations, this book reveals the power of S- shaped utility functions for modeling in the financial market. By considering the average of the relative risk aversion (RRA) of the consumers instead of the RRA of the average (representative) consumer, it exhibits an utility that has stable and low mean RRA and avoids the risk-free puzzle present in the most commonly used utilities. The particular form of the RRA as a function of consumption level has important implications for behavioral finance and the potential to explain many psychological phenomena in economics. As an unexpected spin-off, the book shows that the oil shocks were the main causes of havoc in the American financial market in the second half of the XX century, this discovery being deemed relevant for geopolitics and warfare analysis.