Utility Models and Prospect Theory
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Utility Models and Prospect Theory2015-06-27Alexander HarinDecision confidence in the Ellsberg experiment
http://d.repec.org/n?u=RePEc:awi:wpaper:0594&r=upt
Subjects are asked to report their confidence in their own decisions regarding the Ellsberg three color urn. Subjective confidence is measured via a 5 point Likert scale. Surprisingly, subjects are more confident in their answer for the more complicated two color question, compared to the simple one color question. This is robust across a wide range of experimental contexts.Duersch, Peter2015-06-18Ellsberg experiment; ConfidenceBayesian learning with multiple priors and non-vanishing ambiguity
http://d.repec.org/n?u=RePEc:rza:wpaper:521&r=upt
The existing models of Bayesian learning with multiple priors by Marinacci (2002) and by Epstein and Schneider (2007) formalize the intuitive notion that ambiguity should vanish through statistical learning in an one-urn environment. Moreover, the multiple priors decision maker of these models will eventually learn the Â‘'truthÂ’'. To accommodate non vanishing violations of SavageÂ’s (1954) sure-thing principle, as reported in Nicholls et al. (2015), we construct and analyze a model of Bayesian learning with multiple priors for which ambiguity does not necessarily vanish. Our decision maker only forms posteriors from priors that pass a plausibility test in the light of the observed data in the form of a Î³-maximum expected loglikelihood prior-selection rule. The "Â“stubbornness"Â” parameter Î³â‰¥1 determines the magnitude by which the expectation of the loglikelihood with respect to plausible priors can differ from the maximal expected loglikelihood. The greater the value of y, the more priors pass the plausibility test to the effect that less ambiguity vanishes in the limit of our learning model.Alexander Zimper and Wei Ma2015Ambiguity, Bayesian learning, MisspeciÂ…ed Priors, BerkÂ’s Theo- rem, Kullback-Leibler Divergence, Ellsberg ParadoxExamining the Relationship between Risk Aversion and Behavioral Loyalty in the presence of Brand Affects and Attitudinal Loyalty as mediator: Evidence from Emerging Market
http://d.repec.org/n?u=RePEc:sek:ibmpro:2303924&r=upt
The Purpose of this study was to determine the effect of risk aversion on behavioral loyalty in telecom sector of Pakistan. A self-administered questionnaire was used to collect data from respondents using different mobile phone brands on five-point likert scale. Overall 300 filled useable questionnaires were used for data analysis. Data was analyzed through SPSS 21 and AMOS 18. The outcome of various path analyses such as confirmatory factor analysis and Structural Equation Modeling suggest that Risk aversion has direct and positive effect Attitudinal Loyalty; while it has no direct effect on behavioral loyalty Although Risk Aversion has indirect effect on behavioral loyalty through brand affects and attitudinal loyalty as mediator. Different factors are investigated and studies in this study which connects risk aversion with behavioral loyalty. As a result research endeavors to fill the gap about the lack of academic literature on risk aversion and behavioral loyalty relationship in Pakistani context. The results suggest that practitioners may need to be responsive of Loyalty programs as a key indicator in strengthening customer relationship management. The study proposed theoretical implications for Risk aversion and customer loyalty construct. The study will further help practitioners as well as academicians to formulize novel theories to understand consumers’ behavior.Muhammad Irfan Tariq2015-06Risk aversion, behavioral loyalty, attitudinal loyalty, brand affects, customer relationship managementPrivate ownership economies with externalities and existence of competitive equilibria: A differentiable approach
http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-01164015&r=upt
We consider a general equilibrium model of a private ownership economy with consumption and production externalities. Utility functions and production technologies may be affected by the consumption and production activities of all other agents in the economy. We use differential techniques to show that the set of competitive equilibria is non-empty and compact. Fixing the externalities, the assumptions on utility functions and production technologies are standard in a differentiable framework. Competitive equilibria are written in terms first-order conditions associated with agents' behavior and market clearing conditions, following the seminal work by Smale (1974). Adapting differential techniques to economies with externalities is non trivial and it requires some ingenious adjustments, because the production technologies are not required to be convex with respect to the consumption and production activities of all agents.Elena L. Del Mercato, Vincenzo Platino2015-04A bitter choice turned sweet: How acknowledging individuals' concern at having a low relative income serves to align utilitarianism and egalitarianism
http://d.repec.org/n?u=RePEc:zbw:tuewef:81&r=upt
When individuals' utility is a convex combination of their income and their concern at having a low relative income (the weights attached to income and to the concern at having a low relative income sum up to one), the maximization of aggregate utility yields an equal income distribution. This alignment of utilitarianism and egalitarianism is obtained for any number of individuals, and for general utility functions that are convex combinations of a power function of income and the concern at having a low relative income. The alignment can also hold when the weights sum up to a number different than one.Stark, Oded, Jakubek, Marcin, Kobus, Martyna2015Utilitarianism,Egalitarianism,Social welfare maximization,Low relative incomeAnnuitization and asset allocation
http://d.repec.org/n?u=RePEc:arx:papers:1506.05990&r=upt
This paper examines the optimal annuitization, investment and consumption strategies of a utility-maximizing retiree facing a stochastic time of death under a variety of institutional restrictions. We focus on the impact of aging on the optimal purchase of life annuities which form the basis of most Defined Benefit pension plans. Due to adverse selection, acquiring a lifetime payout annuity is an irreversible transaction that creates an incentive to delay. Under the institutional all-or-nothing arrangement where annuitization must take place at one distinct point in time (i.e. retirement), we derive the optimal age at which to annuitize and develop a metric to capture the loss from annuitizing prematurely. In contrast, under an open-market structure where individuals can annuitize any fraction of their wealth at anytime, we locate a general optimal annuity purchasing policy. In this case, we find that an individual will initially annuitize a lump sum and then buy annuities to keep wealth to one side of a separating ray in wealth-annuity space. We believe our paper is the first to integrate life annuity products into the portfolio choice literature while taking into account realistic institutional restrictions which are unique to the market for mortality-contingent claims.Moshe A. Milevsky, Virginia R. Young2015-06Gauge field theory of market dynamics: Toward a solution of the "man vs. men" dilemma
http://d.repec.org/n?u=RePEc:pra:mprapa:65274&r=upt
The current economics and psychology are developed within the Newtonian tradition in physics from both conceptual and instrumental perspectives. This paper aims to integrate economics and cognitive science by applying gauge field theory of modern theoretical physics. Many controversies between normative theories and behavioral theories are characterized by the “man vs. men” dilemma. Gauge potential and gauge field strength are constructed at both the man-level and the men-level in order to satisfy the principle of gauge invariance. To maintain the Lagrangian density function invariant, the gauge transformations of the first kind and the second kind are performed at the man-level and the men-level, respectively. The market dynamics is modeled by the logic of electrodynamics. The interactions of the market and individual participants are formulated by the logic of electromagnetic coupling. In establishing the market dynamic equations, individual utility function serves as gauge function and efficiency provides gauge freedom.Yang, Yingrui2015-06bounded rationality; economic rational man; electrodynamics; gauge theory; market dynamics; cognitive fieldPortfolio Optimization under Local-Stochastic Volatility: Coefficient Taylor Series Approximations & Implied Sharpe Ratio
http://d.repec.org/n?u=RePEc:arx:papers:1506.06180&r=upt
We study the finite horizon Merton portfolio optimization problem in a general local-stochastic volatility setting. Using model coefficient expansion techniques, we derive approximations for the both the value function and the optimal investment strategy. We also analyze the `implied Sharpe ratio' and derive a series approximation for this quantity. The zeroth-order approximation of the value function and optimal investment strategy correspond to those obtained by Merton (1969) when the risky asset follows a geometric Brownian motion. The first-order correction of the value function can, for general utility functions, be expressed as a differential operator acting on the zeroth-order term. For power utility functions, higher order terms can also be computed as a differential operator acting on the zeroth-order term. We give a rigorous accuracy bound for the higher order approximations in this case in pure stochastic volatility models. A number of examples are provided in order to demonstrate numerically the accuracy of our approximations.Matthew Lorig, Ronnie Sircar2015-06A Case for Standard Theory?
http://d.repec.org/n?u=RePEc:bie:wpaper:542&r=upt
Using data from an experiment by Forsythe, Myerson, Rietz, and Weber (1993), designed for a different purpose, we test the "standard theory" that players have preferences only over their own mentary payoffs and that play will be in (evolutionary stable) equilibrium. In the experiment each subject is recurrently (24 times) randomly matched with ever changing opponents to play a 14 player game. We find that assuming risk-neutrality for all players leads to a predicted evolutionary stable equilibrium that, while it can be rejected at the 5% level of significance, is nevertheless remarkably close to "explaining" the data. Moreover, when we assume that players are risk-averse and we calibrate their risk-aversion in one treatment with a simple game, this theory cannot be rejected at the 5% level of significance for another treatment with a more complicated game, despite the fact that we have close to 400 data points.Christoph Kuzmics, Daniel Rodenburger2015-06opinion polls, elections, voting, testing, Nash equilibrium, attainable equilibrium, symmetriesHedging, arbitrage and optimality with superlinear frictions
http://d.repec.org/n?u=RePEc:arx:papers:1506.05895&r=upt
In a continuous-time model with multiple assets described by c\`{a}dl\`{a}g processes, this paper characterizes superhedging prices, absence of arbitrage, and utility maximizing strategies, under general frictions that make execution prices arbitrarily unfavorable for high trading intensity. Such frictions induce a duality between feasible trading strategies and shadow execution prices with a martingale measure. Utility maximizing strategies exist even if arbitrage is present, because it is not scalable at will.Paolo Guasoni, Mikl\'os R\'asonyi2015-06How to cope with (new) uncertainties: A bounded rationality approach
http://d.repec.org/n?u=RePEc:zbw:ifwedp:201546&r=upt
A rigorous reconstruction of scenario-based real choice making reveals the incompleteness of decision-modeling and the practical prevalence of uncertainty. Theoretically complete models conceal it. As a remedy a scenario-based procedure of coping with uncertainty can prescribe how the boundedly rational decision-maker should proceed from her or his internal point of view. Though models of substantive rationality cannot serve as guidance for decision-making under uncertainty, we can improve prescriptions for coping with uncertainties in view of evidence of substantive success or failure. Decision theory should aim for a reflective equilibrium incorporating internalist-prescriptive and externalist-descriptive aspects to turn good into better practice.Güth, Werner, Kliemt, Hartmut2015uncertainty,procedural rationality,satisficing,risk-communicationNot so classy after all: Identity utility and the risk of discrimination of LGB people
http://d.repec.org/n?u=RePEc:pra:mprapa:65125&r=upt
The present study contributes to the literature on the economics of discrimination by considering some consequences of sexual orientation discrimination. Specifically, we analyse LGB people's decision to "come out" within an identity utility theoretical framework, and estimate the model on a representative sample of the EU population. We aim to investigate the factors that systematically affect a person's inclusion in competing definitions of LGB people and the potential role of sample selection biases, such as the one leading to the commonplace mistaken assumption of the affluence of gay men. Interval regression estimates of the risk attitude coefficient within the choice to come out suggest that heterogeneity in the objective dimensions of socio-economic welfare may explain a sample selection between "out" and "closeted" LGB people, which lies behind the "myth of gay affluence".Botti, Fabrizio, Conte, Anna, D'Ippoliti, Carlo2015-06-01Identity utility, Expected utility, Sexual Orientation; DisclosureViolations of first-order stochastic dominance as salience effects
http://d.repec.org/n?u=RePEc:zbw:dicedp:189&r=upt
In contradiction to expected utility theory, various studies find that splitting events or attributes into subevents and subattributes can reverse a decision maker's choices. Most notably, these effects can induce first-order stochastic dominated choices. These violations of first-order stochastic dominance are framing effects, which expected utility theory, cumulative prospect theory and salience theory of choice under risk cannot account for. However, we propose a version of salience theory which unravels the underlying mechanism triggering such effects and which can explain the impact of event- and attribute-splitting on choices. Hereby, we provide further rationale for the broad validity of the salience mechanism and its strong descriptive power concerning human decision making.Dertwinkel-Kalt, Markus, Köster, Mats2015First-order stochastic dominance,Framing effects,Prospect theory,Salience theoryHow Natural Disasters Can Affect Environmental Concerns, Risk Aversion, and Even Politics: Evidence from Fukushima and Three European Countries
http://d.repec.org/n?u=RePEc:diw:diwsop:diw_sp762&r=upt
We study the impact of the Fukushima disaster on environmental concerns, well-being, risk aversion, and political preferences in Germany, Switzerland, and the UK. In these countries, overall life satisfaction did not significantly decrease, but the disaster significantly increased environmental concerns among Germans. One underlying mechanism likely operated through the perceived risk of a similar meltdown of domestic reactors. After Fukushima, more Germans considered themselves as “very risk averse”. However, drastic German policy action shut down the oldest reactors, implemented the phaseout of the remaining ones, and proclaimed the transition to renewables. This shift in energy policy contributed to the subsequent decrease in environmental concerns, particularly among women, Green party supporters, and people living in close distance to the oldest reactors. In Germany, political support for the Greens increased significantly, whereas in Switzerland and the UK, this increase was limited to people living close to reactors.Jan Goebel, Christian Krekel, Tim Tiefenbach, Nicolas R. Ziebarth2015Fukushima, nuclear phase-out, environmental concerns, well-being, risk aversion, Green partyOn Game-Theoretic Risk Management (Part One) - Towards a Theory of Games with Payoffs that are Probability-Distributions
http://d.repec.org/n?u=RePEc:arx:papers:1506.07368&r=upt
Optimal behavior in (competitive) situation is traditionally determined with the help of utility functions that measure the payoff of different actions. Given an ordering on the space of revenues (payoffs), the classical axiomatic approach of von Neumann and Morgenstern establishes the existence of suitable utility functions, and yields to game-theory as the most prominent materialization of a theory to determine optimal behavior. Although this appears to be a most natural approach to risk management too, applications in critical infrastructures often violate the implicit assumption of actions leading to deterministic consequences. In that sense, the gameplay in a critical infrastructure risk control competition is intrinsically random in the sense of actions having uncertain consequences. Mathematically, this takes us to utility functions that are probability-distribution-valued, in which case we loose the canonic (in fact every possible) ordering on the space of payoffs, and the original techniques of von Neumann and Morgenstern no longer apply. This work introduces a new kind of game in which uncertainty applies to the payoff functions rather than the player's actions (a setting that has been widely studied in the literature, yielding to celebrated notions like the trembling hands equilibrium or the purification theorem). In detail, we show how to fix the non-existence of a (canonic) ordering on the space of probability distributions by only mildly restricting the full set to a subset that can be totally ordered. Our vehicle to define the ordering and establish basic game-theory is non-standard analysis and hyperreal numbers.Stefan Rass2015-06Income effects and the welfare consequences of tax in differentiated product oligopoly
http://d.repec.org/n?u=RePEc:cpr:ceprdp:10670&r=upt
Random utility models are widely used to study consumer choice. The vast majority of applications make strong assumptions about the marginal utility of income, which restricts income effects, demand curvature and pass-through. We show that flexibly modeling income effects can be important, particularly if one is interested in the distributional effects of a policy change, even in a market in which, a priori, the expectation is that income effects will play a limited role. We allow for much more flexible forms of income effects than is common and we illustrate the implications by simulating the introduction of an excise tax.Griffith, Rachel, Nesheim, Lars, O'Connell, Martin2015-06compensation variation; demand estimation; income effects; oligopoly; pass-through