nep-upt New Economics Papers
on Utility Models and Prospect Theories
Issue of 2006‒04‒01
eight papers chosen by
Alexander Harin
Modern University for the Humanities

  1. On the nature of certainty equivalent functionals By Hennessy, David A.; Lapan, Harvey E.
  2. Social Choice Theory and the Informational Basis Approach By Kevin Roberts
  3. Why people choose negative expected return assets - an empirical examination of a utility theoretic explanation By Thomas A. Garrett; Nalinaksha Bhattacharyya
  4. The Basics of International Trade: A Classroom Experiment By Alberto Isgut; Ganesan Ravishanker; Tanya Rosenblat
  5. Computation of the compensating variation within a random utility model using GAUSS software By Marilena Locatelli; Steinar Strøm
  6. Performance Pay and Risk Aversion By Christian Grund; Dirk Sliwka
  7. Imperfect competition and indeterminacy of aggregate output By Pengfei Wang; Yi Wen
  8. Reference-Dependent Risk Attitudes By Botond Koszegi; Matthew Rabin

  1. By: Hennessy, David A.; Lapan, Harvey E.
    Abstract: We explore connections between the certainty equivalent return (CER) functional and the underlying utility function. Curvature properties of the functional depend upon how utility function attributes relate to Hyperbolic Absolute Risk Aversion (HARA) type utility functions. If the CER functional is concave, i.e., if risk tolerance is concave in wealth, then preferences are standard. The CER functional is linear in lotteries if utility is HARA and lottery payoffs are on a line in state space. Implications for the optimality of portfolio diversification are given. When utility is concave and Non-increasing Relative Risk Averse, then the CER functional is superadditive in lotteries. Depending upon the nature of covariation among lottery payoffs,CERs for Constant Absolute Risk Averse utility functions may be subadditive or superadditive in lotteries. Our approach lends itself to straightforward experiments to elicit higher order attributes on risk preferences.
    Keywords: Convexity; Covariation; HARA preferences; Standardness; Superadditivity
    JEL: C6 D8 G1
    Date: 2006–03–23
  2. By: Kevin Roberts (Nuffield College, Oxford University)
    Abstract: For over a quarter of a century, the use of utility information based upon interpersonal comparisons has been seen as an escape route from the Arrow Impossibility Theorem. This paper critically examines this informational basis approach to social choice. Even with comparability of differences and levels, feasible social choice rules must be insensitive to a range of distributional issues. Also, the Pareto principle is not solely to blame for the inability to adopt rules combining utility and non-utility information: if the Pareto principle is not invoked then there is no way of combining utility and non-utility information in a ranking of states unless levels of utility are comparable; with only level comparability, information must be combined in restrictive ways and the notion of giving different independent weight to different considerations is ruled out. If informational bases are viewed as the restriction on information that is available, rather than a theoretical limit on information, then there exist methods to estimate richer informational structures and overcome some of these difficulties.
    Date: 2005–08–01
  3. By: Thomas A. Garrett; Nalinaksha Bhattacharyya
    Abstract: Using a theoretical extension of the Friedman and Savage (1948) utility function developed in Bhattacharyya (2003), we predict that for financial assets with negative expected returns, expected return will be a declining and convex function of skewness. Using a sample of U.S. state lottery games, we find that our theoretical conclusions are supported by the data. Our results have external validity as they also hold for an alternative and more aggregated sample of lottery game data.
    Date: 2006
  4. By: Alberto Isgut (Institute for Competitiveness & Prosperity, Toronto, Ontario M5S 2V6); Ganesan Ravishanker (ITS, Wesleyan University); Tanya Rosenblat (Department of Economics, Wesleyan University)
    Abstract: We introduce a simple web-based classroom experiment in which students learn the Ricardian model of international trade. Students are assigned to countries and then make individual production, trade and consumption decisions. The analysis of experimental data introduces students to the concepts of absolute and comparative advantage, relative prices, production possibility frontier, specialization, gains from trade, utility maximization and general equilibrium. Students learn about the relationship between individual decision-making and aggregate economic activity. The associated software, Ricardian Explorer, is easy to setup and requires minimal preparation time for instructors. The game is developed as a tool to complement courses in international trade, but it can be used in introductory and intermediate microeconomics courses as well. The analysis of teaching effectiveness has demonstrated that integration of this experiment in the curriculum enhances student learning.
    Keywords: Absolute advantage, comparative advantage, specialization, production possibility frontier, gains from trade, utility maximization, general equilibrium, classroom experiments
    Date: 2005–05
  5. By: Marilena Locatelli; Steinar Strøm
    Abstract: In this paper we describe a software instrument, implemented with GAUSS, to evaluate a tax reform in terms of change in household welfare, and in particular in term of Compensating Variation (CV), within a random utility model. The program flow and the program list with comments are supplied.
    Keywords: Compensating variation, computing welfare change, GAUSS application, tax system evaluation
    JEL: C63 B21
    Date: 2006–01
  6. By: Christian Grund (RWTH Aachen University, Templergraben 59, 52056 Aachen, Germany, tel: +49 241 8096381.; Dirk Sliwka (University of Cologne, Herbert-Lewin-Str. 2, 50931 Köln, Germany, tel: +49 221 470-5888, fax: +49 221 470-5078.
    Abstract: A main prediction of agency theory is the well known risk-incentive trade-off. Incentive contracts should be found in environments with little uncertainty and for agents with low degrees of risk aversion. There is an ongoing debate in the literature about the first trade-off. Due to lack of data, there has so far been hardly any empirical evidence about the second. Making use of a unique representative data set, we find clear evidence that risk aversion has a highly significant and substantial negative impact on the probability that an employee's pay is performance contingent.
    Keywords: Agency theory, GSOEP, Incentives, Pay for performance, Performance appraisal, Risk, Risk aversion
    JEL: J33 M52 D80
    Date: 2006–03
  7. By: Pengfei Wang; Yi Wen
    Abstract: This paper shows that imperfect competition can lead to indeterminacy in aggregate output in a standard DSGE model that features no distortions except imperfect competition. Indeterminacy arises in the model from the composition of aggregate output. In sharp contrast to the indeterminacy literature pioneered by Benhabib and Farmer (1994) and Gali (1994), indeterminacy in our model is global (i.e., independent of the eigenvalues near the steady state); hence it is robust to parameter values of the utility function and production technologies. In addition, sunspots shocks to expectations in our model can be autocorrelated. The paper provides a justification for exogenous variations over time in desired markups, which play an important role as a source of cost-push shocks in the monetary policy literature. Our model can explain procyclical marginal cost and procyclical labor productivity simultaneously, and it outperforms a standard RBC model driven by technology shocks in explaining fluctuations in the labor market.
    Keywords: Prices ; Business cycles
    Date: 2006
  8. By: Botond Koszegi; Matthew Rabin
    Date: 2006–03–27

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