nep-upt New Economics Papers
on Utility Models and Prospect Theories
Issue of 2006‒04‒08
ten papers chosen by
Alexander Harin
Modern University for the Humanities

  1. A Model of Income Insurance and Social Norms By Assar Lindbeck; Mats Persson
  2. Native-Migrant Differences in Risk Attitudes By Bonin, Holger; Constant, Amelie; Tatsiramos, Konstantinos; Zimmermann, Klaus F
  3. “Itô’s Lemma“ and the Bellman Equation for Poisson Processes: An Applied View By Ken Sennewald; Klaus Wälde
  4. Indirect Taxation and Progressivity: Revenue and Welfare Changes By John Creedy; Catherine Sleeman
  5. The Ex Ante Incentive Compatible Core in Exchange Economies with and without Indivisibilities By Francoise Forges
  6. Business corruption, uncertainty and risk aversion By Tina Søreide
  7. Bargaining with Imperfect Enforcement By White, Lucy; Williams, Mark
  8. Risk Aversion When Gains Are Likely and Unlikely: Evidence from a Natural Experiment with Large Stakes By Pavlo Blavatskyy; Ganna Pogrebna
  9. Cognitive Dissonance and Choice By Larry Epstein; Igor Kopylov
  10. Time Dependent Relative Risk Aversion By Enzo Giacomini; Michael Handel; Wolfgang K. Härdle

  1. By: Assar Lindbeck; Mats Persson
    Abstract: A large literature on ex ante moral hazard in income insurance emphasizes that the individual can affect the probability of an income loss by choice of lifestyle and hence, the degree of risk-taking. The much smaller literature on moral hazard ex post mainly analyzes how a “moral hazard constraint” can make the individual abstain from fraud (“mimicking”). The present paper instead presents a model of moral hazard ex post without a moral hazard constraint; the individual's ability and willingness to work is represented by a continuous stochastic variable in the utility function, and the extent of moral hazard depends on the generosity of the insurance system. Our model is also well suited for analyzing social norms concerning work and benefit dependency.
    Keywords: moral hazard, sick pay insurance, labor supply, asymmetric information
    JEL: G22 H53 I38 J21
    Date: 2006
  2. By: Bonin, Holger; Constant, Amelie; Tatsiramos, Konstantinos; Zimmermann, Klaus F
    Abstract: This paper questions the perceived wisdom that migrants are more risk-loving than the native population. We employ a new large German survey of direct individual risk measures to find that first-generation migrants have lower risk attitudes than natives, which only equalize in the second generation.
    Keywords: ethnicity; gender differences; native-migrant differences; risk attitudes; second-generation effects
    JEL: D1 D81 F22 J15 J16 J31 J62 J82
    Date: 2006–03
  3. By: Ken Sennewald; Klaus Wälde
    Abstract: Using the Hamilton-Jacobi-Bellman equation, we derive both a Keynes-Ramsey rule and a closed form solution for an optimal consumption-investment problem with labor income. The utility function is unbounded and uncertainty stems from a Poisson process. Our results can be derived because of the proofs presented in the accompanying paper by Sennewald (2006). Additional examples are given which highlight the correct use of the Hamilton-Jacobi-Bellman equation and the change-of-variables formula (sometimes referred to as “Ito’s-Lemma”) under Poisson uncertainty.
    Keywords: stochastic differential equation, Poisson process, Bellman equation, portfolio optimization, consumption optimization
    JEL: C61 D81 D90 G11
    Date: 2006
  4. By: John Creedy; Catherine Sleeman
    Abstract: This paper compares the disproportional effects of indirect taxation using two alternative measures, tax-progressivity and welfare-progressivity. In the context of an indirect tax imposed on a single good, tax-progressivity requires the taxed good to be luxury. In contrast, welfare-progressivity requires the equivalent variation as fraction of total expenditure to rise with total expenditure. Sufficient conditions for welfare-progressivity are derived for both the Linear Expenditure System (LES) and the Almost Ideal Demand System (AIDS). When the parameters of the direct utility functions are held constant, imposing homogeneous preferences, the condition required for welfare-progressivity is the same as that required for tax-progressivity, namely that the taxed good is a luxury. Parameter constancy also implies a particular pattern for the variation in budget shares with total expenditure, which is unique for each demand system. When parameters are allowed to vary with total expenditure, according to a general budget share relationship, which enables preference heterogeneity amongst households, welfare-progressivity is independent of tax-progressivity for both models, giving rise to possible conflicts in tax and welfare disproportionality. The empirical application of these conditions to New Zealand data shows that many such cases of conflict can arise. Furthermore, conflicting results are also obtained when examining the effects of the overall indirect tax structure. The majority of conflicts arise where tax-regressivity exists at the same time as welfareprogressivity.
    Keywords: Tax progressivity; equivalent variations; budget shares
    JEL: H23 H22 H31
    Date: 2005
  5. By: Francoise Forges
    Abstract: The ex ante incentive compatible core of an exchange economy with private information is the (standard) core of a socially designed characteristic function, which expresses the fact that coalitions allocate goods by means of random incentive compatible mechanisms. We first survey some results in the case of perfectly divisible goods. Examples then show that the ex ante incentive compatible core can be empty, even if utility functions are quasi-linear. If, in addition to quasi-linearity, further assumptions are made (like independent private values), the non-emptiness of the core follows nevertheless from d’Aspremont and Gérard-Varet’s construction of incentive compatible, ex post efficient mechanisms. We also introduce a private information version of Shapley and Scarf’s economies with indivisible goods, and prove that the ex ante incentive compatible core is always non-empty in this framework.
    Keywords: core, incentive compatible mechanism, indivisible goods, private information
    JEL: C71 C78 D82
    Date: 2006
  6. By: Tina Søreide
    Abstract: The presence of business-corruption in a market provokes firms to make choices between legal business approaches and illegal bribery. The outcome of a chosen strategy will usually be uncertain at the time the decision is made, and a firm's decision will depend partly on its attitude towards risk. Drawing on the empirical data provided by a survey of 82 Norwegian exporting businesses, the paper proposes a theory about firm's choices between legal and illegal business practices. It begins by describing the risks, uncertainties and benefits attached to bribery, and specifies their impact on firm's propensity to offer bribes. It then demonstrates how risk averse firms can be more inclined to offer bribes than risk neutral, and even risk attracted firms. Although the analysis diverges from existing theory in stressing the differences between illegal and legal forms of rent-seeking, the findings correspond to the results reported in the literature on legal forms of rent-seeking. JEL D81, F23, K40
    Keywords: Rent-seeking Corruption Firms Risk JEL D81, F23, K40
    Date: 2006
  7. By: White, Lucy; Williams, Mark
    Abstract: The game-theoretic bargaining literature insists on non-cooperative bargaining procedure but allows 'cooperative' implementation of agreements. The effect of this is to allow free-reign of bargaining power with no check upon it. In reality, courts cannot implement agreements costlessly, and parties often prefer to use 'non-cooperative' implementation. We present a bargaining model which incorporates the idea that agreements may be enforced non-cooperatively. We show that this has a substantial impact in limiting the inequality of agreements, and results in a non-montonicity of the discount rate. The general need to maintain incentives for co-operation means it may appear that 'other-regarding' elements enter agents' utility functions. This helps us to understand why experimental subjects might begin negotiations anticipating 'fair' bargains. The model also explains why some parties may have incentives to deliberately write incomplete contracts which cannot be enforced in a court of law.
    Keywords: enforcement; incomplete contracts; non-cooperative bargaining; strength in weakness
    JEL: C72 C78 C91 D23
    Date: 2006–02
  8. By: Pavlo Blavatskyy; Ganna Pogrebna
    Abstract: In the television show Affari Tuoi a contestant is endowed with a sealed box containing a monetary prize between one cent and half a million euros. In the course of the show the contestant learns more information about the distribution of possible monetary prizes inside her box. Consider two groups of contestants, who learned that the chances of their boxes containing a large prize are 20% and 80% correspondingly. Contestants in both groups receive qualitatively similar price offers for selling the content of their boxes. If contestants are less risk averse when facing unlikely gains, the price offer is likely to be more frequently rejected in the first group than in the second group. However, the fraction of rejections is virtually identical across two groups. Thus, contestants appear to have identical risk attitudes over (large) gains of low and high probability.
    Keywords: risk attitude, risk aversion, risk seeking, natural experiment
    JEL: C93 D81
    Date: 2006–03
  9. By: Larry Epstein (University of Rochester); Igor Kopylov (University of California Irvine)
    Abstract: People like to feel good about past decisions. This paper models self- justification of past decisions. The model is axiomatic: axioms are defined on preference over ex ante actions (modeled formally by menus) The representation of preference admits the interpretation that the agent adjusts beliefs after taking an action so as to be more optimistic about its possible consequences. In particular, the ex post choice of beliefs is part of the representation of preference and not a primitive assumption. Behavioral characterizations are given to the comparisons "1 exhibits more dissonance than 2" and "1 is more self-justifying than 2."
    Keywords: cognitive dissonance, optimism, temptation, self-control, self-justification, choice-theoretic, choosing beliefs
    JEL: D81
    Date: 2006–03
  10. By: Enzo Giacomini; Michael Handel; Wolfgang K. Härdle
    Abstract: Risk management and the thorough understanding of the relations between financial markets and the standard theory of macroeconomics have always been among the topics most addressed by researchers, both financial mathematicians and economists. This work aims at explaining investors’ behavior from a macroeconomic aspect (modeled by the investors’ pricing kernel and their relative risk aversion) using stocks and options data. Daily estimates of investors’ pricing kernel and relative risk aversion are obtained and used to construct and analyze a three-year long time-series. The first four moments of these time-series as well as their values at the money are the starting point of a principal component analysis. The relation between changes in a major index level and implied volatility at the money and between the principal components of the changes in relative risk aversion is found to be linear. The relation of the same explanatory variables to the principal components of the changes in pricing kernels is found to be log-linear, although this relation is not significant for all of the examined maturities.
    Keywords: risk aversion, pricing kernels, time dependent preferences
    JEL: C13 C22 G12
    Date: 2006–03

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