nep-upt New Economics Papers
on Utility Models and Prospect Theories
Issue of 2006‒05‒06
eight papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Risk, Uncertainty, and Option Exercise By Jianjun Miao; Neng Wang
  2. Beauty is a Beast, Frog is a Prince: Assortative Matching with Nontransferabilities By Patrick Legros; Andrew F. Newman
  3. Equality of Opportunity and Optimal Cash and In-Kind Policies By Leonardo Gasparini; Santiago Pinto
  4. Consumption and Saving under Knightian Uncertainty By Jianjun Miao;
  5. Cooperation and Reciprocity: a Theoretical Approach By Marcello Basili; Maurizio Franzini
  6. Does Propitious Selection Explain Why Riskier People Buy Less Insurance? By De Donder, Philippe; Hindriks, Jean J.G.
  7. Persistent Inequality By Dilip Mookherjee; Debraj Ray
  8. The as-is journal review process: Let authors own their ideas By Benno Torgler,; Sascha L. Schmidt; Bruno S. Frey

  1. By: Jianjun Miao (Institute for Economic Development, Boston University); Neng Wang (University of Rochester)
    Keywords: Knightian undertainty, multiple-priors utility, real options, optimal stopping problem
    JEL: D81
  2. By: Patrick Legros (ECARES, Universite Libre de Bruxelles); Andrew F. Newman (Institute for Economic Development, Boston University)
    Abstract: We present sufficient conditions for monotone matching in environments where utility is not fully transferable between partners. These conditions involve complementarity in types not only of the total payoff to a match, as in the transferable utility case, but also in the degree of transferability between partners. We apply our conditions to study some models of risk sharing and incentive problems, deriving new results for predicted matching patterns in those contexts
    Keywords: Assortative matching, nontransferable utility, risk sharing, interhousehold allocation.
    JEL: C78 D13 J41
  3. By: Leonardo Gasparini (Centro de Estudios Distributivos, Laborales y Sociales (CEDLAS) - Universidad Nacional de La Plata); Santiago Pinto (Department of Economics, West Virginia University)
    Abstract: This paper examines the argument for public provision of certain private goods, like education and health, based on equality of opportunity by studying the utility possibility frontier of a society in which there is a concern for the distribution of these goods. A given quality of education or health services can be consumed for free in the public sector, but people can opt-out and purchase their desired quality levels in the private sector. Some of the conclusions are: (i) a pure cash transfer is optimal when the utility redistribution is either “sufficiently” small or large; (ii) if and only if both the equality-of-opportunity concern and the utility redistribution are large enough, can an in-kind program which attracts the whole population be justified; (iii) even when everybody chooses the in-kind program, it may be optimal to perform some additional utility redistribution by increasing the size of such program.
    Keywords: equality of opportunity, redistribution, education, in-kind
    JEL: D3 H4 I2
    Date: 2005–04
  4. By: Jianjun Miao (Institute for Economic Development, Boston University);
    Abstract: This paper studies consumption/saving problem under Knightian uncer- tainty in a two period setting. The multiple-priors utility model is adopted. The e®ects of income uncertainty and capital uncertainty on optimal savings are analyzed by deriving closed form solutions.
    JEL: D81 D91
  5. By: Marcello Basili; Maurizio Franzini
    Abstract: Cooperation among genetically unrelated agents occurs in many situations where economic theory would not expect it. A too narrow conception of self-interest is widely considered the culprit. In particular, relying on experimental evidence in plenty, we consider strong reciprocity rules of behaviour, according to which it is worth bearing the cost of punishing those who defect, and we give analytical foundation to such behaviour – and more generally to cooperation-proneness. The basic idea is that most agents may include self-esteem in their utility function and actually produce or destroy self-esteem through their effective behaviour. The latter amounts to introducing a moral system in individual behaviour in such a way to make it amenable to rational maximization. We also show how the presence of cooperation-prone agents may impact on the best contract in Principal-Agents situations by altering the convenience of gift giving and trust.
    Keywords: agency, altruism, self-interest, punishment, reciprocity
    JEL: J41 D64
    Date: 2005–11
  6. By: De Donder, Philippe; Hindriks, Jean J.G.
    Abstract: Empirical testing of asymmetric information in the insurance market has uncovered a negative correlation between risk levels and insurance purchases, rather than the positive correlation predicted by the standard insurance theory. Hemenway (1990) proposes an explanation for this negative correlation, called 'propitious selection''. He argues that potential insurance buyers have different tastes for risk and that 'individuals who are highly risk avoiding are more likely both to try to reduce the hazard and to purchase insurance' (p. 1064). Chiappori and Salanié (2000) also suggest that this line of argument, which they call 'cherry picking', may explain the observed negative correlation. In this paper, we show that the propitious selection argument does not imply negative correlation between risk levels and insurance purchases, be-cause it fails to take into account the supply side of the insurance market. To illustrate this claim, we provide a model where, although we assume that individuals differ in risk aversion and that the more risk averse individuals exert more precaution and buy more insurance, we end up with a positive correlation between risk and insurance purchases at equilibrium. The reason is that, in any separating equilibrium, the more risk averse individuals face insurance overprovision which, combined with moral hazard, increases their risk relative to the less risk averse individuals. To obtain the negative correlation between risk and insurance purchases, one further needs the extra condition of decreasing marginal willingness to pay for the less risk averse individuals. Finally, we find that propitious selection has profound policy implications for social insurance.
    Keywords: cherry picking; precaution; preference-based adverse selection; social insurance
    JEL: D82 G22
    Date: 2006–04
  7. By: Dilip Mookherjee (Institute for Economic Development, Boston University); Debraj Ray (Department of Economics, New York University)
    Abstract: When human capital accumulation generates pecuniary externalities across professions, and capital markets are imperfect, persistent inequality in utility and consumption is inevitable in any steady state. This is true irrespective of the degree of divisibility in investments. However, divisibility (or fineness of occupational structure) has implications for both the multiplicity and Pareto-efficiency of steady states. Indivisibilities generate a continuum of inefficient and efficient steady states with varying per capita income On the other hand, perfect divisibility typically implies the existence of a unique steady state distribution which is Pareto-efficient.
  8. By: Benno Torgler,; Sascha L. Schmidt; Bruno S. Frey
    Abstract: In this paper we present a two period model, where the agent's preferences are described by prospect theory as proposed by Kahneman and Tversky. We solve for the agent's portfolio decision. Our findings are that the changes in portfolio weights depend crucially on the reference point and the ratio between the reference point and the current wealth, and thus only indirectly on the performance of the risky asset. Our model explains why investor keep on holding, or even buy, loosing investments.
    Keywords: Disposition effect, house money effect, prospect theory, port-folio choice
    JEL: D00 D60 L83
    Date: 2006–04

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