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on Utility Models and Prospect Theories |
| By: | Pavlo Blavatskyy; Ganna Pogrebna |
| Abstract: | In the television show Affari Tuoi an individual faces a sequence of binary choices between a risky lottery with equiprobable prizes of up to half a million euros and a monetary amount for certain. The decisions of 114 show participants are used to test the predictions of ten decision theories: risk neutrality, expected utility theory, fanning-out hypothesis (weighted utility theory, transitive skew-symmetric bilinear utility theory), (cumulative) prospect theory, regret theory, rank-dependent expected utility theory, Yaari’s dual model, prospective reference theory and disappointment aversion theory. Assumptions of risk neutrality and loss aversion are clearly violated, respectively, by 55% and 46% of all contestants. There appears to be no evidence of nonlinear probability weighting or disappointment aversion. Observed decisions are generally consistent with the assumption of regret aversion and there is strong evidence for the fanning-out hypothesis. Nevertheless, we find no behavioral patterns that cannot be reconciled within the expected utility framework (or prospective reference theory that gives identical predictions). |
| Keywords: | decision theory, natural experiment, television show, expected utility, nonexpected utility |
| JEL: | C93 D81 |
| Date: | 2006–06 |
| URL: | http://d.repec.org/n?u=RePEc:zur:iewwpx:291&r=upt |
| By: | Hartley, Roger (University of Manchester); Lanot, Gauthier (Queen’s University,); Walker, Ian (University of Warwick,) |
| Keywords: | Risk aversion ; gameshow |
| JEL: | D81 C93 C23 |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:wrk:warwec:719&r=upt |
| By: | Philippe, DE DONDER; Jean, HINDRIKS (UNIVERSITE CATHOLIQUE DE LOUVAIN, Department of Economics) |
| Abstract: | Empirical testing of asymmetric information in the insurance market has uncovered a negative correlation between risks 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 Salanie (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, because 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: | preference-based adverse selection, cherry picking, precaution, social insurance |
| JEL: | D82 G22 |
| Date: | 2006–03–15 |
| URL: | http://d.repec.org/n?u=RePEc:ctl:louvec:2006017&r=upt |
| By: | Marco Ottaviani (London Business School); Peter Norman Sørensen (Department of Economics, University of Copenhagen) |
| Abstract: | According to the favorite-longshot bias, longshots are overbet relative to favorites. We propose an explanation for this bias (and its reverse) based on an equilibrium model of informed betting in parimutuel markets. The bias arises because bettors take positions without knowing the positions simultaneously taken by other privately informed bettors. The direction and the extent of the bias depend on the amount of private information relative to noise present in the market. With realistic ex-post noise and ex-ante asymmetries, our model replicates the main qualitative features of expected returns observed in horse races. |
| Keywords: | parimutuel betting; favorite-longshot bias; private information; noise; lotteries |
| JEL: | D82 D83 D84 |
| Date: | 2006–05 |
| URL: | http://d.repec.org/n?u=RePEc:kud:kuiefr:200604&r=upt |
| By: | Robin, BOADWAY; Laurence, JACQUET (UNIVERSITE CATHOLIQUE DE LOUVAIN, Department of Economics) |
| Abstract: | Using the Mirrlees optimal income tax model with a maxi-min social welfare function, we derive conditions for a decreasing marginal tax rate throughout the skill distribution, a strictly concave tax function in income and a single-peaked average tax schedule. With additive preferences and a constant labor supply elasticity, marginal tax rates are decreasing below the modal skill level, and will also decrease above the mode if aggregate skills are non-decreasing with the skill level. In this case and with a bounded skill distribution or with a constant hazard rate, the tax function is strictly concave in income and the average tax rate single-peaked. When quasilinear utility functions apply in either consumption or leisure, under fairly mild restrictions on the truncated or untruncated distribution function, marginal tax rates are decreasing in skill and the average tax profile is sinlgle-peaked. The distribution of skills has the same qualitative influence for either case of quasilinearity. These results continue to hold when there is bunching at the bottom due to a binding non-negativity constraint. We also illustrate how relaxing the assumption of constant elasticity of labor supply, generally used in the literature, modifies the results. |
| Keywords: | maxi-min, optimal income taxation |
| JEL: | H21 |
| Date: | 2006–05–16 |
| URL: | http://d.repec.org/n?u=RePEc:ctl:louvec:2006020&r=upt |