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on Utility Models and Prospect Theories |
| By: | Klaus Nehring (Department of Economics, University of California Davis) |
| Abstract: | A decision-maker is utility-sophisticated if he ranks acts according to their expected utility whenever such comparisons are meaningful. We characterize utility sophistication in cases in which probabilistic beliefs are not too imprecise, and show that in these cases utility-sophisticated preferences are completely determined by consequence utilities and event attitudes captured by preferences over bets. The Anscombe-Aumann framework as employed in the classical contributions of Schmeidler (1989) and Gilboa-Schmeidler (1989) can be viewed as an important special case. For the class of utility sophisticated preferences with sufficiently precise beliefs, we also propose a definition of revealed probabilistic beliefs that overcomes the limitations of existing definitions. |
| Keywords: | Expected Utility, Ambiguity, Probalistic Sophistication, Revealed Probabilistic Beliefs |
| JEL: | D81 |
| Date: | 2006–05 |
| URL: | http://d.repec.org/n?u=RePEc:ads:wpaper:0072&r=upt |
| By: | Finn Olesen (Department of Environmental and Business Economics, University of Southern Denmark) |
| Abstract: | As a core element in economic theory we accept that economic agents behave rationally. They either maximize their profit or their utility. But is the behavior of the rational economic man really a realistic assumption? Or is Simon right when he argues that firms satisfy rather than maximize? In this paper we dis-cuss some aspects of bounded rationality and pose the question: Is this the way out? Uden på nogen måde at ville kompromittere mine kolleger, Tommy S. Poulsen og Eva Roth, skal jeg takke dem begge for kommentarer til en tidligere version at dette papir. |
| Date: | 2006–09 |
| URL: | http://d.repec.org/n?u=RePEc:sdk:wpaper:71&r=upt |
| By: | Astrid Hopfensitz (University of Geneva); Frans van Winden (Universiteit van Amsterdam) |
| Abstract: | From the viewpoint of the independence axiom of expected utility theory, an interesting empirical dynamic choice problem involves the presence of a “global risk”, that is, a chance of losing everything whichever safe or risky option is chosen. In this experimental study, participants have to allocate real money between a safe and a risky project. Treatment variable is the particular decision stage at which a global risk is resolved: (i) before the investment decision; (ii) after the investment decision but before the resolution of the investment risk; (iii) after the resolution of the investment risk. The baseline treatment is without global risk. Our goal is to investigate the isolation effect and the principle of timing independence under the different timing options of the global risk. In addition, we examine the role played by anticipated and experienced emotions in the choice problem. Main findings are a violation of the isolation effect, and support for the principle of timing independence. Although behavior across the different global risk cases shows similarities, we observe clear differences in people’s affective responses. This may be responsible for the conflicting results observed in earlier experiments. Dependent on the timing of the global risk different combinations of anticipated and experienced emotions influence decision making. |
| Keywords: | emotions; investment; global-risk; background risk; laboratory experiment; regret; anxiety |
| JEL: | A12 C91 D81 |
| Date: | 2006–10–09 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:uvatin:20060087&r=upt |
| By: | Birnbaum, Michael H.; Schmidt, Ulrich |
| Abstract: | Recently proposed models of risky choice imply systematic violations of transitivity of preference. Five studies explored whether people show patterns of intransitivity predicted by four descriptive models. To distinguish “true” violations from those produced by “error,” a model was fit in which each choice can have a different error rate and each person can have a different pattern of true preferences that need not be transitive. Error rate for a choice is estimated from preference reversals between repeated presentations of the same choice. Results of five studies showed that very few people repeated intransitive patterns. We can retain the hypothesis that transitivity best describes the data of the vast majority of participants. |
| Keywords: | decision making, errors, gambling effect, reference points, regret, transitivity |
| JEL: | C91 D81 |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cauewp:5101&r=upt |
| By: | Gerlinde Fellner (University of Bonn, Department of Economics, Adenauerallee 24-42, 53113 Bonn. fellner@uni-bonn.de); Matthias Sutter (University of Innsbruck and Max Planck Institute for Economics Jena) |
| Abstract: | Myopic loss aversion (MLA) has been established as one prominent explanation for the equity premium puzzle. In this paper we address two issues related to the effects of MLA on risky investment decisions. First, we assess the relative impact of feedback frequency and investment flexibility (via the investment horizon) on risky investments. Second, given that we observe higher investments with a longer investment horizon, we examine conditions under which investors might endogenously opt for a longer investment horizon in order to avoid the negative effects of MLA on investments. We find in our experimental study that investment flexibility seems to be at least as relevant as feedback frequency for the effects of myopic loss aversion. When subjects are given the choice to opt for a long or short investment horizon, there is no clear preference for either. Yet, if subjects face a default horizon (either long or short), there is rather little switching from the one to the other horizon, showing that a default might work to attenuate the effects of MLA. However, if subjects switch, they are more often willing to switch from the long to the short horizon than vice versa, suggesting a preference for higher investment flexibility. |
| Keywords: | loss aversion, risk, investment, experiment |
| JEL: | C91 D80 G11 |
| Date: | 2005–06 |
| URL: | http://d.repec.org/n?u=RePEc:trf:wpaper:171&r=upt |
| By: | Klaus Nehring (Department of Economics, University of California Davis) |
| Abstract: | It is shown that well-behaved preference orderings may exhibit the Ellsberg paradox on the set of unambiguous events as defined by Epstein and Zhang (2001). Moreover, since such counterexamples can be constructed even when the set of unambiguous events is rich, EZ’s main representation result does not clarify satisfactorily when the proposed definition delivers probabilistic sophistication on unambiguous events. We conclude by conjecturing that these problems indicate the existence of inherent limitations of a strictly behavioral approach to identifying probabilistic beliefs in the presence of ambiguity, rather than deficiencies in EZ’s implementation of that approach. |
| Date: | 2006–04 |
| URL: | http://d.repec.org/n?u=RePEc:ads:wpaper:0067&r=upt |
| By: | L. Joe Moffitt (Department of Resource Economics, University of Massachusetts Amherst); John K. Stranlund (Department of Resource Economics, University of Massachusetts Amherst); Barry C. Field (Department of Resource Economics, University of Massachusetts Amherst) |
| Abstract: | Protecting against terrorist attacks requires making decisions in a world in which attack probabilities are largely unknown. The potential for very large losses encourages a conservative perspective, in particular toward decisions that are robust. But robustness, in the sense of assurance against extreme outcomes, ordinarily is not the only desideratum in uncertain environments. We adopt Yakov Ben-Haim’s (2001b) model of information gap decision making to investigate the problem of inspecting a number of similar targets when one of the targets may be attacked, but with unknown probability. We apply this to a problem of inspecting a sample of incoming shipping containers for a terrorist weapon. While it is always possible to lower the risk of a successful attack by inspecting more vessels, we show that robustness against the failure to guarantee a minimum level of expected utility might not be monotonic. Robustness modeling based on expected utility and incorporating inspection costs yields decision protocols that are a useful alternative to traditional risk analysis. |
| Keywords: | Terrorism, Robustness, Severe Uncertainty, Port Security |
| Date: | 2005–03 |
| URL: | http://d.repec.org/n?u=RePEc:dre:wpaper:2005-3&r=upt |
| By: | Bruno S. Frey; Alois Stutzer |
| Abstract: | Cross-disciplinary ‘happiness research’ has made big progress in the measurement of individual welfare. This development makes it tempting to pursue the old dream of maximizing aggregate happiness as a social welfare function. However, we postulate that the appropriate approach is not to maximize aggregate happiness in seeking to improve outcomes by direct policy interventions. The goal of happiness research should rather be to improve the nature of the processes through which individuals can express their preferences. Individuals should become better able to advance their idea of the good life, both individually and collectively. |
| Keywords: | Economic policy; happiness; life satisfaction; political economy; social welfare; utility |
| JEL: | D60 D70 H11 I31 |
| Date: | 2006–10 |
| URL: | http://d.repec.org/n?u=RePEc:cra:wpaper:2006-26&r=upt |
| By: | Fred Espen Benth; Alvaro Cartea (School of Economics, Mathematics & Statistics, Birkbeck); Ruediger Kiesel |
| Abstract: | In this paper we provide a framework that explains how the market risk premium, defined as the difference between forward prices and spot forecasts, depends on the risk preferences of market players. In commodities markets this premium is an important indicator of the behaviour of buyers and sellers and their views on the market spanning between short-term and long-term horizons. We show that under certain assumptions it is possible to derive explicit solutions that link levels of risk aversion and market power with market prices of risk and the market risk premium. |
| Keywords: | Contango, backwardation, market price of risk, electricity forwards, market risk premium, forward risk premium, forward bias. |
| Date: | 2006–10 |
| URL: | http://d.repec.org/n?u=RePEc:bbk:bbkefp:0611&r=upt |
| By: | Maria Alejandra Vélez (The Earth Institute, Columbia University); John K. Stranlund (Department of Resource Economics, University of Massachusetts Amherst); James J. Murphy (Department of Resource Economics, University of Massachusetts Amherst) |
| Abstract: | This paper develops and tests several models of pure Nash strategies of individuals who extract from a common pool resource when they are motivated by a combination of self-interest and other motivations such as altruism, reciprocity, inequity aversion and conformism. We test whether an econometric summary of subjects’ strategies is consistent with one of these motivations using data from a series of common pool resource experiments conducted in three regions of Colombia. As expected, average extraction levels are less than that predicted by a model of pure self-interest, but are nevertheless sub-optimal. Moreover, we find that a model of conformism with monotonically increasing best response functions best describes average strategies. Our empirical results are inconsistent with models of altruism, reciprocity and inequity aversion. |
| Keywords: | common pool resources, experiments, altruism, reciprocity, conformism |
| JEL: | C93 D64 H41 Q20 C70 |
| Date: | 2005–03 |
| URL: | http://d.repec.org/n?u=RePEc:dre:wpaper:2005-4&r=upt |
| By: | Klaus Nehring (Department of Economics, University of California Davis) |
| Abstract: | We consider situations in which a group takes a collective decision by aggregating individual’s judgments on a set of criteria according to some agreed-upon decision functions. Assuming the criteria and the decision to be binary, we demonstrate that, except when the aggregation rule is dictatorial or the decision rule is particularly simple, such reason-based social choice must violate the Pareto principle at some profile of individual judgments. In the second part of the paper, the normative implications of this impossibility result are discussed. We argue that the normative case for the Pareto Principle is strong in situations of “shared self-interest”, but weak in situations of “shared responsibility”. |
| Keywords: | Judgment Aggregation, Pareto Principle, Discursive Dilemma, Group Choice, Responsibility |
| JEL: | D70 D71 |
| Date: | 2005–11 |
| URL: | http://d.repec.org/n?u=RePEc:ads:wpaper:0068&r=upt |
| By: | Klaus Nehring (Department of Economics, University of California Davis) |
| Abstract: | Coherent imprecise probabilistic beliefs are modelled as incomplete comparative likelihood relations admitting a multiple-prior representation. Under a structural assumption of Equidivisibility, we provide an axiomatization of such relations and show uniqueness of the representation. In the second part of the paper, we formulate a behaviorally general axiom relating preferences and probabilistic beliefs which implies that preferences over unambiguous acts are probabilistically sophisticated and which entails representability of preferences over Savage acts in an Anscombe-Aumann-style framework. The motivation for an explicit and separate axiomatization of beliefs for the study of decision-making under ambiguity is discussed in some detail. |
| Date: | 2006–04 |
| URL: | http://d.repec.org/n?u=RePEc:ads:wpaper:0034&r=upt |
| By: | Cassie Mogilner; Tamar Rudnick; Sheena Iyengar (School of Business, Columbia University) |
| Abstract: | This investigation contrasts choosers who have one of two choice making goals—to either select an option matching previously established preferences or to construct a preference from among the options provided. Evidence from field and laboratory studies, in which choosers selected magazines, indicates that irrespective of the number of options provided, chooser satisfaction results from fulfilling one’s specific choice making goal. For Preference Matchers, satisfaction requires a choice set that includes their established favorite. For Preference Constructors, satisfaction requires perceptions of a variety of options to identify their optimal preference. Display cues (i.e., categories) serve to enhance these perceptions of choice. |
| Keywords: | Preference Matching, Preference Constructors, Display Cues |
| Date: | 2006–05 |
| URL: | http://d.repec.org/n?u=RePEc:ads:wpaper:0071&r=upt |
| By: | Topi Miettinen |
| Abstract: | Experiments suggest that communication increases the contribution to public goods (Ledyard, 1995). There is also evidence that, when contemplating a lie, people trade off their private benefit from the lie with the harm it inflicts on others (Gneezy, 2005). We develop a model of bilateral pre-play agreements that assumes the latter and implies the former. A preference for not lying provides a partial commitment device that enables informal agreements. We establish some general properties of the set of possible agreements in normal form games and characterize the smallest and largest such set. In symmetric games, pre-play agreements crucially depend on whether actions are strategic complements or substitutes. With strategic substitutes, commitment power tends to decrease in efficiency whereas the opposite may be true with strategic complements. |
| Keywords: | pre-play negotiations, communication, social norms, agreements, guilt |
| JEL: | C72 C78 Z13 |
| Date: | 2006–11 |
| URL: | http://d.repec.org/n?u=RePEc:esi:discus:2006-29&r=upt |