nep-upt New Economics Papers
on Utility Models and Prospect Theories
Issue of 2007‒01‒23
fourteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Poptávková funkce na trhu s pojištěním: porovnání maximalizace paretovské pravděpodobnosti přežití s teorií EUT von-Neumanna a Morgensterna a s prospektovou teorií Kahnemana a Tverského / Demand for Insurance: Comparison of von Neumann-Morgenstern's and Kahneman-Tverovsky's Approaches [available in Czech only] By Jiří Hlaváček; Michal Hlaváček
  2. Ethnic Persistence, Assimilation and Risk Proclivity By Holger Bonin; Amelie Constant; Konstantinos Tatsiramos; Klaus F. Zimmermann
  3. Bayesian Decision Theory and the Representation of Beliefs By Edi Karni
  4. The Store-of-Value-Function of Money as a Component of Household Risk Management By Ingrid Groessl; Ulrich Fritsche
  5. Rationality, Rule-Following and Emotions: On the Economics of Moral Preferences By V. Vanberg
  6. Ambiguity Aversion as a Predictor of Technology Choice: Experimental Evidence from Peru By Jim Engle-Warnick; Javier Escobal; Sonia Laszlo
  7. Strategic Referring in Labor Market Social Networks By Natálie Reichlová; Petr Švarc
  8. The Revealed Preference Implications of Reference Dependent Preferences By Faruk Gul; Wolfgang Pesendorfer
  9. Individual and Couple Decision Behavior under Risk:The Power of Ultimate Control By André de Palma; Nathalie Picard; Anthony Ziegelmeyer
  10. Optimal Risk-Sharing and Deductables in Insurance By Aase, Knut K.
  11. The Role of Risk Aversion and Lay Risk in the Probabilistic Externality Assessment for Oil Tanker Routes to Europe By Andrea Bigano; Mariaester Cassinelli; Anil Markandya; Fabio Sferra
  12. Rationality of Belief Or: Why Savage's axioms are neither necessary nor sufficient for rationality, Second Version By Itzhak Gilboa; Andrew Postlewaite; David Schmeidler
  13. Some critical comments on credit risk modeling. By ilya, gikhman
  14. Why Suggest Non-Binding Retail Prices? By Clemens Puppe; Stephanie Rosenkranz

  1. By: Jiří Hlaváček (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic); Michal Hlaváček (Czech National Bank, Prague, Czech Republic; Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)
    Abstract: This paper shows results of comparison of the original theoretical conception of modeling human decisions under risk with two well known models. In the paper the demand function for insurance is constructed for the model of maximization of the probability of agent’s (economical) survival. This demand function is compared with the demand function in two models: the expected-utility theory (von-Neumann, Morgenstern) and the asymmetric value function (Kahnemann, Tversky). While in the expected-utility model the purest agents are interested in insurance in the first place, in the model of Kahnemann-Tversky purest agents do not buy insurance because of their liking for risk. The model of maximization of the probability of survival corresponds better to the real structure of insured: neither extremely rich people, nor extremely poor people accept insurance contracts. The first ones do not accept the game because of negative expected value of gains, for the second ones is the insurance – in relation to their income - too expensive.
    Keywords: moral hazard; adverse selection; Pareto survival distribution
    Date: 2006–05
  2. By: Holger Bonin; Amelie Constant; Konstantinos Tatsiramos; Klaus F. Zimmermann
    Abstract: The paper investigates the role of social norms as a determinant of individual attitudes by analyzing risk proclivity reported by immigrants and natives in a unique representative German survey. We employ factor analysis to construct measures of immigrants' ethnic persistence and assimilation. The estimated effect of these measures on risk proclivity suggests that adaptation to the attitudes of the majority population closes the immigrant-native gap in risk proclivity, while stronger commitment to the home country preserves it. As risk attitudes are behaviourally relevant, and vary by ethnic origin, our results could also help explain differences in economic assimilation of immigrants.
    Keywords: Risk attitudes, ethnic persistence, assimilation, second generation effects, gender
    JEL: D1 D81 F22 J15 J16 J31 J62 J82
    Date: 2006
  3. By: Edi Karni
    Abstract: In this paper, I present a Bayesian decision theory and define choice-based subjective probabilities that faithfully represent Bayesian decision makers’ prior and posterior beliefs regarding the likelihood of the possible effects contingent on his actions. I argue that no equivalent results can be obtained in Savage’s (1954) subjective expected utility theory and give an example illustrating the potential harm caused by ascribing to a decision maker subjective probabilities that do not represent his beliefs.
    Date: 2007–01
  4. By: Ingrid Groessl (Department for Economics and Politics, University of Hamburg); Ulrich Fritsche (Department for Economics and Politics, University of Hamburg, and DIW Berlin)
    Abstract: We analyse how money as a store of value affects the decisions of a representative household under diversifiable and non-diversifiable risks. given that the central bank successfully stabilizes the rate of inflation at a low level. Assuming exponential utility allows us to derive an explicit relationship between optimal money holdings, the household's desire to tilt, smooth and stabilize consumption as well as minimize portfolio risk. In this context we also show how the correlation between stochastic labour income and stock returns impact the store-of-value function of money. Finally we prove that the store-of-value benefits of money holdings continue to hold even if we take riskless alternatives into account.
    Keywords: Money demand, consumption, CRRA, CARA, exponential utility, households, risk, risk management
    JEL: D11 E21 E41
    Date: 2006–12
  5. By: V. Vanberg
    Abstract: The long-standing critique of the ‘economic model of man’ has gained new impetus not least due to the broadening research in behavioral and experimental economics. Many of the critics have focused on the apparent difficulty of traditional rational choice theory to account for the role of moral or ethical concerns in human conduct, and a number of authors have suggested modifications in the standard model in response to such critique. This paper takes issue with a quite commonly adopted ‘revisionist’ strategy, namely seeking to account for moral concerns by including them as additional preferences in an agent’s utility function. It is argued that this strategy ignores the critical difference between preferences over outcomes and preferences over actions, and that it fails to recognize that ‘moral preferences’ belong into the second category. Preferences over actions, however, cannot be consistently accounted for within a theoretical framework that focuses on the rationality of single actions. They require a shift of perspective, from a theory of rational choice to a theory of rule-following behavior. Length 30 pages
    Date: 2007–01
  6. By: Jim Engle-Warnick; Javier Escobal; Sonia Laszlo
    Abstract: The lack of adoption of new farming technologies despite known benefis is a well-documented phenomenon in development economics. In addition to a number of market constraints, risk aversion predominates the discussion of behavioral determinants of technology adoption. We hypothesize that ambiguity aversion may also be a determinant, since farmers may have less information about the distribution of yield outcomes from new technologies compared with traditional technologies. We test this hypothesis with a laboratory experiment in the field in which we measure risk and ambiguity preferences. We combine our experiment with a survey in which we collect information on farm decisions and identify market constraints. We find that ambiguity aversion does indeed predict actual technology choices on the farm. <P>Un phénomène bien documenté en économie du développement est le nombre peu élevé d’agriculteurs qui décident d’adopter de nouvelles technologies en agriculture, malgré leurs avantages connus. En plus des nombreuses contraintes imposées par le marché, l’aversion au risque prédomine la discussion sur les déterminants de l’adoption de nouvelles technologies. Nous émettons l’hypothèse que l’aversion à l’ambiguïté pourrait aussi être un déterminant puisqu’il est possible que les agriculteurs aient moins d’information sur la distribution du rendement des nouvelles technologies que sur celle des technologies traditionnelles. Nous testons la validité de cette hypothèse avec une expérience en laboratoire sur le terrain où nous mesurons les préférences vis-à-vis du risque et de l’ambiguïté. Nous combinons notre expérience à un sondage portant sur les décisions prises en matière d’agriculture et identifiant les contraintes du marché. Nous constatons qu’effectivement, l’aversion à l’ambiguïté dicte les choix technologiques réels relatifs à la ferme.
    Keywords: experimental economics, risk measurement instruments, risk preferences, rural development, technology choice, choix technologiques, développement rural, économie expérimentale, instruments de mesure du risque, préférences vis-à-vis du risque
    JEL: O33 O18 C91
    Date: 2007–01–01
  7. By: Natálie Reichlová (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic); Petr Švarc (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)
    Abstract: We present a model of job search in which information about job opportunities is available either through direct search at the labor market or through network of socially tied individuals. We consider two cases - altruistic and self-interested agents that maximize their utility function. We show that optimal strategies range between full and no referring cases. Altruistic individuals tend to refer more than selfinterested agents. Strategic referring allows agents alleviate employment variation and leads to higher average utility levels and lower unemployment rates.
    Keywords: agent-based modeling; networks; strategy; job referring
    JEL: J62 J64 D82 D83
    Date: 2006–12
  8. By: Faruk Gul; Wolfgang Pesendorfer
    Date: 2007–01–12
  9. By: André de Palma (University of Cergy-Pontoise (théma) and ENPC, Member of Institut Universitaire de France); Nathalie Picard (University of Cergy-Pontoise (théma) and INED); Anthony Ziegelmeyer (Max Planck Institute)
    Abstract: This paper reports results of an experiment designed to analyze the link between risky decisions made by couples, and risky decisions made separately by each spouse. We estimate both the individuals and the couples’ degrees of risk aversion, and we analyze how the risk preferences of the two spouses aggregate when they have to perform joint decisions under risk. We show that the man has more decision power than the woman, but the woman’s decision power increases when she has ultimate control over the joint decision.
    Date: 2007
  10. By: Aase, Knut K. (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)
    Abstract: Risk-sharing in insurance is analyzed, with a view towards explaining the prevalence of deductibles. First we introduce, in a modern setting, the main concepts of the theory of risk-sharing in a group of agents. This theory we apply to the risk-sharing problem between an insurer and an insurance customer. We motivate the development through simple examples, illustrating some of the subtle points of this theory. In order to deduce deductibles endogenously, not explained in the neoclassical model, we separately introduce (i) the insurable asset as a decision variable, (ii) administrative costs, and (iii) moral hazard, and illustrate by examples.
    Keywords: Reinsurance Exchange; Equilibrium; Pareto Optimality; Representative Agent; Core Solution; Individual Rationality; Deductibles; Costs; Moral Hazard
    JEL: D50 G22
    Date: 2006–12–29
  11. By: Andrea Bigano (Fondazione Eni Enrico Mattei); Mariaester Cassinelli (Fondazione Eni Enrico Mattei); Anil Markandya (Fondazione Eni Enrico Mattei and University of Bath); Fabio Sferra (Fondazione Eni Enrico Mattei)
    Abstract: Oil spills are a major cause of environmental concern, in particular for Europe. However, the traditional approach to the evaluation of the expected external costs of these accidents fails to take into full account the implications of their probabilistic nature. By adapting a methodology originally developed for nuclear accidents to the case of oil spills, we extend the traditional approach to the assessment of the welfare losses borne by potentially affected individuals for being exposed to the risk of an oil spill. The proposed methodology differs from the traditional approach in three respects: it allows for risk aversion; it adopts an ex-ante rather than an ex-post perspective; it allows for subjective oil spill probabilities (held by the lay public) higher than those assessed by the experts in the field. In order to illustrate quantitatively this methodology, we apply it to the hypothetical (yet realistic) case of an oil spill in the Aegean Sea. We assess the risk premiums that potentially affected individuals would be willing to pay in order to avoid losses to economic activities such as tourism and fisheries, and non-use damages resulting from environmental impacts on the Aegean coasts. In the scenarios analysed, the risk premiums on expected losses for tourism and fisheries turn out to be substantial when measured as a percentage of expected losses; by contrast, they are quite small for the case of damages to the natural environment.
    Keywords: Oil Spills, Probabilistic Externalities, Risk Aversion, Lay Risk Assessment, Mediterranean
    JEL: Q51 Q53 L91
    Date: 2006–11
  12. By: Itzhak Gilboa (Tel-Aviv University, HEC, and Cowles Foundation, Yale University); Andrew Postlewaite (University of Pennsylvania); David Schmeidler (Tel-Aviv University and Ohio State University)
    Abstract: Economic theory reduces the concept of rationality to internal consistency. The practice of economics, however, distinguishes between rational and irrational beliefs. There is therefore an interest in a theory of rational beliefs, and of the process by which beliefs are generated and justified. We argue that the Bayesian approach is unsatisfactory for this purpose, for several reasons. First, the Bayesian approach begins with a prior, and models only a very limited form of learning, namely, Bayesian updating. Thus, it is inherently incapable of describing the formation of prior beliefs. Second, there are many situations in which there is not sufficient information for an individual to generate a Bayesian prior. It follows that the Bayesian approach is neither sufficient not necessary for the rationality of beliefs.
    Keywords: Decision making, Bayesian, Behavioral Economics
    JEL: B4 D8
    Date: 2004–03–01
  13. By: ilya, gikhman
    Abstract: In this notice we are comment popular approaches to the credit risk modeling.
    Keywords: Credit risk; credit derivatives; risk neutral world; risk neutral probability; structural model; reduced form.
    JEL: G12 G13 C63 C6
    Date: 2006–07
  14. By: Clemens Puppe; Stephanie Rosenkranz
    Abstract: We provide a simple behavioral explanation of why manufacturers frequently announce non-binding suggested retail prices for their products. Our model is based on the assumption that once the actual price for a product exceeds its suggested retail price, the marginal propensity to consume suddenly jumps downward. This property of individual demand corresponds to Kahneman and TverskyÕs concept of loss aversion. We show that it may induce a monopolistic retailer to set the price equal to the suggested retail price in equilibrium, although the latter price is nonbinding. This, in turn, leads to a shift of profits from the retailer to the manufacturer.
    Keywords: manufacturer's suggested retail price, reference dependence, loss aversion
    JEL: D4 D10 L1 L2
    Date: 2006–05

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