nep-upt New Economics Papers
on Utility Models and Prospect Theories
Issue of 2007‒01‒28
four papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Dynamic Choice, Independence, and Emotions By Hopfensitz, Astrid; van Winden, Frans A.A.M.
  2. Kahneman and Tversky and the Origin of Behavioral Economics By Floris Heukelom
  3. Understanding individuals’ decisions about vaccination: a comparison between Expected Utility and Regret Theory models By M Zia Sadique; John Edmunds; Nancy Devlin; David Parkin
  4. What Simon says By Floris Heukelom

  1. By: Hopfensitz, Astrid; van Winden, Frans A.A.M.
    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 behaviour across the different global risk cases is approximately the same, 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: anxiety; background risk; emotions; global risk; investment; laboratory experiment; regret
    JEL: A12 C91 D81
    Date: 2007–01
  2. By: Floris Heukelom (ASE, Universiteit van Amsterdam)
    Abstract: Kahneman and Tversky and their behavioral economics stand in a long tradition of applying mathematics to human behavior. In the seventeenth century, attempts to describe rational behavior in mathematical terms run into problems with the formulation of the St. Petersburg paradox. Bernoulli’s celebrated solution to use utility instead of money marks the beginning of expected utility theory (EUT). Bernoulli’s work is taken up by psychophysics which in turn plays an important role in the making of modern economics. In the 1940s von Neumann and Morgenstern throw away Bernoulli and psychophysics, and redefine utility in monetary terms. Relying on this utility definition and on von Neumann and Morgenstern’s axiomatic constraints of the individual’s preferences, Friedman and Savage attempt to continue Bernoulli’s research. After this fails economics and psychology go separate ways. Economics employs Friedman’s positive-normative distinction; psychology uses Savag! e’s normative-descriptive distinction. Using psychophysics Kahneman and Tversky broaden the normative-descriptive distinction and argue with increasing strength for a descriptive theory of rational behavior. A prominent part of contemporary behavioral economics is founded upon the export of Tversky and Kahneman’s program to economics. Within this research, two different branches of research can be observed. One branch continues Kahneman and Tversky’s search for a descriptive theory of rational behavior and extends the normative-descriptive distinction with a prescriptive part. A second branch takes Tversky and Kahneman’s work as a falsification of positive economics. It argues that economics should take account of the psychological critique but stick to rigorous mathematical model building and Friedman’s positive-normative distinction.
    Keywords: Kahneman and Tversky; behavioral economics; expected utility theory; normative economics
    JEL: A12 B21 D01
    Date: 2007–01–11
  3. By: M Zia Sadique (Department of Economics, City University, London); John Edmunds (Health Protection Agency, Centre for Infections, London); Nancy Devlin (Department of Economics, City University, London); David Parkin (Department of Economics, City University, London)
    Abstract: This paper proposes two new theoretical models for examining individual decision-making regarding vaccination. In each case, individuals’ decisions are modelled as a binary choice (i.e. to accept or to reject an invitation to receive vaccination) which are a product both of the perceived risk of the preventable disease in question and of the perceived risk of adverse side effects of the vaccine itself. Individuals decisions are modelled in two ways – first, as expected utility maximising and second, as regret minimising – and the results compared. In both cases, the decision to vaccinate is explained by a threshold condition with respect to the risk of remaining exposed to the disease by rejecting vaccination, and the risk of experiencing adverse events from vaccination itself. Regret-averse individuals have a higher threshold – suggesting a lower propensity to vaccinate than that suggested by the expected utility models. Although the results are intuitively plausible, they rest on assumptions about the perceived severity of side effects as opposed to preventable disease. We conclude by identifying a number of theoretical issues that remain to be explored, and outlining the empirical research required.
    Date: 2005–07
  4. By: Floris Heukelom (Universiteit van Amsterdam)
    Abstract: This paper provides an overview of the work of Herbert Simon and his ideas about rational decision making. By his own standards, Simon is an economist who works in the tradition of Adam Smith and Alfred Marshall. The central theme in Simon’s research is how human beings organize themselves in different structures of distributed decision making in order to achieve a degree of rationality that is higher than which can be attained by the individual. In this realm his main preoccupation are hierarchic organizations such as the business firm and the computer. Simon sharply contrasts his views with the EUT, the dominant view on rational decision making in economics and other social sciences.
    Keywords: Herbert Simon; decision making; Expected Utility Theory; hierarchic organizations
    JEL: A12 D01 D21
    Date: 2007–01–12

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