nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2007‒04‒14
eight papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Hedging global environment risks: An option based portfolio insurance By André de Palma; Jean-Luc Prigent
  2. Twofold Optimality of the Relative Utilitarian Bargaining Solution By Pivato, Marcus
  3. Limited Liability and the Trade-off between Risk and Incentives By Matthias Kräkel
  4. Optimal Risk Taking in an Uneven Tournament Game with Risk Averse Players By Matthias Kräkel
  5. Technical progress in North and welfare gains in South under nonhomothetic preferences By Lilas Demmou
  6. Estimating Euler Equations with Noisy Data: Two Exact GMM Estimators By Sule Alan; Orazio Attanasio; Martin Browning
  7. Resolving the unbiasedness and forward premium puzzles By Daniel L.Thornton
  8. Rationality as a Barrier to Peace: Micro-Evidence from Kosovo By Sumon Kumar Bhaumik; Ira N. Gang; Myeong-Su Yun

  1. By: André de Palma (University of Cergy-Pontoise (THEMA),and Ecole Polytechnique); Jean-Luc Prigent (University of Cergy-Pontoise (THEMA))
    Abstract: This paper introduces a financial hedging model for global environment risks. Our approach is based on portfolio insurance under hedging constraints. Investors are assumed to maximize their expected utilities defined on financial and environmental asset values. The optimal investment is determined for quite general utility functions and hedging constraints. In particular, our results suggest how to introduce derivative assets written on the environmental asset.
    Keywords: utility maximization, hedging, environmental asset, martingale theory
    JEL: C6 G11 G24 L10
    Date: 2007
  2. By: Pivato, Marcus
    Abstract: Given a bargaining problem, the `relative utilitarian' (RU) solution maximizes the sum total of the bargainer's utilities, after having first renormalized each utility function to range from zero to one. We show that RU is `optimal' in two very different senses. First, RU is the maximal element (over the set of all bargaining solutions) under any partial ordering which satisfies certain axioms of fairness and consistency; this result is closely analogous to the result of Segal (2000). Second, RU offers each person the maximum expected utility amongst all rescaling-invariant solutions, when it is applied to a random sequence of future bargaining problems which are generated using a certain class of distributions; this is somewhat reminiscent of the results of Harsanyi (1953) and Karni (1998).
    Keywords: relative utilitarian; bargaining solution; impartial observer
    JEL: D63 D71
    Date: 2007–04–09
  3. By: Matthias Kräkel (Department of Economics, BWL II, University of Bonn, Adenauerallee 24-42, D-53113 Bonn. Tel: +49-228-739211, Fax: +49-228-739210, Germany, e-mail:
    Abstract: Several empirical findings have challenged the traditional trade-off between risk and incentives. By combining risk aversion and limited liability in a standard principal-agent model the empirical puzzle on the positive relationship between risk and incentives can be explained.
    Keywords: limited liability, piece rates, risk aversion, risk-incentives trade-off
    JEL: D01 D82 J3 M5
    Date: 2007–04
  4. By: Matthias Kräkel (Department of Economics, BWL II, University of Bonn, Adenauerallee 24-42, D-53113 Bonn. Tel: +49-228-739211, Fax: +49-228-739210, Germany, e-mail:
    Abstract: We analyze the optimal choice of risk in a two-stage tournament game between two players that have different concave utility functions. At the first stage, both players simultaneously choose risk. At the second stage, both observe overall risk and simultaneously decide on effort or investment. The results show that those two effects which mainly determine risk taking — an effort effect and a likelihood effect — are strictly interrelated. This finding sharply contrasts with existing results on risk taking in tournament games with symmetric equilibrium efforts where such linkage can never arise. Hence, previous findings based on symmetry at the effort stage turn out to be nongeneric.
    Keywords: asymmetric equilibria, rank-order tournaments, risk taking
    JEL: C72 J3 L1 M5
    Date: 2007–04
  5. By: Lilas Demmou
    Abstract: The paper proposes a theoretical model investigating the welfare consequences of technological shocks in a Ricardian framework (a la Dornbush, Fisher and Samuelson, 1977). Contrary to existing literature, the model incorporates a nonhomothetic demand function whose price and income elasticities are endogenously determined by technology. The model is applied to the case of trade between two economies with different development levels. It is shown in particular that the developing country can experience a fall in utility as a result of technical progress in the developed country. This result depends on the type of technological shock assumed (biased vs uniform technical progress), as well as on the size of the development gap.
    Date: 2007
  6. By: Sule Alan; Orazio Attanasio; Martin Browning
    Abstract: In this paper we exploit the specific structure of the Euler equation and develop two alternative GMM estimators that deal explicitly with measurement error. The first estimator assumes that the measurement error is lognormally distributed. The second estimator drops the distributional assumption and solves out for the unknown, but constant, conditional mean. Our Monte Carlo results suggest that both proposed estimators perform much better than conventional alternatives based on the exact Euler equation or its log-linear approximation, especially with short panels. The empirical application of the proposed estimators yields plausible estimates of the coefficient of relative risk aversion and discount rate.
    Keywords: Nonlinear Models, Measurement Error, Euler Equation
    JEL: C13 E21
    Date: 2006
  7. By: Daniel L.Thornton
    Abstract: There are two unresolved puzzles in the empirical foreign exchange literature. The first is the finding that tests of forward rate unbiasedness using the forward rate and forward premium equations yield markedly different conclusions. A companion puzzle?the forward premium puzzle?is the fact that the forward premium incorrectly predicts the direction of the subsequent change in the spot rate, which implies a massive rejection of uncovered interest parity. This paper resolves both puzzles.
    Keywords: Foreign exchange
    Date: 2007
  8. By: Sumon Kumar Bhaumik (Brunel University and IZA); Ira N. Gang (Rutgers University and IZA); Myeong-Su Yun (Tulane University and IZA)
    Abstract: Despite a significant expansion of the literature on conflicts and fragility of states, only a few systematic attempts have been made to link the theoretical literature on social conflicts to the available micro-level information about the people who are involved in these conflicts. We address this lacuna in the literature using a household-level data set from Kosovo. Our analysis suggests that it is individually rational for competing ethnic communities, Kosovo Albanians and Kosovo Serbs, to resist a quick agreement on a social contract to share the region’s resources.
    Keywords: conflict, individual rationality, economic deprivation, micro-evidence, Balkans, Kosovo
    JEL: I32 O12 J15
    Date: 2007–03

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