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on Utility Models and Prospect Theory |
| By: | Anne Spencer (Queen Mary, University of London); Angela Robinson (University of East Anglia) |
| Abstract: | In the conventional QALY model, people’s preferences are assumed to satisfy utility independence. When health varies over time, utility independence implies that the value attached to a health state is independent of the health state that arise before or after it. In this paper we set out to test the extent to which utility independence is undermined by sequence and duration effects. Two separate studies were conducted involving a total of 155 respondents. In study one, we conducted 5 tests of utility independence using a standard gamble question. Three of the tests of utility independence were repeated in study two after randomisation was introduced in order to take account of possible ordering effects. Utility independence holds in the majority of cases examined here and so our work generally supports the use of utility independence to derive more tractable models. |
| Keywords: | Utility independence, QALY |
| JEL: | H5 I10 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:qmw:qmwecw:wp596&r=upt |
| By: | Marie Pfiffelmann (Laboratoire de Recherche en Gestion et en Economie,Pôle Européen de Gestion et d'Economie, Strasbourg.) |
| Abstract: | Lottery-linked deposit accounts (LLDAs) are financial assets that provide an interest rate determined by a lottery. These accounts that combine savings and lot- tery have become very popular in recent years and in a number of countries (Guillen and Tschoegel). However, their existence cannot be explained in the framework of the expected utility model. Their popularity can only be understood in light of behavioral ?nance studies, especially if individual preferences are described by Kahneman and Tversky?s cumulative prospect theory (1992). Actually, this theory provides a good explanation for the emergence of these deposit accounts by integrating simultaneously risk-averse and risk-seeking behaviors. In this paper, we propose a behavioral analysis of these financial assets by assuming that investors individuals preferences obey cumulative prospect theory. We study how the structure of prizes of the LLDAs should be framed to appeal to and attract many investors.Our aim is thus to determine the optimal design of these financial assets. |
| JEL: | D81 G11 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:dul:wpaper:07-09rs&r=upt |
| By: | Ariel Rubinstein; Yuval Salant |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:cla:levrem:843644000000000029&r=upt |
| By: | Fiore, Annamaria; Morone, Andrea |
| Abstract: | Seminal models of herd behaviour and informational cascades point out existence of negative information externalities, and propose to ‘destroy’ information in order to achieve social improvements. Although in the last years many features of herd behaviour and informational cascades have been studied, this particular aspect has never been extensively analysed. In this article we try to fill this gap, investigating both theoretically and experimentally whether and to which extent destroying information can improve welfare. Our empirical results show that this decisional mechanism actually leads to a behaviour more consistent with the theory that in turn produces the predicted efficiency gain. |
| Keywords: | Informational cascades, information externality, individual decision making, experiment |
| JEL: | C91 D62 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:ifwedp:5568&r=upt |
| By: | Kris de Jaegher |
| Abstract: | Benchmark two-good utility functions involving a good with zero income elasticity and unit income elasticity are well known. This paper derives utility functions for the additional benchmark cases where one good has zero cross-price elasticity, unit own-price elasticity, and zero own price elasticity. It is shown how each of these utility functions arises from a simple graphical construction based on a single given indifference curve. Also, it is shown that possessors of such utility functions may be seen as thinking in a particular sense of their utility, and may be seen as using simple rules of thumb to determine their demand. |
| Keywords: | Benchmark Utility Functions, Rules of Thumb |
| JEL: | D11 |
| Date: | 2007–02 |
| URL: | http://d.repec.org/n?u=RePEc:use:tkiwps:0709&r=upt |
| By: | John C. V. Pezzey (Australian National University,Centre for Resource and Environmental Studies); Frank Jotzo (Australian National University, Research School of Pacific and Asian Studies) |
| Abstract: | We give theoretical, partial equilibrium comparisons of a tax with thresholds, tradable targets ('emissions trading' or ET), and non-tradable targets, as mechanisms to abate well-mixed ('global') emissions from many parties, under independent uncertainties in both future business-as-usual emissions and marginal abatement costs. All three mechanisms are revenue-neutral, and use flexible thresholds or targets indexed continuously to parties' activity levels. We analyse both risk-neutral or risk-averse behaviour. Key theoretical results are that because of emissions uncertainty, there is no simple Weitzman (1974) rule for choosing between 'prices' (a tax) to 'quantities' (ET); under ET, marginal abatement cost uncertainty is a benefit, compared to certainty; and under risk aversion, any mechanism with more expected welfare also gives more expected abatement. We apply our theory to global greenhouse gas abatement in 2020, using an 18-region numerical simulation model with new uncertainty estimates. Key global, empirical results are that under either risk behaviour, a tax dominates ET, which hugely dominates non-tradable targets; and under risk aversion, an optimally indexed tax gives about 60% more welfare and 30% more abatement than unindexed ET, while optimally indexed ET achieves about two-fifths of these improvements. |
| Keywords: | emissions trading, global abatement, greenhouse gases, risk aversion, tax, uncertainty |
| JEL: | D81 H23 Q54 Q58 |
| Date: | 2006–08 |
| URL: | http://d.repec.org/n?u=RePEc:anu:eenwps:0604&r=upt |
| By: | George A. Schieren |
| Abstract: | Past discussions about economic efficiency and personal injury torts have focused on the relationship between the optimal amount of care a potential injurer should take for economic efficiency. Typically this discussion has assumed that the economic damages are strictly monetary without any full consideration of how these damages should be measured. This paper constructs a general model which incorporates as an unknown the amount of monetary damages that an injurer should pay in the interest of economic efficiency. The optimal amount of damages need to be known to serve as signal for the amount of care a potential injurer should take. The model shows that the optimal damage award should be at that point where that marginal utility of money paid out by the injurer equals the marginal utility of the money received by the victim under his utility function after the accident and not considering any non-monetary damages. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:apl:wpaper:07-08&r=upt |
| By: | Antoine Billot |
| Abstract: | This paper aims at proving that social interactions can easily be rationalized by individual preferences as defined in standard microeconomic theory. For that purpose, we show individual choice rationality to be logically equivalent to social consistency, when individual rationality means that individual preferences are completely ordered and social consistency that there is a one-to-one mapping between a given family of social communities and the existence of a particular (unique, reflexive and symmetric) interaction relation between individuals. Moreover, continuity and monotonicity of individual preferences are shown to fit the modeling of group loyalty when group loyalty is defined as the ability to freely accept a personal loss for the global gain of a particular population. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:pse:psecon:2007-14&r=upt |
| By: | Olga Bourachnikova (LaRGE (Laboratoire de Recherche en Gestion et en Economie), FSEG, ULP, Strasbourg I, Pôle Européen de Gestion et d’Economie, Strasbourg.) |
| Abstract: | The Behavioral Portfolio Theory (BTP) developed by Shefrin and Statman (2000) considers a probability weighting function rather than the real probability distribution used in Markowitz’s Portfolio Theory (1952). The optimal portfolio of a BTP investor, which consists in a combination of bonds and lottery ticket, can differ from the perfectly diversified portfolio of Markowitz. We found that this particular form of portfolio is not due to the weighting function. In this article we explore the implication of weighting function in the portfolio construction. We prove that the expected wealth criteria (used by Shefrin and Statman), even if the objective probabilities were deformed, is not a sufficient condition for obtaining significantly different forms of portfolio. Not only probabilities but also future outcomes have to be transformed. |
| JEL: | G11 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:dul:wpaper:07-07rs&r=upt |
| By: | Kevin J. Lansing |
| Abstract: | This paper derives a general class of intrinsic rational bubble solutions in a standard Lucas-type asset pricing model. I show that the rational bubble component of the price-dividend ratio can evolve as a geometric random walk without drift. The volatility of bubble innovations depends exclusively on fundamentals. Starting from an arbitrarily small positive value, the rational bubble expands and contracts over time in an irregular, wholly endogenous fashion, always returning to the vicinity of the fundamental solution. I also examine a near-rational solution in which the representative agent does not construct separate forecasts for the fundamental and bubble components of the asset price. Rather, the agent constructs only a single forecast for the total asset price that is based on a geometric random walk without drift. The agent's forecast rule is parameterized to match the moments of observable data. In equilibrium, the actual law of motion for the price-dividend ratio is stationary, highly persistent, and nonlinear. The agent's forecast errors exhibit near-zero autocorrelation at all lags, making it difficult for the agent to detect a misspecification of the forecast rule. Unlike a rational bubble, the near-rational solution allows the asset price to occasionally dip below its fundamental value. Under mild risk aversion, the near-rational solution generates pronounced low-frequency swings in the price-dividend ratio, positive skewness, excess kurtosis, and time-varying volatility--all of which are present in long-run U.S. stock market data. An independent contribution of the paper is to demonstrate an approximate analytical solution for the fundamental asset price that employs a nonlinear change of variables. |
| Keywords: | Stock - Prices ; Forecasting |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2007-10&r=upt |
| By: | Loek Groot |
| Abstract: | This study considers the performance of countries at the Olympic Games as a public good and investigates different welfare optimal distributions of Olympic success. First, it is argued that at the national level Olympic success, measured as the number of gold medals won, meets the two key conditions of a public good, nonrivalry and non-excludability. Second, it is demonstrated that standard income inequality measures as the Lorenz curve and Atkinson’s measure can successfully be applied to the distribution of Olympic success. Four different distributions are considered: the actual distribution, the distribution according to population shares, the distribution under constant and declining marginal utility of medals and the one also taking production costs and declining marginal utility of per capita income into account. For the latter two, the rules for the welfare optimal distributions are stated, viz. equality of the marginal contributions to welfare and the Samuelson condition. At the end, a device is proposed to make the distribution of Olympic success more equitable. |
| Keywords: | Olympic Games, Public Goods, Externalities, Social Welfare |
| JEL: | D63 H41 H50 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:use:tkiwps:0713&r=upt |
| By: | Orazio P. Attanasio (University College London); Monica Paiella (Bank of Italy) |
| Abstract: | This paper builds a unifying framework based on the theory of intertemporal consumption choices that brings together the limited participation-based explanation of the C-CAPM poor empirical performance and the transaction costs-based explanation of incomplete portfolios. Using the implications of the consumption model and observed household consumption and portfolio choices, we identify the preference parameters of interest and a lower bound for the costs rationalizing non-participation in financial markets Assuming isoelastic preferences, we estimate the coefficient of relative risk aversion at 1.7 and a cost bound of 0.4 percent of non-durable consumption. Our estimate of the preference parameter is theoretically plausible and the bound sufficiently small to be likely to be exceeded by the actual total (observable and unobservable) costs of participating in financial markets. |
| Keywords: | limited participation in financial markets, fixed participation costs, Euler equation for consumption. |
| JEL: | E21 G11 G12 |
| Date: | 2007–04 |
| URL: | http://d.repec.org/n?u=RePEc:bdi:wptemi:td_620_07&r=upt |