nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2008‒01‒05
eleven papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Testing the predective validity of the time trade-off and the Stardard Gamble By Jose María Abellán-Perpiñán; Han Bleichrodt; Jose Luis Pinto-Prades
  2. Utility-Based Utility By David Cass
  3. Risk Aversion and Reservation Wages By Markus Pannenberg
  4. Are Regional Differences in Utility Eliminated over Time? : Evidence from Germany By David Maddison; Katrin Rehdanz
  5. The Marginal Utility of Income By Richard Layard; Guy Mayraz; Stephen J. Nickell
  6. Reference-Dependent Preferences and Loss Aversion: A Discrete Choice Experiment In the Health-Care Sector By Neuman, Einat; Neuman, Shoshana
  7. The weight of argument and non-additive measures: a note By Marcello Basili; Carlo Zappia
  8. Utility Indifference Pricing in an Incomplete Market Model with Incomplete Information By Kazuhiro Takino
  9. Productivity Growth, Bounded Marginal Utility, and Patterns of Trade By Philip Sauré
  10. An Expository Note on Alchian-Allen Theorem When Sub-Utility Functions are Homogeneous of Degree n ą 0 By Saito, Tetsuya
  11. To Claim or Not to Claim : Estimating Non-Take-Up of Social Assistance in Germany and the Role of Measurement Error By Joachim R. Frick; Olaf Groh-Samberg

  1. By: Jose María Abellán-Perpiñán (Universidad de Murcia); Han Bleichrodt (Erasmus University Rotterdam); Jose Luis Pinto-Prades (Centro de Estudios Andaluces)
    Abstract: This paper tests the consistency of health utility measurements with individual preferences. We compare three methods, the time trade-off, the standard gamble and a version of the standard gamble that corrects for the deviations from expected utility modelled by prospect theory. Individual preferences are measured both through a ranking task and through a choice task. In decisions involving no risk the time trade-off is most consistent with people’s preferences with the standard gamble a close second. In decisions involving risk the corrected standard gamble is most consistent with people’s preferences. Our data do not support the common assumption in health economics that utility is transferable across decision contexts.
    Keywords: Health utility measurement, QALYs,stardard gamble, time trade-off, prospect theory.
    JEL: I10
    Date: 2007
  2. By: David Cass (Department of Economics, University of Pennsylvania)
    Abstract: A major virtue of von Neumann-Morgenstern utilities, for example, in the theory of general financial equilibrium (GFE), is that they ensure time consistency: consumption-portfolio plans (for the future) are in fact executed (in the future) — assuming that there is perfect foresight about relevant endogenous variables. This paper proposes an alternative to expected utility, one which also delivers consistency between plan and execution — and more. In particular, the formulation affords an extremely natural setting for introducing extrinsic uncertainty. The key idea is to divorce the concept of filtration (of the state space) from any considerations involving probability, and then concentrate attention on nested utilities of consumption looking forward from any date-event: utility today depends only on consumption today and prospective utility of consumption tomorrow, utility tomorrow depends only on consumption tomorrow and prospective utility of consumption the day after tomorrow, and so on.
    Keywords: Utility theory, Expected utility, Time consistency, Extrinsic uncertainty, Cass-Shell Immunity Theorem
    JEL: D61 D81 D91
    Date: 2007–12–15
  3. By: Markus Pannenberg
    Abstract: This study examines the relationship between individual risk aversion and reservation wages using a novel set of direct measures of individual risk attitudes from the German Socio-Economic Panel (SOEP). We find that risk aversion has a significantly negative impact on the level of reservation wages. Moreover, we show that the elasticity of the reservation wage with respect to unemployment benefits is remarkably lower for risk-averse job seekers than for risk-loving job seekers. The results are consistent with an interpretation that risk-averse job seekers set their reservation wage levels sufficiently low, so that they accept almost every job offer.
    Keywords: Risk Aversion, Reservation Wages, Survey Data
    JEL: J64 J65
    Date: 2007
  4. By: David Maddison; Katrin Rehdanz
    Abstract: Hedonic theory assumes that changes in land prices and wage rates eliminate the utility advantages of differing locations. Using happiness data from the German socio-economic panel this paper empirically tests whether regional utility differences exist and if so whether utility levels show any tendency to converge over time. Empirical analysis reveals substantial differences in utility over different regions of Germany. Analysing a panel of data indicates that even if individual utility levels are at any one moment in disequilibrium they are rapidly converging over Germany for all types of individuals.
    Keywords: Educational expansion, correlated random coefficient model, heterogenous returns to education, conditional mean independence
    Date: 2007
  5. By: Richard Layard; Guy Mayraz; Stephen J. Nickell
    Abstract: In normative public economics it is crucial to know how fast the marginal utility of income declines as income increases. One needs this parameter for cost-benefit analysis, for optimal taxation and for the (Atkinson) measurement of inequality. We estimate this parameter using four cross-sectional surveys of subjective well-being and two panel surveys. Altogether, we use data from over 50 countries, and in a period extending from 1972 to 2005. In all six surveys we find a consistent relationship between reported well-being and income. We estimate the elasticity of marginal utility with respect to income at around (minus) 1.26. In the second part of the paper we ask whether true utility may not have a convex relationship to reported happiness, making it less concave with respect to income. We find some evidence of this, so that the elasticity of marginal utility with respect to income may be somewhat lower at roughly (minus) 1.2.
    Keywords: Marginal utility, income, life satisfaction, happiness, public economic, welfare, inequality, optimal taxation, reference-dependent preferences
    JEL: I31 H00 D1 D61 H21
    Date: 2007
  6. By: Neuman, Einat; Neuman, Shoshana
    Abstract: A Discrete Choice Experiment (DCE) in the health-care sector is used to test the loss aversion theory that is derived from reference-dependent preferences: The absolute subjective value of a deviation from a reference point is generally greater when the deviation represents a loss than when the same-sized change is perceived as a gain. As far as is known, this paper is the first to use a DCE to test the loss aversion theory. A DCE appears to be a highly suitable tool for this testing because it estimates the marginal valuations of attributes, based on deviations from a reference point (a constant scenario). Moreover, loss aversion can be examined for each attribute separately. A DCE can also be applied to non-traded goods with non-tangible attributes. A health-care event is used for empirical illustration: The loss aversion theory is tested within the context of preference structures for maternity-ward attributes, estimated using data entailing 3850 observations from a sample of 542 women who recently gave birth. Seven hypotheses are presented and tested. Overall, significant support for behavioural loss aversion theories was found.
    Keywords: attributes; Discrete Choice Experiment; loss aversion; maternity-wards; preferences; reference-dependence
    JEL: D01 D12 I19
    Date: 2007–12
  7. By: Marcello Basili; Carlo Zappia
    Abstract: This note argues that a representation of the epistemic state of the individual through a non-additive measure provides a novel account of Keynes’s view of probability theory proposed in his Treatise on Probability. The paper shows, first, that Keynes’s “non-numerical probabilities” can be interpreted in terms of decisional weights and distorsions of the probability priors. Second, that the degree of non-additivity of the probability measure can account for the confidence in the assessment without any reference to a second order probability. And, third, that the criterion for decision making under uncertainty derived in the non-additive literature incorporates a measure of the degree of confidence in the probability assessment. The paper emphasises the Keynesian derivation of Ellsberg’s analysis: the parallel between Keynes and Ellsberg is deemed to be significant since Ellsberg’s insights represent the main starting point of the modern developments of decision theory under uncertainty and ambiguity.
    Keywords: uncertainty, probabilities, Keynes.
    JEL: B16 D21
    Date: 2007–06
  8. By: Kazuhiro Takino (Graduate School of Economics, Osaka University)
    Abstract: In this article, we consider a derivative pricing model for the stochastic volatility model under an incomplete information. The incomplete information in our works, supposes that the true value of the drift for the stock price process is a random variable, investors only have an information of its distribution. This is more practical financial market than the situation with knowledge of the drift. There are many studies about the dynamic portfolio optimization problem under the incomplete information. In that situation, the corresponding problem becomes a easy to treat by Separating Principle and Bayesian updating formula. We apply these arguments to the utility indifference price approach, and present pricing method taken into account the incomplete information. On the other hand, Sircar and Zariphopoulou (2005) gives bounds and asymptotic approximations for the indifference prices in the stochastic volatility model. In them works, bounds include the drift parameter for the underlying price process. However, in practice, it is able to observe the drift parameter by estimation only. Therefore, it is meaningful to extended to the incomplete information. We derive bounds for the indifference prices using estimated drift, and the relationship between the buyerfs indifference price and the sellerfs one.
    Keywords: Incomplete market, Incomplete information, Utility indifference price, Bayesian updating formula, Super/sub solution for PDEs.
    JEL: G11 G13 G14
    Date: 2007–12
  9. By: Philip Sauré
    Abstract: The workhorse model of the New Trade Theory fails to explain four strong and central patterns of postwar trade data. These patterns are, first, the massive increase in trade volumes, second, the small fraction of traded varieties the average country imports, third the correlation between per capita income growth and trade growth, and fourth, the correlation between trade growth and growth in the number of source countries per imported good. The present paper shows that a small and reasonable change in the demand structure can reconcile the model with the data. It departs from standard theory by assuming that consumers derive bounded marginal utility from varieties. This implies that consumers purchase only the cheaper share of varieties and that expensive foreign varieties bearing high transport costs are not imported. Technological progress which increases per capita consumption of the varieties in the consumption basket decreases marginal utility derived from each of them and induces consumers to extend their consumption to more expensive varieties produced at more distant locations. This additional margin along which trade can expand induces a substantial increase in the trade share as productivity grows. Productivity change is thus identified as a joint determinant of trade shares, the number of source countries per good, and per capita income, explaining the trends and correlations in the data.
    Keywords: Trade Volume, Source Country
    JEL: F1 F4
    Date: 2007
  10. By: Saito, Tetsuya
    Abstract: This expository note shows Alchian and Allen’s conjecture–consumers purchase fine quality relatively more than coarse one– is true under some specific conditions about homogeneity, inner solution and substitutability while allowing the influence of the income effect. In the proof, to be an exposition, I emphasize graphical representations of Alchian-Allen Theorem than algebra.
    Keywords: Fixed transaction cost; quality of goods; Alchian-Allen Theorem; change in consumption pattern
    JEL: F10 D01
    Date: 2007–12–21
  11. By: Joachim R. Frick; Olaf Groh-Samberg
    Abstract: Using representative micro data from the German Socio-Economic Panel Study (SOEP) for the year 2002, we analyse non-take-up behaviour of Social Assistance (SA) in Germany. According to our simulation as much as 67 percent of the eligible population did not claim SA in that year which is slightly higher than reported in previous work. We particularly emphasize the role of measurement error in estimating non-take-up. First, we consider misspecifications of the simulation model due, e.g., to households claiming to have received SA although not simulated as eligible (“beta-error”). Second, we employ sensitivity analyses revealing the impact of measurement errors in reported household income and wealth as well as in simulated needs. Misreported household incomes appear to have the greatest impact on the estimated non-take-up rates, as shown in Monte-Carlo-type simulations. Regression analysis of the potential determinants of non-take-up behaviour confirm that rational motives – i.e., the expected net utility from claiming – as well as stigma and other barriers play a crucial role in explaining the puzzle of large non-take-up rates of SA.
    Keywords: Non-Take-Up,Social assistance, measurement error, microsimulation, SOEP
    JEL: I38 D61 C15
    Date: 2007

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