nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2008‒03‒25
twelve papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Non Utility Maximizing Behaviour: Probabilistic Choice in a Budget Set “Box”. Properties of Expected Demand Functions By Larsson, Lars-Göran
  2. A pure variation of risk in first-price auctions By Oliver Kirchkamp; J. Philipp Reiß; Abdolkarim Sadrieh
  3. Risk aversion in low income countries: Experimental evidence from Ethiopia By Yesuf, Mahmud; Bluffstone, Randy
  4. Stock Market Volatility and Learning By Albert Marcet; Klaus Adam; Juan Pablo Nicolini
  5. Persistent Private Information By Noah Williams
  6. Risk-Taking Tournaments: Theory and Experimental Evidence By Nieken, Petra; Sliwka, Dirk
  7. Incorporating fairness motives into the Impulse Balance Equilibrium concept: an application to experimental 2X2 games By Tavoni, Alessandro
  8. Random Utility Pseudo Panel Model and Application on Car Ownership Forecast By Huang, Biao
  9. Labor Markets and Monetary Policy: A New-Keynesian Model with Unemployment By Olivier Blanchard; Jordi Gali
  10. Self-Knowledge and Self-Deception By H. Peyton Young
  11. Optimal saving in the presence of two small risks By M. Menegatti
  12. Forecasting the Risk Attitudes of Women and Men: An Experimental Test of the Strength of Gender Stereotypes By Oleksandr Lugovskyy; Philip J. Grossman

  1. By: Larsson, Lars-Göran (Department of Economics, School of Business, Economics and Law, Göteborg University)
    Abstract: In this paper we use some(even a convex) probabilistic frequency functions in two choice variables defined over the budget set” box” and calculate the expected demand to study its properties The expected demands have own price negativity , are normal goods and are homogeneous of degree zero*. The detailed properties of deterministic demand functions can be replaced with similar properties for some expected demand functions the latter found with fewer and behaviourally less restrictive assumptions. To assume a deterministic utility function to be maximized is more restrictive in a behavioural sense than assuming random choice between some boundaries.<p>
    Keywords: Non-maximising behaviour; Bounded rationality; Random choice; Expected demand
    JEL: C60 D01 D11
    Date: 2008–03–18
  2. By: Oliver Kirchkamp (University of Jena, School of Economics); J. Philipp Reiß (Maastricht University, Economics Department); Abdolkarim Sadrieh (University of Magdeburg, Faculty of Economics and Management)
    Abstract: We introduce a new method of varying the risk that bidders face in first-price private value auctions. We find that decreasing bidders' risk significantly reduces the degree of overbidding relative to the risk-neutral Bayesian-Nash equilibrium prediction. This implies that risk a?ects bidding behavior as generally expected in auction theory. While resolving a long-standing debate on the e?ect of risk on auction behavior, our results give rise to a new puzzle. As risk is diminished and overbidding decreases for most of the value range, a significant degree of underbidding sets in for very low values.
    Keywords: risk, fist-price auctions, risk-aversion, overbidding
    JEL: C92 D44
    Date: 2008–03–19
  3. By: Yesuf, Mahmud; Bluffstone, Randy
    Abstract: "Production systems in low-income developing countries are generally poorly diversified, focusing on rainfed staple crop production and raising livestock. These activities are inherently risky and investment and production decisions by farm households are therefore made within environments that are affected by risk. Because of poorly developed or absent credit and insurance markets it is difficult to pass any of these risks to a third party. As a result, it is often found that even when the expected net return is high, households are reluctant to adopt new agricultural technologies when they involve risk. Better understanding risk behavior will be essential for identifying appropriate farm-level strategies for adaptation to climate change by low-income farmers. Despite risk's potentially central role in farm investment decisions, there have been few attempts to estimate the magnitude and nature of risk aversion of farm households in low-income developing countries. To partially close this gap, this paper uses an experimental approach applied to 262 households in the Ethiopian highlands with real payoffs. By incorporating both small and large stakes and gains and losses into the experiment, we test for the presence of low stake risk aversion and loss aversion. We find that more than 50 percent of the households are severely or extremely risk averse. This contrasts with studies in Asia where most household decision-makers exhibit moderate to intermediate risk aversion. We find that households that stand to lose as well as gain something from participation in games are significantly more risk averse than households playing gains-only games. This strongly suggests that agricultural extension efforts involving losses as well as gains may face systematic resistance by farmers in low-income, high-risk environments. Promotion of technologies with downside risks – even if the upside potential is enormous – should therefore be combined with insurance or other support. We also find that even without the possibility of losses households are much more averse to risk when stakes are high. Results indicate that insurance or other support can likely be phased out. After initial successes have convinced farmers that technologies are viable, risk aversion declines. There are also significant differences in risk averting behavior between relatively poorer and wealthier farm households, which is consistent with decreasing absolute risk aversion. This suggests that as wealth is built up households are willing to take on more risk in exchange for higher returns. Both these findings suggest a strong path dependence. Efforts to develop poor rural areas through promotion of risky technologies should take this path dependence into account. Early successes are important, but households should also be allowed to build up wealth before they are challenged or tempted to take on more risky ventures. Furthermore, the finding that even without the possibility of losses households are much more risk averse when stakes are higher, suggests that agricultural extension should start modestly before asking households to take on larger gambles." from Authors' Abstract
    Keywords: experimental studies, loss aversion, risk aversion, Risk management, econometric models, Farm households,
    Date: 2007
  4. By: Albert Marcet; Klaus Adam; Juan Pablo Nicolini
    Abstract: Introducing bounded rationality in a standard consumption-based asset pricing model with time separable preferences strongly improves empirical performance. Learning causes momentum and mean reversion of returns and thereby excess volatility, persistence of price-dividend ratios, long-horizon return predictability and a risk premium, as in the habit model of Campbell and Cochrane (1999), but for lower risk aversion. This is obtained, even though our learning scheme introduces just one free parameter and we only consider learning schemes that imply small deviations from full rationality. The findings are robust to the learning rule used and other model features. What is key is that agents forecast future stock prices using past information on prices.
    JEL: G12 D84
    Date: 2008–01–25
  5. By: Noah Williams
    Abstract: This paper studies the design of optimal contracts in dynamic environments where agents have private information that is persistent. In particular, I focus on a continuous time version of a benchmark insurance problem where a risk averse agent would like to borrow from a risk neutral lender to stabilize his income stream. The income stream is private information to the borrower and is persistent. I find that the optimal contract conditions on the agent's reported endowment as well as two additional state variables: the agent's utility and marginal utility under the contract. I show how persistence alters the nature of the contract, and consider an exponential utility example which can be solved in closed form. Unlike the previous discrete time models with i.i.d. private information, the agent's consumption under the contract may grow over time. Furthermore, in my setting the efficiency losses due to private information increase with the persistence of the endowment, and the distortions vanish as I approximate an i.i.d. endowment.
    JEL: D82 D86 E21
    Date: 2008–03
  6. By: Nieken, Petra (University of Cologne); Sliwka, Dirk (University of Cologne)
    Abstract: We study risk-taking behavior in a simple two person tournament in a theoretical model as well as a laboratory experiment. First, a model is analyzed in which two agents simultaneously decide between a risky and a safe strategy and we allow for all possible degrees of correlation between the outcomes of the risky strategies. We show that risk-taking behavior crucially depends on this correlation as well as on the size of a potential lead of one of the contestants. We find that the experimental subjects acted mostly quite well in line with the derived theoretical predictions.
    Keywords: tournaments, competition, risk-taking, experiment
    JEL: M51 C91 D23
    Date: 2008–03
  7. By: Tavoni, Alessandro
    Abstract: Substantial evidence has been accumulated in recent empirical works on the limited ability of the Nash equilibrium to rationalize observed behavior in many classes of games played by experimental subjects. This realization has led to several attempts aimed at finding tractable equilibrium concepts which perform better empirically, often by introducing a reference point to which players compare the available payoff allocations, as in impulse balance equilibrium (Selten & Chmura, forthcoming) and in the inequity aversion model (Fehr & Schmidt,1999). The purpose of this paper is to review some features of this recent literature and to propose a new, empirically sound, unifying concept which combines elements of fairness with reference considerations.
    Keywords: Fairness; Inequity aversion; Aspiration level; Impulse balance; Behavioral economics; Experimental economics; Jacknife estimator
    JEL: D63 D01 C72 C91
    Date: 2007–10
  8. By: Huang, Biao
    Abstract: This paper reports the recent development on the theoretical aspects of the nonlinear pseudo panel, its empirical application on car demand model, and forecast of car ownership level in Great Britain to year 2026.
    Keywords: random utility; pseudo panel; Car Ownership
    JEL: C53 C23 C25
    Date: 2007
  9. By: Olivier Blanchard; Jordi Gali
    Abstract: We construct a utility-based model of fluctuations, with nominal rigidities and unemployment, and draw its implications for the unemployment-inflation tradeoff and for the conduct of monetary policy.<br><br>We proceed in two steps. We first leave nominal rigidities aside. We show that, under a standard utility specification, productivity shocks have no effect on unemployment in the constrained efficient allocation. We then focus on the implications of alternative real wage setting mechanisms for fluctuations in unemployment. We show the role of labor market frictions and real wage rigidities in determining the effects of productivity shocks on unemployment.<br><br>We then introduce nominal rigidities in the form of staggered price setting by firms. We derive the relation between inflation and unemployment and discuss how it is influenced by the presence of labor market frictions and real wage rigidities. We show the nature of the tradeoff between inflation and unemployment stabilization, and its dependence on labor market characteristics. We draw the implications for optimal monetary policy.
    JEL: E3 E31 E32 E52
    Date: 2008–03
  10. By: H. Peyton Young
    Abstract: A person is concerned about self-image if his utility function depends, not only on his actions, but also on his beliefs about what sort of person he is. This dual motivation problem makes it difficult, and in some cases impossible, for someone to learn who he really is based solely on his revealed behavior. Indeed, there are very simple situations, involving just two actions and two possible identities, such that, if there is any initial uncertainty about one's true identity, it will never be resolved even when one has an infinite number of opportunities to act.
    Keywords: Knowledge, Self-Signalling, Learning
    JEL: C70 D83
    Date: 2008
  11. By: M. Menegatti
    Abstract: We examine optimal saving in the presence of two small risks: income risk and a background risk. First, we compute the necessary and sufficient condition for a positive precautionary saving, showing that it depends on two terms capturing respectively the direct effect of income risk and the interaction between the two risks. Secondly, we examine the necessary and sufficient condition for a positive extra-saving due to the contemporaneous presence of the two risks. We show that this condition also depends on a term capturing the direct effect of background risk and that it can hold independently of the previous one.
    Keywords: Precautionary saving, Background risk, Uncertainty
    JEL: D11 D81 E21
    Date: 2008
  12. By: Oleksandr Lugovskyy; Philip J. Grossman (Department of Economics, St. Cloud State University)
    Abstract: This paper experimentally investigates the role of gender-based stereotypes in the forecasting of risk attitudes. Subjects predict the gamble choice of target subjects in one of three treatments: 1) Visual – the predictor can only observe the target; 2) Information – the predictor has information about the targets’ response to two statements from a risk-preference survey; and 3) Combined – the predictor both observes the targets and has the targets’ two responses to the risk-preference survey. Our results suggest that stereotypes play a considerable role in forming predictions about others’ risk attitudes and that these stereotypes persist even when more relevant information is available.
    Keywords: Experiment, Gender, Risk
    Date: 2006–10

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