nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2008‒04‒04
fourteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Vector Expected Utility and Attitudes toward Variation By Marciano Siniscalchi
  2. Risky Punishment and Reward in the Prisoner By Dürsch, Peter; Servátka, Maros
  3. Objective and Subjective Rationality in a Multiple Prior Model By Itzhak Gilboa; Fabio Maccheroni; Massimo Marinacci; David Schmeidler
  4. Estimating Ambiguity Aversion in a Portfolio Choice Experiment By David Ahn; Syngjoo Choi; Douglas Gale; Shachar Kariv
  5. Social Decision Theory: Choosing within and between Groups By Fabio Maccheroni; Massimo Marinacci; Aldo Rustichini
  6. Ambiguity By Eichberger, Jürgen; Kelsey, David
  7. Manipulation in Elections with Uncertain Preferences By Andrew McLennan
  8. Executive Stock Options when Managers are Loss-Averse By Dittmann, Ingolf; Maug, Ernst; Spalt, Oliver
  9. Lower Salaries and No Options: The Optimal Structure of Executive Pay By Maug, Ernst; Dittmann, Ingolf
  10. Ambiguity and Social Interaction By Eichberger, Jürgen; Kelsey, David; Schipper, Burkhard
  11. Determinants of Risk Taking Behavior: The role of Risk Attitudes, Risk Perceptions and Beliefs By Nosic, Alen; Weber, Martin
  12. Myopically Forward-Looking Agents in a Network Formation Game: Theory and Experimental Evidence By Berninghaus, Siegfried K.; Ehrhart, Karl-Martin; Ott, Marion
  13. Shareholders' expectations, aspiration levels, and mergers By Enrico Diecidue; Jeroen van de Ven; Utz Weitzel
  14. Liquidity and Ambiguity: Banks or Asset Markets? By Eichberger, Jürgen; Spanjers, Willy

  1. By: Marciano Siniscalchi
    Abstract: This paper analyzes a model of decision under ambiguity, deemed vector expected utility or VEU. According to the proposed model, an act f, mapping states of nature to prizes, is evaluated via the sum of (1) a baseline expected-utility term, and (2) an ambiguity-adjustment term. The adjustment term may be interpreted as reflecting the variability of the act f around its baseline expected utility; in particular, like classical statistical measures of variability, it is invariant to location and sign changes. A behavioral characterization of the VEU model is provided. Furthermore, an updating rule for VEU preferences is proposed and characterized. The suggested updating rule facilitates the analysis of sophisticated dynamic choice with VEU preferences.
    Keywords: ambiguity, reference prior, vector measures
    JEL: D81 D83
    Date: 2007–12
  2. By: Dürsch, Peter (Department of Economics, University of Heidelberg); Servátka, Maros (Department of Economics, University of Canterbury)
    Abstract: We conduct a prisoner’s dilemma experiment with a punishment/reward stage, where punishments and rewards are risky. This is compared with a risk free treatment. We find that subjects do not change their behavior in the face of risky outcomes. Additionally, we measure risk attitude and the emotions of subjects. While we find a strong influence of emotions, individual risk aversion has no effect on the decision to punish or reward. This is good news for lab experiments who abstract from risky outcomes. From the perspective of social preferences, our results provide evidence for risk neutral inclusion of other player’s payoffs in the decisionmaker’s utility function.
    Date: 2007–09–05
  3. By: Itzhak Gilboa; Fabio Maccheroni; Massimo Marinacci; David Schmeidler
    Abstract: A decision maker is characterized by two binary relations. The first reflects decisions that are rational in an “objective” sense: the decision maker can convince others that she is right in making them. The second relation models decisions that are rational in a “subjective” sense: the decision maker cannot be convinced that she is wrong in making them. We impose axioms on these relations that allow a joint representation by a single set of prior probabilities. It is “objectively rational” to choose f in the presence of g if and only if the expected utility of f is at least as high as that of g given each and every prior in the set. It is “subjectively rational” to choose f rather than g if and only if the minimal expected utility of f (relative to all priors in the set) is at least as high as that of g.
    Keywords: Rationality, Multiple Priors.
    JEL: D81
    Date: 2008
  4. By: David Ahn; Syngjoo Choi; Douglas Gale; Shachar Kariv
    Date: 2008–03–21
  5. By: Fabio Maccheroni; Massimo Marinacci; Aldo Rustichini
    Abstract: We introduce a theoretical framework in which to study interdependent preferences, where the outcome of others affects the preferences of the decision maker. The dependence may take place in two conceptually different ways, depending on how the decision maker evaluates what the others have. In the first he values his outcome and that of others on the basis of his own utility. In the second, he ranks outcomes according to a social value function. These two different views of the interdependence have separate axiomatic foundations. We then characterize preferences according to the relative importance assigned to social gains and losses, or in other words to pride and envy. Finally, we study a two period economy in which agents have our social preferences. We show how envy leads to conformism in consumption behavior and pride to diversity.
    Keywords: Social preferences, social economics.
    JEL: D81 E21
    Date: 2008
  6. By: Eichberger, Jürgen (Sonderforschungsbereich 504); Kelsey, David (Department of Economics, The University of Birmingham)
    Abstract: Ambiguity refers to a decision situation under uncertainty when there is incomplete information about the likelihood of events. Different formal models of this notion have been developed with differing implications about the representation of ambiguity and ambiguity aversion.
    Date: 2007–07–11
  7. By: Andrew McLennan (School of Economics, The University of Queensland)
    Abstract: A decision scheme (Gibbard (1977)) is a function mapping profiles of strict preferences over a set of social alternatives to lotteries over the social alternatives. Motivated by conditions typically prevailing in elections with many voters, we say that a decision scheme is weakly strategy-proof if it is never possible for a voter to increase expected utility (for some vNM utility function consistent with her true preferences) by misrepresenting her preferences when her belief about the preferences of other voters is generated by a model in which the other voters are i.i.d. draws from a distribution over possible preferences. We show that if there are at least three alternatives, a decision scheme is necessarily a random dictatorship if it is weakly strategy-proof, never assigns positive probability to Pareto dominated alternatives, and is anonymous in the sense of being unaffected by permutations of the components of the profile. This result is established in two settings- a) a model with a fixed set of voters; b) the Poisson voting model of Meyerson (1998a,b, 2000, 2002).
    Date: 2008
  8. By: Dittmann, Ingolf (Erasmus School of Economics Rotterdam); Maug, Ernst (Chair for Corporate Finance, University of Mannheim and Sonderforschungsbereich 504); Spalt, Oliver (Chair for Corporate Finance, University of Mannheim and Sonderforschungsbereich 504)
    Abstract: This paper analyzes optimal executive compensation contracts when managers are loss averse. We establish the general optimal contract analytically and parameterize the model using data on compensation contracts for 595 CEOs. Parameters for preferences are based on the experimental literature. Overall, the Loss Aversion-model dominates an equivalent Risk Aversion-model, especially with respect to its ability to predict options as part of the optimal contract. The Loss Aversion-model performs well in terms of predicting observed compensation contracts if the reference wage is assumed to lie not too far above previous year’s fixed wage. Our results suggest that loss aversion is a better paradigm for analyzing design features of stock options and for developing preference-based valuation models than the conventional model used in the literature.
    Date: 2007–06–26
  9. By: Maug, Ernst (Chair for Corporate Finance, University of Mannheim and Sonderforschungsbereich 504); Dittmann, Ingolf (Erasmus School of Economics Rotterdam)
    Abstract: We estimate a standard principal agent model with constant relative risk aversion and lognormal stock prices for a sample of 598 US CEOs. The model is widely used in the compensation literature, but it predicts that almost all of the CEOs in our sample should hold no stock options. Instead, CEOs should have lower base salaries and receive additional shares in their companies. For a typical value of relative risk aversion, almost half of the CEOs in our sample would be required to purchase additional stock in their companies from their private savings. The model predicts contracts that would reduce average compensation costs by 20% while providing the same incentives and the same utility to CEOs. We investigate a number of extensions and modi.cations of the standard model, but .nd none of them to be satisfactory. We conclude that the standard principal agent model typically used in the literature cannot rationalize observed contracts. One reason may be that executive pay contracts are suboptimal.
    Date: 2007–06–26
  10. By: Eichberger, Jürgen (Sonderforschungsbereich 504); Kelsey, David (Department of Economics, The University of Birmingham); Schipper, Burkhard (University of California, Davis Department of Economics)
    Abstract: We present a non-technical account of ambiguity in strategic games and show how it may be applied to economics and social sciences. Optimistic and pessimistic responses to ambiguity are formally modelled. We show that pessimism has the effect of increasing (decreasing)equilibrium prices under Cournot (Bertrand) competition. In addition the effects of ambiguity on peace-making are examined. It is shown that ambiguity may select equilibria in coordination games with multiple equilibria. Some comparative statics results are derived for the impact of ambiguity in games with strategic complements.
    Date: 2007–06–20
  11. By: Nosic, Alen (Sonderforschungsbereich 504); Weber, Martin (Lehrstuhl für ABWL, Finanzwirtschaft, insb. Bankbetriebslehre)
    Abstract: Our study analyzes determinants of investors' risk taking behavior. We find that investors' risk taking behavior, i.e. portfolio choices can be predicted using risk attitudes, risk perceptions and belief measures such as optimism and overconfidence. However, the predictive power of these determinants heavily depends on the domain in which it was elicited. More specifically, risk attitudes, risk perceptions and beliefs only allow us to predict investors' risk taking behavior if they are elicited in an investment related context. We think that our results could also benefit practitioners who could incorporate some of the determinants we have used in their investment advisory process.
    Date: 2007–07–31
  12. By: Berninghaus, Siegfried K. (Universität Karlsruhe); Ehrhart, Karl-Martin (Universitaet Karlsruhe); Ott, Marion (Universitaet Karlsruhe)
    Abstract: A population of players is considered in which each agent can select her neighbors in order to play a 2x2 Hawk-Dove game with each of them. We design our experiment in continuous time where participants may change their Hawk-Dove action and/or their neighborhood at any point in time. We are interested in the resulting formation of networks and the action distributions. Compared with static Nash equilibrium (e.g., Berninghaus and Vogt, 2004, 2006; Bramoulle, Lopez-Pintado, Goyal, and Vega-Redondo, 2004) and social optimum as theoretical benchmark solutions, subjects seem to employ a more complex, forward-looking thinking. We develop an other benchmark solution, called one-step-ahead stability, that combines forward-looking belief formation with rational response and that fits the data much better.
    Date: 2008–01–31
  13. By: Enrico Diecidue; Jeroen van de Ven; Utz Weitzel
    Abstract: This paper offers a new explanation of value-reducing mergers and stock market driven takeovers by introducing recent research on aspiration levels and individual decision making under risk. If market valuation constitutes an aspiration level for managers, we show that managers may be tempted to seek riskier mergers in order to meet shareholder optimism. Such merger seeking behavior increases in bidder overvaluation and can also favor acquisitions when the expected value of takeovers is lower than alternative investments. The paper provides support for several empirical findings and complements existing market-timing models as its predictions are decoupled from equity offers and are independent from the means of payment.
    Keywords: aspiration level, mergers and acquisitions, market-driven takeovers, overvaluation
    Date: 2008–02
  14. By: Eichberger, Jürgen (Sonderforschungsbereich 504); Spanjers, Willy (Department of Economics, Kingston University)
    Abstract: We study the impact of ambiguity on two alternative institutions of financial intermediation in an economy where consumers face uncertain liquidity needs. The ambiguity the consumers experience is modeled by the degree of confidence in their additive beliefs. We analyze the optimal liquidity allocation and two institutional settings for implementing this allocation: a secondary asset market and a bank deposit contract. For full confidence we obtain the well-known result that consumers prefer the bank deposit contract over the asset market, since the former can provide the optimal cross subsidy for consumers with high liquidity needs. With increasing ambiguity this preference will be reversed: the asset market is preferred, since it avoids inecient liquidation if the bank reserve holdings turn out to be suboptimal.
    Date: 2007–06–22

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