nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2008‒04‒29
eight papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Facts, Norms and Expected Utility Functions By Sophie Jallais; Pierre-Charles Pradier; David Teira
  2. Preferences for One-Shot Resolution of Uncertainty and Allais-Type Behavior By Dillenberger, David
  3. Auctions under Payoff Uncertainty: The Case with Heterogeneous Bidder Aversion to Downside Risk By Audrey Hu; Liang Zou
  4. Risk Taking in Winner-Take-All Competition By Matthias Kräkel; Petra Nieken; Judith Przemeck
  5. A non-dictatorial criterion for optimal growth models By Alain Ayong Le Kama; Cuong Le Van; Katheline Schubert
  6. Are the Joneses making you financially vulnerable? By Barnett, Richard C; Bhattacharya, Joydeep; Bunzel, Helle
  7. Insiders-Outsiders, Transparency and the Value of the Ticker By Cespa, Giovanni; Foucault, Thierry
  8. Homo Sapiens Sapiens Meets Homo Strategicus at the Laboratory By Ludovic Renou; Ralph C. Bayer

  1. By: Sophie Jallais (PHARE - Pôle d'Histoire de l'Analyse et des Représentations Economiques - CNRS : FRE2541 - Université Panthéon-Sorbonne - Paris I - Université de Paris X - Nanterre); Pierre-Charles Pradier (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, SAMOS - Statistique Appliquée et MOdélisation Stochastique - Université Panthéon-Sorbonne - Paris I); David Teira (Dpto. de Lógica, Historia y Filosofía de la ciencia. UNED - uned)
    Abstract: In this paper we want to explore an argumentative pattern that provides a normative justification for expected utility functions grounded on empirical evidence, showing how it worked in three different episodes of their development. The argument claims that we should prudentially maximize our expected utility since this is the criterion effectively applied by those who are considered wisest in making risky choices (be it gamblers or businessmen). Yet, to justify the adoption of this rule, it should be proven that this is empirically true: i.e., that a given function allows us to predict the choices of that particular class of agents. We show how expected utility functions were introduced and contested in accordance to this pattern in the 18th century and how it recurred in the 1950s when M. Allais made his case against the neobernoullians.
    Keywords: Expected utility;Normative theory;
    Date: 2008–05
  2. By: Dillenberger, David
    Abstract: Experimental evidence suggests that individuals are more risk averse when they perceive risk gradually. We address these findings by studying a decision maker (DM) who has recursive preferences over compound lotteries and who cares about the way uncertainty is resolved over time. DM has preferences for one-shot resolution of uncertainty if he always prefers any compound lottery to be resolved in a single stage. We establish an equivalence between dynamic preferences for one-shot resolution of uncertainty and static preferences that are identified with the behavior observed in Allais-type experiments. The implications of this equivalence on preferences over information systems are examined. We define the gradual resolution premium and demonstrate its magnifying effect when combined with the usual risk premium. In an intertemporal context, preferences for one-shot resolution of uncertainty capture narrow framing.
    JEL: D81 D80
    Date: 2008–04–09
  3. By: Audrey Hu (University of Amsterdam); Liang Zou (University of Amsterdam)
    Abstract: This paper characterizes the optimal first-price auction (FPA) and second-price auction (SPA) for selling rights, contracts, or licenses that involve ensuing payoff uncertainty for the winning bidder. The distribution of the random payoff is common knowledge, except that bidders have private degrees of aversion to downside-risk. In this model, the optimal FPA entails a lower reserve price, a higher expected revenue, and higher expected utilities for at least some or all bidders than the optimal SPA does, which suggests that FPA dominates SPA in terms of both allocative and Pareto efficiency. Increasing risk or risk aversion generally leads to lower equilibrium bids.
    Keywords: auction; downside risk; risk aversion; payoff uncertainty; allocative efficiency; Pareto efficiency
    JEL: D44
    Date: 2008–04–21
  4. By: Matthias Kräkel (University of Bonn, Adenauerallee 24-42, D-53113 Bonn, Germany, tel: +49 228 733914, fax: +49 228 739210, e-mail:; Petra Nieken (University of Cologne, Herbert-Lewin-Str. 2, D-50931 Köln, Germany, tel: +49 221 4706310, fax: +49 221 4705078, e-mail:; Judith Przemeck (University of Bonn, Adenauerallee 24-42, D-53113 Bonn, Germany, tel: +49 228 739213, fax: +49 228 739210, e-mail:
    Abstract: We analyze a two-stage game between two heterogeneous players. At stage one, common risk is chosen by one of the players. At stage two, both players observe the given level of risk and simultaneously invest in a winner-take-all competition. The game is solved theoretically and then tested by using laboratory experiments. We find three effects that determine risk taking at stage one - an effort effect, a likelihood effect and a reversed likelihood effect. For the likelihood effect, risk taking and investments are clearly in line with theory. Pairwise comparison shows that the effort effect seems to be more relevant than the reversed likelihood effect when taking risk.
    Keywords: Tournaments, Competition, Risk-Taking, Experiment
    JEL: M51 C91 D23
    Date: 2008–03
  5. By: Alain Ayong Le Kama (EQUIPPE - Université de Lille I); Cuong Le Van (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, Ecole d'économie de Paris - Paris School of Economics - Université Panthéon-Sorbonne - Paris I); Katheline Schubert (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, Ecole d'économie de Paris - Paris School of Economics - Université Panthéon-Sorbonne - Paris I)
    Abstract: There are two main approaches for defining social welfare relations for an economy with infinite horizon. The first one is to consider the set of intertemporal utility streams generated by a general set of bounded consumptions and define a preference relation between them. This relation is ideally required to satisfy two main axioms, the Pareto axiom, which guarantees efficiency and the Anonymity axiom, which guarantees equity. Basu and Mitra (2003) show that it is impossible to represent by a function a preference relation embodying both requirements, and Basu and Mitra (2007) propose and characterize a new welfare criterion called utilitarian social welfare relation. In the same framework, Chichilnisky (1996) proposes two axioms that capture the idea of sustainable growth : non-dictatorship of the present and non-dictatorship of the future, and exhibits a mixed criterion, adding a discounted utilitarian part, which gives a dictatorial role to the present, and a long term part, which gives a dictatorial role to the future. The drawback of Chichilnisky's approach is that it often does not allow to explicity characterize optimal growth paths with optimal control techniques. Our aim is less general than Chichilnisky's and Basu and Mitra's : we want to have a non-dictatorial criterion for optimal growth models. We restrict ourselves to the set of utilities of consumptions which are generated by a specific technology. We show that the undiscounted utilitarian criterion pioneered by Ramsey (1928) is not only convenient if one wants to solve an optimal growth problem but also sustainable, efficient and equitable.
    Keywords: Anonymity, intergenerational equity, natural resources, non-dictatorship of the future, non-dictatorship of the present, optimal growth models, Pareto, social welfare function, social welfare relation, sustainability, utilitarian undiscounted criterion.
    Date: 2008–04
  6. By: Barnett, Richard C; Bhattacharya, Joydeep; Bunzel, Helle
    Abstract: This note studies a model in which heterogeneous income agents get a utility jolt only when their consumption catches up with the Joneses'. The resulting utility function is non-concave. In this setup, participation in a fair lottery has the potential to make some agents better off in an ex-ante sense even as it makes them financially vulnerable. More income-diverse people join the lottery pool when the `kick' from catching up increases. Worsening income inequality may increase the number of financially vulnerable people. The analysis sheds light on some aspects of the ongoing sub-prime mortgage crisis.
    Keywords: catching up with the Joneses, housing crisis, consumption externalities, non-concave utility, lotteries, inequality
    JEL: D0
    Date: 2008–04–17
  7. By: Cespa, Giovanni; Foucault, Thierry
    Abstract: We consider a multi-period rational expectations model in which risk-averse investors differ in their information on past transaction prices (the ticker). Some investors (insiders) observe prices in real-time whereas other investors (outsiders) observe prices with a delay. As prices are informative about the asset payoff, insiders get a strictly larger expected utility than outsiders. Yet, information acquisition by one investor exerts a negative externality on other investors. Thus, investors’ average welfare is maximal when access to price information is rationed. We show that a market for price information can implement the fraction of insiders that maximizes investors’ average welfare. This market features a high price to curb excessive acquisition of ticker information. We also show that informational efficiency is greater when the dissemination of ticker information is broader and more timely.
    Keywords: Hirshleifer effect; Market data sales; Price discovery; Transparency
    JEL: G10 G14
    Date: 2008–04
  8. By: Ludovic Renou; Ralph C. Bayer
    Abstract: Homo Strategicus populates the vast plains of Game Theory. He knows all logical implications of his knowledge (logical omniscience) and chooses optimal strategies given his knowledge and beliefs (rationality). This paper investigates the extent to which the logical capabilities of Homo Sapiens Sapiens resemble those possessed by Homo Strategicus. Controlling for other-regarding preferences and beliefs about the rationality of others, we show, in the laboratory, that the ability of Homo Sapiens Sapiens to perform complex chains of iterative reasoning is much better than previously thought. Subjects were able to perform about three iterations of reasoning on average.
    Keywords: iterative reasoning; depth of reasoning; logical omniscience; rationality; experiments; other-regarding preferences
    JEL: C70 C91
    Date: 2008–04

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