nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2008‒08‒31
six papers chosen by
Alexander Harin
Modern University for the Humanities

  1. A Dynamic Mechanism and Surplus Extraction Under Ambiguity By Subir Bose; Arup Daripa
  2. What Good Is Wealth without Health? The Effect of Health on the Marginal Utility of Consumption By Finkelstein, Amy; Luttmer, Erzo F. P.; Notowidigdo, Matthew J.
  3. Religion and Faith: A Decision Theory Perspective By Tigran Melkonyan; Mark Pingle
  4. Ambiguity, Pessimism, and Religious Choice By Tigran Melkonyan; Mark Pingle
  5. Debt and Risk Preference: A Household Level Analysis By Sarah Brown; Gaia Garino; Peter Simmons; Karl Taylor
  6. Risk and Lack of Diversification under Employee Ownership and Shared Capitalism By Joseph R. Blasi; Douglas L. Kruse; Harry M. Markowitz

  1. By: Subir Bose; Arup Daripa
    Abstract: In the standard independent private values (IPV)model, each bidder’s beliefs about the values of any other bidder is represented by a unique prior. In this paper we relax this assumption and study the question of auction design in an IPV setting characterized by ambiguity: bidders have an imprecise knowledge of the distribution of values of others, and are faced with a set of priors. We also assume that their preferences exhibit ambiguity aversion; in particular, they are represented by the epsilon-contamination model. We show that a simple variation of a discrete Dutch auction can extract almost all surplus. This contrasts with optimal auctions under IPV without ambiguity as well as with optimal static auctions with ambiguity - in all of these, types other than the lowest participating type obtain a positive surplus. An important point of departure is that the modified Dutch mechanism we consider is dynamic rather than static, establishing that under ambiguity aversion – even when the setting is IPV in all other respects – a dynamic mechanism can have additional bite over its static counterparts.
    Keywords: Ambiguity Aversion; Epsilon Contamination; Modified Dutch Auction; Dynamic Mechanism; Surplus Extraction
    JEL: D44
    Date: 2008–07
  2. By: Finkelstein, Amy (Massachusetts Institute of Technology); Luttmer, Erzo F. P. (Harvard U); Notowidigdo, Matthew J. (Massachusetts Institute of Technology)
    Abstract: We estimate how the marginal utility of consumption varies with health. To do so, we develop a simple model in which the impact of health on the marginal utility of consumption can be estimated from data on permanent income, health, and utility proxies. We estimate the model using the Health and Retirement Study’s panel data on the elderly and near-elderly, and proxy for utility with measures of subjective well-being. We find robust evidence that the marginal utility of consumption declines as health deteriorates. Our central estimate is that a one-standard¬deviation increase in the number of chronic diseases is associated with an 11 percent decline in the marginal utility of consumption relative to this marginal utility when the individual has no chronic diseases. The 95 percent confidence interval allows us to reject declines in marginal utility of less than 2 percent or more than 17 percent. Point estimates from a wide range of alternative specifications tend to lie within this confidence interval. We present some simple, illustrative calibration results that suggest that state dependence of the magnitude we estimate can have a substantial effect on important economic problems such as the optimal level of health insurance benefits and the optimal level of life-cycle savings.
    JEL: D12
    Date: 2008–06
  3. By: Tigran Melkonyan (Department of Resource Economics, University of Nevada, Reno); Mark Pingle (Department of Economics, University of Nevada, Reno)
    Abstract: We examine the implications of decision theory for religious choice and evangelism, under the assumption that people choose their religion. The application of decision theory leads us to a broad definition of religion and a particular definition of faith, each related to the uncertainty associated with what happens to a person after death. We examine two extremes: total ambiguity and no ambiguity. For total ambiguity, we show there is “designer religion,” which is a religion that will capture all decision makers applying any one of the standard decision criteria. For no ambiguity, we characterize when a decision maker will find new religious information more valuable and we characterize a “miracle” in a specific way.
    Keywords: Religion; Decision Theory; Ambiguity; Optimism; Pessimism
    JEL: C44 D81 D83
    Date: 2008–08
  4. By: Tigran Melkonyan (Department of Resource Economics, University of Nevada, Reno); Mark Pingle (Department of Economics, University of Nevada, Reno)
    Abstract: Using a relatively mild restriction on the beliefs of the MMEU-apreference functional, in which the decision maker’s degree of ambiguity and degree of pessimism are each parameterized, we present a rather general theory of religious choice in the decision theory tradition, one that can resolve dilemmas, address the many Gods objection, and address the inherent ambiguity. Using comparative static analysis, we are able to show how changes in either the degree of ambiguity or the degree of pessimism can lead a decision maker to “convert” from one religion to another. We illustrate the theory of religious choice using an example where the decision maker perceives three possible religious alternatives.
    Keywords: Religion; Decision Theory; Ambiguity; Optimism; Pessimism
    JEL: C44 D81 D83
    Date: 2008–08
  5. By: Sarah Brown; Gaia Garino; Peter Simmons; Karl Taylor (Department of Economics, The University of Sheffield)
    Abstract: We explore the relationship between risk preference and the level of unsecured debt at the household level within the context of a two period theoretical framework, which predicts that debt is a function of risk aversion. We test the predictions of our theoretical framework for a sample of households drawn from the U.S. Panel Study of Income Dynamics (PSID) and the U.S. Survey of Consumer Finances (SCF). Using a sequence of questions from the 1996 PSID and the 1989 to 2004 SCF, we construct measures of risk preference allowing us to explore the implications of interpersonal differences in risk preference for the accumulation of unsecured debt at the household level. Our empirical findings, which accord with our theoretical priors, suggest that risk preference is an important determinant of the level of unsecured debt acquired at the household level with risk aversion serving to reduce the level of unsecured debt accumulated by households.
    Keywords: Debt; Financial Assets; Risk Aversion; Risk Preference
    JEL: D18 D84 D91
    Date: 2008–04
  6. By: Joseph R. Blasi; Douglas L. Kruse; Harry M. Markowitz
    Abstract: Some analysts view risk as the Achilles Heel of employee ownership and to some extent variable pay plans such as profit sharing and gainsharing. Workers in such "shared capitalist" firms may invest too much of their wealth in the firm, contrary to the principle of diversification. This paper addresses whether the risk in shared capitalism makes it unwise for most workers or whether the risk can be managed to limit much of the loss of utility from holding the extra risk. We create an index of financial security based on worker pay and wealth, and find that workers who feel financially insecure exhibit fewer of the positive outcomes associated with shared capitalism, and are less interested than other workers in receiving more employee ownership or even more profit sharing in their workplaces. This response is substantially lessened, however, when accounting for worker empowerment, good employee relations, and high-performance work bundles that appear to buffer worker response toward risk and increase interest in shared capitalism plans. We also discuss portfolio theory which suggests that any risky investment -- including stock in one's company -- can be part of an efficient portfolio as long as the overall portfolio is properly diversified. We show that given estimates of risk aversion parameters, workers could prudently hold reasonable proportions of their assets in employee stock ownership of their firm with only a modest loss in utility due to risk. A good strategy for firms is to personalize individual portfolios on the basis of worker characteristics and preferences, developing investment strategies that would diversify each worker's entire portfolio in ways consistent with individual risk preferences.
    JEL: D81 J33 J54 L23
    Date: 2008–08

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