nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2008‒09‒20
ten papers chosen by
Alexander Harin
Modern University for the Humanities

  1. A general theory of time discounting: The reference-time theory of intertemporal choice By Ali al-Nowaihi; Sanjit Dhami
  2. Financial Risk Aversion and Household Asset Diversification By Barasinska, Nataliya; Schäfer, Dorothea; Stephan, Andreas
  3. Strategic Play and Risk Aversion in One-Shot Normal-Form Games: An Experimental Study By Asen Ivanov
  4. Robust Monopoly Pricing By Dirk Bergemann; Karl Schlag
  5. A value function that explains the magnitude and sign effects By Ali al-Nowaihi; Sanjit Dhami
  6. A Monte Carlo Study of the Necessary and Sufficient Conditions for Weak Separability By Hjertstrand, Per
  7. I can't get no Satisfaction - Necessity Entrepreneurship and Procedural Utility By Joern Block; Philipp Koellinger
  8. Monopoly, Non-linear Pricing, and Imperfect Information : A Reconsideration of the Insurance Market By Szalay, Dezsö
  9. Satisficing and prior-free optimality in price competition: a theoretical and experimental analysis By Werner Güth; M. Vittoria Levatia; Matteo Ploner
  10. Imitative Obesity and Relative Utility By David G. Blanchflower; Andrew J. Oswald; Bert Van Landeghem

  1. By: Ali al-Nowaihi; Sanjit Dhami
    Abstract: We develop a general theory of intertemporal choice: the reference-time theory, RT. RT is a synthesis of ideas from the hyperbolic model and subadditivity of time discounting. These models are extended to allow for a reference point for time as well as wealth. RT is able to account for all the 6 main anomalies of time discounting: gain-loss asymmetry, magnitude effect, common difference effect, delay-speedup asymmetry, apparent intransitivity of time preferences, and non-additivity of time discounting. We provide a class of utility functions compatible with RT. We show how RT can be extended to incorporate uncertainty and attribute models of intertemporal choice.
    Keywords: Anomalies of the discounted utility model; Hyperbolic discounting; Prospect theory; gamma-delay; alpha-subadditivity; SIE value functions
    JEL: C60 D91
    Date: 2008–09
  2. By: Barasinska, Nataliya (DIW Berlin); Schäfer, Dorothea (DIW Berlin); Stephan, Andreas (CESIS and JIBS)
    Abstract: This paper explores the relationship between risk attitude and asset diversifcation in household portfolios. We first examine the impact of manifested risk aversion on the total number of distinct assets held in a portfolio (naive diversification). The second part of the paper focuses on a more sophisticated strategy of diversification and asks whether financial theory is compatible with observed diversification patterns. Based on the German Socioeconomic Panel which provides unique measures of individual propensity for taking risk, the results of the regression analysis show that, along with some socioeconomic characteristics, the propensity for taking investment risk is an important predictor of a household's diversification strategy. However, some of our findings are strongly at odds with what the concept of mean-variance utility suggests.
    Keywords: household finances; diversification; financial portfolio
    JEL: D14 G11
    Date: 2008–09–09
  3. By: Asen Ivanov (Department of Economics, VCU School of Business)
    Abstract: Based on subjects’ play and stated beliefs in ten one-shot normal-form games, we study behavior along the two general dimensions “naive vs. strategic” and “risk neutral vs. risk averse”. We also investigate how behavior varies depending on whether (A) subjects play without interference from belief elicitation, (B) subjects state beliefs while playing, or (C) subjects choose between lottery tickets instead of between actions in a game. With our games and graduate subjects, we find that under (A) a small minority of subjects is naive and a minority is risk neutral. However, these findings are not robust to changing the games or the subject population. Regarding the comparative statics across (A), (B) and (C), we find that naive behavior diminishes from (A) to (B) to (C) and that considerably more subjects are risk neutral under (B) than under (A) or (C). The latter is interpreted in terms of ambiguity aversion.
    Keywords: games, experiments, beliefs, risk aversion, ambiguity aversion
    JEL: C72 C92 C51 D81 D84
    Date: 2008–09
  4. By: Dirk Bergemann (Cowles Foundation, Yale University); Karl Schlag (Department of Economics, Universitat Pompeu Fabra)
    Abstract: We consider a robust version of the classic problem of optimal monopoly pricing with incomplete information. In the robust version, the seller faces model uncertainty and only knows that the true demand distribution is in the neighborhood of a given model distribution. We characterize the optimal pricing policy under two distinct, but related, decision criteria with multiple priors: (i) maximin expected utility and (ii) minimax expected regret. The resulting optimal pricing policy under either criterion yields a robust policy to the model uncertainty. While the classic monopoly policy and the maximin criterion yield a single deterministic price, minimax regret always prescribes a random pricing policy, or equivalently, a multi-item menu policy. Distinct implications of how a monopolist responds to an increase in uncertainty emerge under the two criteria.
    Keywords: Monopoly, Optimal pricing, Robustness, Multiple priors, Regret
    JEL: C79 D82
    Date: 2005–07
  5. By: Ali al-Nowaihi; Sanjit Dhami
    Abstract: Two of the anomalies of the exponentially discounted utility model are the 'magnitude effect' (larger magnitudes are discounted less) and the 'sign effect' (a loss is discounted less than a gain of the same magnitude). The literature has followed Loewenstein and Prelec (1992) in attributing the magnitude effect to the increasing elasticity of the value function and the sign effect to a higher elasticity for losses as compared to gains. We provide a simple, tractable, functional form that has these two properties, which we call the simple increasing elasticity value function (SIE). These functional forms underpin the main explanation of the magnitude and sign effects and may aid applications and further theoretical development.
    Keywords: Anomalies of the exponentially discounted utility model; the magnitude effect; the sign effect; SIE value functions
    JEL: C60 D91
    Date: 2008–09
  6. By: Hjertstrand, Per (Department of Economics, Lund University)
    Abstract: Weak separability is an important concept in many fields of economic theory. This paper uses Monte Carlo experiments to investigate the performance of newly developed nonparametric revealed preference tests for weak separability. A main finding is that the bias of the sequentially implemented test for weak separability proposed by Fleissig and Whitney (A New PC-Based Test for Varian’s Weak Separability Conditions, Journal of Business and Economic Statistics 21, 133-143, 2003) is low. The theoretically unbiased Swofford and Whitney test (A revealed preference test for weakly separable utility maximization with incomplete adjustment, Journal of Econometrics 60, 235-249, 1994) is found to perform better than all sequentially implemented test procedures, but is found to suffer from an empirical bias, most likely because of the complexity in executing the test procedure. As a further source of information, we also perform sensitivity analyses on the nonparametric revealed preference tests. It is found that the Fleissig and Whitney test seems to be sensitive to measurement
    Keywords: GARP; LP test; NONPAR; Swofford and Whitney test; Weak separability
    JEL: C14 C15 C43
    Date: 2008–09–11
  7. By: Joern Block (Technische Universität München); Philipp Koellinger (Erasmus University Rotterdam)
    Abstract: We study a unique sample of 1,547 nascent entrepreneurs in Germany and analyze which factors are associated with their self-reported satisfaction regarding their start-up. Our study identifies a new facet of procedural utility and offers new insights about the motivations and goals of nascent entrepreneurs. Most importantly, we identify a group of nascent entrepreneurs that “cannot get satisfaction” with their start-up—not because their start-up fails to deliver financial returns, but because they did not choose to become entrepreneurs in the first place. This group of unsatisfied entrepreneurs includes individuals starting a business after a period of long-term unemployment and those individuals with a lack of better employment alternatives (necessity entrepreneurs). In addition, we provide additional evidence for the importance of both financial and non-financial incentives of entrepreneurs. While financial success is the most important determinant of start-up satisfaction, achievement of independence and creativity is also highly important. Our results emphasize the relevance of procedural utility for understanding economic behavior.
    Keywords: Entrepreneurship; Satisfaction; Procedural Utility; Unemployment; Necessity Entrepreneurship
    JEL: J24 J17 L26
    Date: 2008–09–02
  8. By: Szalay, Dezsö (Economics Department, University of Warwick.)
    Abstract: I reconsider Stiglitz's (1977) problem of monopolistic insurance with a continuum of types. Using a suitable transformation of control variables I obtain an analytical characterization of the optimal insurance policies. Closed form solutions and comparative statics results for special cases are provided.
    Keywords: nonlinear pricing ; screening ; risk aversion
    JEL: D82
    Date: 2008
  9. By: Werner Güth (Max Planck Institute of Economics, Strategic Interaction Group, Jena, Germany); M. Vittoria Levatia (Max Planck Institute of Economics, Strategic Interaction Group, Jena, Germany); Matteo Ploner (Max Planck Institute of Economics, Strategic Interaction Group, Jena, Germany; University of Trento, Italy)
    Abstract: On a heterogeneous experimental oligopoly market, sellers choose a price, specify a set-valued prior-free conjecture about the others' behavior, and form their own profit-aspiration for each element of their conjecture. We formally define the concepts of satisficing and prior-free optimality and check if seller participants behave in accordance with them. We find that seller participants are satisficers, but fail to be "prior-free" optimal.
    Keywords: Satisficing behavior, Bounded rationality, Triopoly
    JEL: C92 C72 D43
    Date: 2008–09–09
  10. By: David G. Blanchflower; Andrew J. Oswald; Bert Van Landeghem
    Abstract: If human beings care about their relative weight, a form of imitative obesity can emerge (in which people subconsciously keep up with the weight of the Joneses). Using Eurobarometer data on 29 countries, this paper provides cross-sectional evidence that overweight perceptions and dieting are influenced by a person's relative BMI, and longitudinal evidence from the German Socioeconomic Panel that well-being is influenced by relative BMI. Highly educated people see themselves as fatter -- at any given actual weight -- than those with low education. These results should be treated cautiously, and fixed-effects estimates are not always well-determined, but there are grounds to take seriously the possibility of socially contagious obesity.
    JEL: D01 I12 I31
    Date: 2008–09

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