nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2008‒12‒01
fifteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Time to Change What to Sow: Risk Preferences and Technology Adoption Decisions of Cotton Farmers in China By Elaine Meichen Liu
  3. The no-trade interval of Dow and Werlang : some clarifications By Alain Chateauneuf; Caroline Ventura
  4. Managerial Responses to Incentives: Control of Firm Risk, Derivative Pricing Implications, and Outside Wealth Management By Jens Carsten Jackwerth; James E. Hodder
  5. Heterogeneous Risk Preferences and the Welfare Cost of Business Cycles By Sam Schulhofer-Wohl
  6. Modeling Preference Data By ALBERTO MAYDEU
  7. "Macroeconomic Implications of Term Structures of Interest Rates under Stochastic Differential Utility with Non-Unitary IES" By Hisasi Nakamura; Wataru Nozawa; Akihiko Takahashi
  8. What do distortion risk measures tell us on excess of loss reinsurance with reinstatements ? By Antonella Campana; Paola Ferretti
  9. Washington Biofuel Feedstock Supply under Price Uncertainty By Zheng, Qiujie; Shumway, C. Richard
  10. Culturally Risk Averse? – A Model of Economic Growth with Endogenous Culture By Mariko Klasing
  11. Learning, Rationality and Identity Building By David Cayla
  12. The Power of Reasoning: Experimental Evidence By Subhasish Dugar; Haimanti Bhattacharya
  13. Preference aggregation theory without acyclicity: The core without majority dissatisfaction By Kumabe, Masahiro; Mihara, H. Reiju
  14. Trends in Income Inequality, Volatility, and Mobility Risk By Nichols, Austin
  15. Bipolar and bivariate models in multi-criteria decision analysis: descriptive and constructive approaches By Michel Grabisch; Salvatore Greco; Marc Pirlot

  1. By: Elaine Meichen Liu (Princeton University)
    Abstract: The slow diffusion of new technology in the agricultural sector of developing countries has long puzzled development economists. While most of the current empirical research on technology adoption focuses on credit constraints and learning spillovers, this paper examines the role of individual risk attitudes in the decision to adopt a new form of agricultural biotechnology in China. I conducted a survey and a field experiment to elicit the risk preferences of 320 Chinese farmers, who faced the decision of whether to adopt genetically modified Bt cotton a decade ago. Bt cotton is more effective in pest prevention and thus requires less pesticides than traditional cotton. In my analysis, I expand the measurement of risk preferences beyond expected utility theory to incorporate prospect theory parameters such as loss aversion and nonlinear probability weighting. Using the parameters elicited from the experiment, I find that farmers who are more risk averse or more loss averse adopt Bt cotton later. Farmers who overweight small probabilities adopt Bt cotton earlier.
    Keywords: Technology Adoption, Risk Preferences, Prospect Theory
    JEL: O14 O33
    Date: 2008–05
  2. By: Renaud Bourlès (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales - CNRS : UMR6579)
    Abstract: This paper examines the effect of moral hazard on dynamic insurance contract. It models primary prevention in a two period model with classification risk. Agents' preferences appear to play an important role in the determination of preventive effort and prepayment. If absolute prudence is larger that absolute risk aversion, moral hazard increases prepayment of premium and classification risk. This highlights a tradeoff between prevention and prepayment that arises from the classification risk. An increase in the difference between prudence and twice risk aversion (that we define as the degree of foresight) moreover makes dynamic insurance contracts more stable (when competing with spot insurance) if the cost of prevention is low enough when agents preferences exhibit CRRA. Under a formulated utility function with linear reciprocal derivative, we finally show that an increase in agents' degree of foresight enhances the stability of dynamic contract and the extent of prepayment.
    Keywords: Dynamic Insurance, Classification Risk, Moral Hazard, Prudence
    Date: 2008–11–22
  3. By: Alain Chateauneuf (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I); Caroline Ventura (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I)
    Abstract: The aim of this paper is two-fold : first, to emphasize that the seminal result of Dow and Werlang [9] remains valid under weaker conditions and this even if non-positive prices are considered, or equally that the no-trade interval result is robust when considering assets which can yield non-positive outcomes, second to make precise the weak uncertainty aversion behavior characteristic of the existence of such an interval.
    Keywords: Choquet expected utility, no-trade interval, perfect hedging, comonotone diversification, capacity.
    Date: 2008–07
  4. By: Jens Carsten Jackwerth (Universität Konstanz); James E. Hodder
    Abstract: We model a firm’s value process controlled by a manager maximizing expected utility from restricted shares and employee stock options. The manager also dynamically controls allocation of his outside wealth. We explore interactions between those controls as he partially hedges his exposure to firm risk. Conditioning on his optimal behavior, control of firm risk increases the expected time to exercise for his employee stock options. It also reduces the percentage gap between his certainty equivalent and the firm’s fair value for his compensation, but that gap remains substantial. Managerial control also causes traded options to exhibit an implied volatility smile.
    Date: 2008–02–25
  5. By: Sam Schulhofer-Wohl (Princeton University)
    Abstract: I study the welfare cost of business cycles in a complete-markets economy where some people are more risk averse than others. Relatively more risk-averse people buy insurance against aggregate risk, and relatively less risk-averse people sell insurance. These trades reduce the welfare cost of business cycles for everyone. Indeed, the least risk-averse people benet from business cycles. Moreover, even innitely risk-averse people suer only nite and, in my empirical estimates, very small welfare losses. In other words, when there are complete insurance markets, aggregate uctuations in consumption are essentially irrelevant not just for the average person { the surprising nding of Lucas (1987) { but for everyone in the economy, no matter how risk averse they are. If business cycles matter, it is because they aect productivity or interact with uninsured idiosyncratic risk, not because aggregate risk per se reduces welfare.
    Keywords: business cycles; risk aversion; risk sharing; heterogeneity
    JEL: E32 E21
    Date: 2008–01
  6. By: ALBERTO MAYDEU (Instituto de Empresa)
    Abstract: We provide a gentle overview of modeling choice data, with an emphasis on statistical models that allow treating both observed and unobserved effects due to the decision makers and choice options. We first consider the situation when decision makers express their preferences in the form of liking judgments or purchase intentions (as in conjoint studies).Then, we consider applications that involve partial and/or incomplete ranking data -including paired comparisons and first choices. In this case, we assume that choice outcomes are a result of a maximization process, i.e., decision makers are assumed to select or choose options that have the highest utility among the considered options.
    Keywords: Preference data, Random utility models
    Date: 2008–10
  7. By: Hisasi Nakamura (Faculty of Economics, University of Tokyo); Wataru Nozawa (Graduate School of Economics, University of Tokyo); Akihiko Takahashi (Faculty of Economics, University of Tokyo)
    Abstract: This paper proposes a continuous-time term-structure model under stochastic differential utility with non-unitary intertemporal elasticity of substitution (IES, henceforth) in a representative-agent endowment economy with mean-reverting expectations on real output growth and ination. Using this model, we make clear structural relationships among a term structure of real and nominal interest rates, utility form and underlying economic factors, in particular, ination expectation. Specifically, we show that, if (1) the IES is less than one, (2) the agent is comparatively more risk-averse relative to time-separable utility, (3) short-term interest rates are pro-cyclical, and (4) the rate of expected ination is negatively correlated with the rate of real output growth and its expected rate, then a nominal yield curve can have a low instantaneous riskless rate and an upward slope.
    Date: 2008–11
  8. By: Antonella Campana (Department SEGeS, University of Molise); Paola Ferretti (Department of Applied Mathematics, University of Venice)
    Abstract: In this paper we focused our attention to the study of an excess of loss reinsurance with reinstatements, a problem previously studied by Sundt [5] and, more recently, by Mata [4] and HÄurlimann [3]. As it is well-known, the evaluation of pure premiums requires the knowledge of the claim size distribution of the insurance risk: in order to face this question, different approaches have been followed in the actuarial literature. In a situation of incomplete information in which only some characteristics of the involved elements are known, it appears to be particularly interesting to set this problem in the framework of risk adjusted premiums. It is shown that if risk adjusted premiums satisfy a generalized expected value equation, then the initial premium exhibits some regularity properties as a function of the percentages of reinstatement.
    Keywords: Excess of loss reinsurance, reinstatements, distortion risk measures, expected value equation
    JEL: G22
    Date: 2008–11
  9. By: Zheng, Qiujie; Shumway, C. Richard
    Abstract: Biofuels, as alternative transportation fuels, are now being used globally. Taking advantage of in-state feedstock supply is an efficient way to stimulate in-state biofuel industries and the local economy. This paper uses the mean-variance model of utility maximization to estimate supply equations for major biofuel feedstock crops in Washington. We consider price risk, examine the comparative statics results of the model, and use the results to draw important decision-making implications for Washington farmers who are considering production of biofuel feedstocks. Of three potential feedstock crops, only one shows immediate promise in Washington.
    Keywords: biofuel feedstock, price uncertainty, supply, Crop Production/Industries, Production Economics, Risk and Uncertainty,
    Date: 2008
  10. By: Mariko Klasing
    Abstract: This research studies the dynamic interplay between the evolution of cultural traits and the process of economic development. In particular, this paper shows how cultural attitudes, in this case differences in risk attitudes, influence economic decision making while at the same time illustrating how these attitudes endogenously change over time. In order to study this joint evolution of cultural and economic variables, an endogenous growth model is integrated with a cultural transmission mechanism along the lines of Bisin & Verdier. This provides us with a framework for the analysis of cultural attitudes that is both general and flexible so that it could be adapted for the study of culture in its full multidimensionality. The model predicts that higher economic success of more risk tolerant agents will over time lead to an increase in their representation in the society, which in turn will speed up economic growth. At the same time, though, the more risk averse type will not be completely eliminated. Using individual level data on risk attitudes across Chinese provinces, empirical evidence supporting this relationship between economic incentives and risk attitudes is provided.
    Keywords: Economic growth, cultural change, cultural transmission, risk aversion
    JEL: A14 J24 O11 O15 O33 O41 Z10
    Date: 2008–11
  11. By: David Cayla (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, IMRI - Institut pour le Management de la Recherche et de l'Innovation - Université Paris Dauphine - Paris IX)
    Abstract: This paper focuses on the link between the economic conceptions of rationality and learning. Traditionally, most economists believe that learning is just a way for agents to become fully rational. But being fully rational cannot describe a process, for there is only one way to be rational in the economic sense of the term. Therefore, what economists have in mind is not the process of learning, but the result of learning: ‘a fully rational agent’. Heterodox rationality conceptions such as the Simonian model of bounded rationality seem more compatible with the idea of learning. Bounded rationality implies that agents may act differently to the same stimulus; it is therefore compatible with the idea of diversity, one of the foundations of the evolutionary logic. But following Simon, learning should not be considered as a creative process that allows a lot of diverse answers. If diversity exists in the agents’ behaviors, the way they learn appears to be unique. As a consequence, learning should decrease the strength of the selection forces, both processes being contradictory (Dosi et al. 2003). Our paper aims to overcome this contradiction by showing how intentionality and identity, and more broadly Fransisco Varela’s ‘enaction’ theory, can help to invent a concept of ‘rational learning’ that is compatible with the evolutionary logic.
    Keywords: learning; rationality; identity; cognitive sciences; enaction; evolutionary theory
    Date: 2008–10–01
  12. By: Subhasish Dugar; Haimanti Bhattacharya
    Abstract: This paper presents an experimental investigation of how a systematic variation in the cognitive demands on subjects affects the optimal play. The innovation of this paper is the choice of a game, which we call the Game of Position. This is a two-player zero-sum game characterized by a dominant-strategy solution that involves iterative steps of reasoning. The equilibrium play is independent of mutual beliefs of players; hence inability of a subject to play the dominant-strategy unambiguously implies the failure of human reasoning prowess. We alter the two parameters of the game to vary the cognitive constraints, as represented by these steps of reasoning, on players. Our main substantive conclusion is that the frequency of the dominant-strategy play sharply increases as we limit the cognitive demands on players.
    Keywords: Non-cooperative game theory, cognition, laboratory experiment
    JEL: C72 D83 C91
    Date: 2008
  13. By: Kumabe, Masahiro; Mihara, H. Reiju
    Abstract: Acyclicity of individual preferences is a minimal assumption in social choice theory. We replace that assumption by the direct assumption that preferences have maximal elements on a fixed agenda. We show that the core of a simple game is nonempty for all profiles of such preferences if and only if the number of alternatives in the agenda is less than the Nakamura number of the game. The same is true if we replace the core by the core without majority dissatisfaction, obtained by deleting from the agenda all the alternatives that are non-maximal for all players in a winning coalition. Unlike the core, the core without majority dissatisfaction depends only onthe players' sets of maximal elements and is included in the union of such sets. A result for an extended framework gives another sense in which the core without majority dissatisfaction behaves better than the core.
    Keywords: Core; Nakamura number; kappa number; simple games; voting games; maximal elements; acyclic preferences; limit ordinals
    JEL: D71 C71 C02
    Date: 2008–11–24
  14. By: Nichols, Austin (Urban Institute)
    Abstract: There has been a renewed interest in recent years in income inequality, economic mobility, and income volatility. I define an aggregate measure of income risk as half the squared coefficient of variation of incomes measured over both people and time, which can be decomposed into an inequality component measuring dispersion in mean incomes, a volatility component measuring the average dispersion of fluctuations about person-specific trends, and a mobility component measuring the dispersion of person-specific trends. I apply this decomposition to the Panel Study of Income Dynamics to characterize trends in inequality, volatility, and mobility over the last several decades in the United States. I also examine changes in the regressivity of income growth over time.
    Keywords: inequality; volatility ; instability ; mobility ; progressivity
    JEL: D31 D63 H23
    Date: 2008–11
  15. By: Michel Grabisch (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I); Salvatore Greco (Faculty of Economics - University of Catania); Marc Pirlot (Faculté polytechnique de Mons - Polytechnic College of Mons)
    Abstract: Multi-criteria decision analysis studies decision problems in which the alternatives are evaluated on several dimensions or viewpoints. In the problems we consider in this paper, the scales used for assessing the alternatives with respect to a viewpoint are bipolar and univariate or unipolar and bivariate. In the former case, the scale is divided in two zones by a neutral point; a positive feeling is associated to the zone above the neutral point and a negative feeling to the zone below this point. On unipolar bivariate scales, an alternative can receive both a positive and a negative evaluation, reflecting contradictory feelings or stimuli. The paper discusses procedures and models that have been proposed to aggregate multi-criteria evaluations when the scale of each criterion is of one of the two types above. We present both a constructive and a descriptive view on this question; the descriptive approach is concerned with characterizations of models of preference, while the constructive approach aims at building preferences by questioning the decision maker. We show that these views are complementary.
    Keywords: Multiple criteria, Decision analysis, Preference, Bipolarmodels, Choquet integral
    Date: 2008–09

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