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on Utility Models and Prospect Theory |
| By: | Michèle Cohen (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris) |
| Abstract: | The classical expected utility model of decision under risk (von Neumann-Morgenstern, 1944) has been criticized from an experimental point of view (Allais' paradox) as well as for its restrictive lack of explanatory power. The Rank-Dependent Expected Utility model (RDU) model (Quiggin, 1982) attempts to answer some of these criticisms. The decision maker is characterized by two functions : a utility function on consequences measuring preferences over sure outcomes and a probability weighting function measuring the subjective weighting of probabilities. As we show and illustrate in this paper, this model allows for more diversified types of behavior : it is consistent with the behavior revealed by the Allais paradox ; the decision maker could dislike risk (prefer to any lottery its expectation) without necessarily avoiding any increase in risk ; diminishing marginal utility may coexists with "weak" risk seeking attitudes ; decision makers with the same utility function may differ in their choices between lotteries when they have different probability weighting functions ; furthemore, the same decision maker may have different, context-dependent, subjective beliefs on events. |
| Keywords: | Decision under risk, risk perception, risk aversion, Allais paradox, Rank-Dependent Expected Utility Model. |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-00348810_v1&r=upt |
| By: | Ortoleva, Pietro |
| Abstract: | Motivated by the extensive evidence about the relevance of status quo bias both in experiments and in real markets, we study this phenomenon from a decision-theoretic prospective, focusing on the case of preferences under uncertainty. We develop an axiomatic framework that takes as a primitive the preferences of the agent for each possible status quo option, and provide a characterization according to which the agent prefers her status quo act if nothing better is feasible for a given set of possible priors. We then show that, in this framework, the very presence of a status quo induces the agent to be more uncertainty averse than she would be without a status quo option. Finally, we apply the model to a financial choice problem and show that the presence of status quo bias as modeled here might induce the presence of a risk premium even with risk neutral agents. |
| Keywords: | Status quo bias; Ambiguity Aversion; Endowment Effect; Risk Premium |
| JEL: | D11 D81 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:12243&r=upt |
| By: | Ortoleva, Pietro |
| Abstract: | The goal of this paper is to model an agent who dislikes large choice sets because of the "cost of thinking" involved in choosing from them. We take as a primitive a preference relation over lotteries of menus and impose novel axioms that allow us to separately identify the genuine preference over the content of menus, and the cost of choosing from them. Using this, we formally define the notion of thinking aversion, much in line with the definitions of risk or ambiguity aversion. We represent such preference as the difference between a monotone and affine evaluation of the content of the set and an anticipated thinking cost function that assigns to each set a thinking cost. We further extend this characterization to the case of monotonicity of the genuine rank and introduce a measure of comparative thinking aversion. Finally, we propose behavioral axioms that guarantee that the cost of thinking can be represented as the sum of the cost to find the optimal choice in a set and the cost to find out which is the optimal choice. |
| Keywords: | Cost of Thinking; Contemplation Cost; Bounded Rationality; Preference Over Menus; Preference for Flexibility; Choice overload |
| JEL: | D81 D84 D83 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:12242&r=upt |
| By: | Kirchkamp Oliver; Reiss J. Philipp; Sadrieh Abdolkarim (METEOR) |
| Abstract: | We introduce a new method of varying risk that bidders face in first-price and second-price private value auctions. We find that decreasing bidders’ risk in first-price auction reduces the degree of overbidding relative to the risk-neutral Bayesian Nash equilibrium prediction.This finding is consistent with the risk-aversion explanation of overbidding. Furthermore, we apply the method to second-price auctions and find that bidding behavior is robust to manipulating bidders'' risk as generally expected in auction theory. |
| Keywords: | microeconomics ; |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:umamet:2008050&r=upt |
| By: | Eric Rasmusen (Department of Business Economics and Public Policy, Indiana University Kelley School of Business) |
| Abstract: | Why do people have ambiguity aversion, preferring, a gamble with a 50% chance of success to one whose expected probability of success is 50% but where that 50% is an unbiased estimate? The answer modelled here, in the spirit of the career concerns literature, is learning: a risk-averse person does not wish observers to learn whether he is good or bad at estimating probabilities. He therefore prefers a gamble with objective probabilities. |
| Keywords: | time inconsistency, hyperbolic discounting |
| Date: | 2008–05 |
| URL: | http://d.repec.org/n?u=RePEc:iuk:wpaper:2008-12&r=upt |
| By: | Alain Chateauneuf (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Michèle Cohen (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris) |
| Abstract: | This chapter of a collective book aims at presenting cardinal extensions of the EU model, based on the Choquet integral, which allow to take into account observed behaviors as in Allais' paradox under risk or Ellsberg's paradox under uncertainty, where the expected utility model is violated. Under a key axiom, the comonotonic independence axiom, Schmeidler under uncertainty, and Quiggin and Yaari under risk, succeeded to characterize preferences which generalize the EU model, by means of a functional that turned out to be a Choquet integral. These models not only explain most of the observed paradoxes but also allow for more diversified patterns of behavior under uncertainty as well under risk. |
| Keywords: | Uncertainty, risk, coomonotony, Choquet capacity, Choquet integral. |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-00348822_v1&r=upt |
| By: | Alain Chateauneuf (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Michèle Cohen (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Jean-Yves Jaffray (LIP6 - Laboratoire d'Informatique de Paris 6 - CNRS : UMR7606 - Université Pierre et Marie Curie - Paris VI) |
| Abstract: | This chapiter of a collective book is dedicated to classical decision models under uncertainty, i.e. under situations where events do not have "objective" probabilities with which the Decision Marker agrees. We present successively the two main theories, their axiomatic, the interpretation and the justification of their axioms and their main properties : first, the general model of Subjective Expected Utility due to Savage (Savage, 1954), second, the Anscombe-Aumann (1963) theory, in a different framework. Both theories enforce the universal use of a probabilistic representation. We then discuss this issue in connection with the experimental result known as the Ellsberg paradox. |
| Keywords: | Uncertainty, subjective probability, Subjective Expected Utility, Savage, Anscombe and Aumann, Ellsberg paradox. |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-00348818_v1&r=upt |
| By: | Itzhak Gilboa (Eitan Berglas School of Economics, Tel Aviv University and HEC, Paris); Andrew Postlewaite (Department of Economics, University of Pennsylvania); David Schmeidler (Tel-Aviv University and Ohio State University) |
| Abstract: | Economic theory reduces the concept of rationality to internal consistency. As far as beliefs are concerned, rationality is equated with having a prior belief over a “Grand State Space”, describing all possible sources of uncertainties. We argue that this notion is too weak in some senses and too strong in others. It is too weak because it does not distinguish between rational and irrational beliefs. Relatedly, the Bayesian approach, when applied to the Grand State Space, is inherently incapable of describing the formation of prior beliefs. On the other hand, this notion of rationality is too strong because there are many situations in which there is not sufficient information for an individual to generate a Bayesian prior. It follows that the Bayesian approach is neither sufficient not necessary for the rationality of beliefs. |
| Keywords: | Decision making, Bayesian, Behavioral Economics |
| JEL: | B4 D8 |
| Date: | 2004–03–01 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:08-043&r=upt |
| By: | Nicolas Gravel (Greqam-Idep, University of the Mediterranean); Benoit Tarroux |
| Abstract: | In this paper, we characterize and empirically implement robust normative criteria for comparing societies on the basis of their al- locations of risks among their members. Risks are modelled as lot- teries on the set of distributions of state-contingent pecuniary conse- quences. Individuals are assumed to have individualistic Von Neuman- Morgenstern preferences for these risks. Appealing to HarsanyiÂ’s ag- gregation theorem, we provide empirically implementable criteria that coincide with the unanimity, over all such individual preferences, of anonymous and Pareto-inclusive Von NeumanMorgenstern social rank- ings of risks. The empirically implementable criteria can be interpreted as sequential expected poverty dominance. Illustrations of the usefulness of the criteria for comparing the exposure to unemployment risk of dif- ferent segments of the French and US workforce and for appraising the evolution, over time, of risks of violent crimes in India are also provided. |
| Keywords: | Risk, Dominance, ex-ante Social Welfare, Expected Poverty, Unemployment, Crime. |
| JEL: | C81 D3 D63 D81 I32 J63 J64 |
| Date: | 2008–10–15 |
| URL: | http://d.repec.org/n?u=RePEc:iep:wpidep:0806&r=upt |
| By: | Andrew J. Oswald (Department of Economics, University of Warwick); Rainer Winkelmann (Socioeconomic Institute, University of Zurich) |
| Abstract: | Economics rests upon a set of presumptions about how human beings are affected by income. Yet causal evidence is scant. This paper reports a longitudinal study of randomly selected lottery winners. Remarkably, we show that it takes almost three years before they enjoy their money. We develop a model of dissonance and deservingness. We argue that, despite the tradition of economics, human beings may weight differently the different kinds of income that accrue to them. If so, it is not sufficient to describe utility by a function u(y), and it is not true that ‘a dollar is a dollar’. |
| Keywords: | well-being, lottery income, deservingness, cognitive dissonance, happiness |
| JEL: | I31 J3 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:soz:wpaper:0815&r=upt |
| By: | André de Palma |
| Abstract: | Certain areas related to the topics under discussion here lie outside my field; for instance the evaluation of risk assessment and security deficiencies in the transport sector. What has convinced me of the importance of this subject are a few very general conclusions, indeed I would say, impressions, that I have drawn from the truly remarkable development of our powers to analyse the risk decision-making process over some years now. In this paper, the term “uncertainty” is often used with reference to the management of risks arising from intentionally malicious acts3. The costs of security in this sense of the term are an element of every transport budget today. In addition to the costs of prevention, surveillance and forecasting, the costs of the potential damages arising from such acts will also have to be taken into consideration from this point onwards. The events of 11 September 2001, which accelerated this trend, should suffice to convince us that, from now on, the consequences of such damages will be on a scale comparable to the costs of war (...) |
| Date: | 2008–10–21 |
| URL: | http://d.repec.org/n?u=RePEc:oec:itfaaa:2008/21-en&r=upt |
| By: | Iñigo Iturbe Ormaetxe (Universidad de Alicante); Giovanni Ponti (Universidad de Alicante); Josefa Tomás (Universidad de Alicante); Luis Ubeda (Universidad de Alicante) |
| Abstract: | This paper studies, both theoretically and experimentally, frame effects in the context of a public good game in which players have to make a costly contribution either i) to achieve or ii) not to lose a non excludable monetary prize. Our protocol leads to public good provision (not deterioration) only if a certain contribution level is achieved. Since both frames differ with respect to the reference point, we use Prospect Theory to derive testable predictions. In particular, Prospect Theory predicts more contribution in the second frame. Our evidence suggests that a) subjects¿ behavior is highly sensitive to frames and b) the theoretical prediction is confirmed except when the threshold is low. We also estimate the parameters which better suit our experimental evidence, partly confirming previous results in the literature. |
| Keywords: | Public goods provision, framing, prospect theory |
| JEL: | C92 D81 H40 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:ivi:wpasad:2008-15&r=upt |