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on Utility Models and Prospect Theory |
| By: | Frederik Herzberg (Institute of Mathematical Economics, Bielefeld University) |
| Abstract: | This article investigates the representative-agent hypothesis for an infinite population which has to make a social choice from a given finite-dimensional space of alternatives. It is assumed that some class of admissible strictly concave utility functions is exogenously given and that each individual's preference ordering can be represented cardinally through some admissible utility function. In addition, we assume that (i) the class of admissible utility functions allows for a smooth parametrization, and (ii) the social welfare function satisfies Arrovian rationality axioms. We prove that there exists an admissible utility function r, called representative utility function, such that any alternative which maximizes r also maximizes the social welfare function. The proof utilizes a special nonstandard model of the reals, viz. the ultraproduct of the reals with respect to the ultrafilter of decisive coalitions; this construction explicitly determines the parameter vector of the representative utility function. |
| Keywords: | representative individual, Arrovian social choice, ultrafilter, ultraproduct, nonstandard analysis |
| JEL: | D71 |
| Date: | 2009–01 |
| URL: | http://d.repec.org/n?u=RePEc:bie:wpaper:411&r=upt |
| By: | Rozen, Kareen (Yale U) |
| Abstract: | We provide theoretical foundations for several common (nested) representations of intrinsic linear habit formation. These representations are dynamically consistent and additive, with geometrically decaying coefficients of habit formation. Our axiomatization introduces a revealed preference theory of weaning a decision-maker from her habits using the device of compensation. We characterize linear habit formation in terms of the ability to wean using uniquely determined compensating streams. Moreover, we distinguish between habits that are responsive to weaning and those that are persistent, develop a simple choice-theoretic measure of the rate of habit decay, and demonstrate how to recover the entire sequence of habit formation coefficients from observed choice behavior. We introduce novel monotonicity and separability axioms that are appropriate for time-nonseparable preferences. Our analysis suggests techniques for eliciting dynamic reference points from choice behavior and obtaining discounted utility representations on endogenously generated auxiliary spaces. |
| JEL: | C60 |
| Date: | 2008–03 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:yaleco:40&r=upt |
| By: | Leandro Nascimento; Gil Riella |
| Abstract: | This paper characterizes ambiguity averse preferences in the absence of the completeness axiom. We axiomatize multiple selves versions of some of the most important examples of complete and ambiguity averse preferences, and characterize when those incomplete preferences are ambiguity averse. |
| Date: | 2009–01 |
| URL: | http://d.repec.org/n?u=RePEc:bcb:wpaper:180&r=upt |
| By: | Frank Riedel (Institute of Mathematical Economics, Bielefeld University) |
| Abstract: | We consider optimal stopping problems for ambiguity averse decision makers with multiple priors. In general, backward induction fails. If, however, the class of priors is time–consistent, we establish a generalization of the classical theory of optimal stopping. To this end, we develop first steps of a martingale theory for multiple priors. We define minimax (super)martingales, provide a Doob–Meyer decomposition, and characterize minimax martingales. This allows us to extend the standard backward induction procedure to ambiguous, time– consistent preferences. The value function is the smallest process that is a minimax supermartingale and dominates the payoff process. It is optimal to stop when the current payoff is equal to the value function. Moving on, we study the infinite horizon case. We show that the value process satisfies the same backward recursion (Bellman equation) as in the finite horizon case. The finite horizon solutions converge to the infinite horizon solution. Finally, we characterize completely the set of time–consistent multiple priors in the binomial tree. We solve two classes of examples: the so–called independent and indistinguishable case (the parking problem) and the case of American Options (Cox–Ross–Rubinstein model). |
| Keywords: | optimal stopping, ambiguity, uncertainty aversion |
| JEL: | D81 C61 G11 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:bie:wpaper:390&r=upt |
| By: | Tomoki Inoue (Institute of Mathematical Economics, Bielefeld University) |
| Abstract: | We prove that a preference relation which is continuous on every straight line has a utility representation if its domain is a convex subset of a finite dimensional vector space. Our condition on the domain of a preference relation is stronger than Eilenberg (1941) and Debreu (1959, 1964), but our condition on the continuity of a preference relation is strictly weaker than theirs. |
| Keywords: | linear continuity, utility representation |
| JEL: | C60 D11 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:bie:wpaper:401&r=upt |
| By: | Fernandez, Pablo (IESE Business School) |
| Abstract: | I review 100 finance and valuation textbooks published between 1979 and 2008 by authors such as Brealey and Myers, Copeland, Damodaran, Merton, Ross, Bruner, Bodie, Penman, Weston, Brigham and Arzac and find that their recommendations regarding the equity premium range from 3% to 10%. I also find that several books use different equity premia on different pages. Some of the confusion arises from not distinguishing among the four concepts that the term equity premium designates: historical equity premium, expected equity premium, required equity premium and implied equity premium. Finance textbooks should clarify the equity premium by providing distinguishing definitions of these four concepts and conveying a clearer message about their sensible magnitudes. |
| Keywords: | equity premium; equity premium puzzle; required market risk premium; historical market risk premium; expected market risk premium; risk premium; market risk premium; market premium; |
| JEL: | G12 G31 G32 |
| Date: | 2008–07–13 |
| URL: | http://d.repec.org/n?u=RePEc:ebg:iesewp:d-0757&r=upt |
| By: | Coyle, Barry T.; Wei, Ran; Rude, James |
| Abstract: | This study analyzes the impact of the Canadian Agriculture Income Stabilization (CAIS)program. The study begins with a specification of dynamic crop production that decomposes static short run crop acreage allocation decisions and dynamic crop yield affects. The modelling framework accommodates risk aversion, price uncertainty, and applies recent aggregation theory to aggregate weather data. Using this framework an analytical model of the impacts of CAIS on crop production is developed. Hypothetical impacts of are simulated using an aggregate Manitoba data set. The results show that CAIS has a substantial impact on the shadow prices of both inputs and outputs. These shadow price effects resulted in a 4 percent increase in long run wheat and barley yields and a 2 percent increase for canola. CAIS has a small impact on nominal wealth but the impacts depend on the properties of producers’ risk preferences. With constant relative risk aversion there is a wealth effect which in turn affects production decisions. |
| Keywords: | Canada, CAIS, risk, crop, production, Agricultural and Food Policy, International Relations/Trade, Production Economics, Risk and Uncertainty, |
| Date: | 2008–07 |
| URL: | http://d.repec.org/n?u=RePEc:ags:catpwp:46630&r=upt |
| By: | Nagore Iriberri; Pedro Rey-Biel |
| Abstract: | We use subjects’ actions in modified dictator games to perform a within-subject classification of individuals into four different types of interdependent preferences: Selfish, Social Welfare maximizers, Inequity Averse and Competitive. We elicit beliefs about other subjects’ actions in the same modified dictator games to test how much of the existent heterogeneity in others’ actions is known by subjects. We find that subjects with different interdependent preferences in fact have different beliefs about others’ actions. In particular, Selfish individuals cannot conceive others being non-Selfish while Social Welfare maximizers are closest to the actual distribution of others’ actions. We finally provide subjects with information on other subjects’ actions and re-classify individuals according to their (new) actions in the same modified dictator games. We find that social information does not affect Selfish individuals, but that individuals with interdependent preferences are more likely to change their behavior and tend to behave more selfishly. |
| Keywords: | Interdependent preferences, social welfare maximizing, inequity aversion, belief elicitation, social information, experiments, mixture-of-types models |
| JEL: | C72 C9 D81 |
| Date: | 2008–04 |
| URL: | http://d.repec.org/n?u=RePEc:upf:upfgen:1137&r=upt |
| By: | Garcia-Torres, Abraham (UNU-MERIT, Maastricht University) |
| Abstract: | Evolution of consumers' preferences has been recognized by many scholars as being key to understanding technological change. However, mainstream economics cannot account for the seemingly irrational behavior of consumers based on changes in taste – consumer theory lacks exibility and accuracy to explain changes in consumer behavior. Adopting a behavioral psychology perspective, this paper argues that there is a rational pattern in the change of consumers' tastes. I argue that behavioral psychology offers us a unique perspective to solve some of the paradoxes of consumer behavior. This paper incorporates exibility into CES utility function to more adequately account for, and differentiate between, habit formation routines. A model is developed in which habit formation and consumption of new goods are interrelated. |
| Keywords: | Consumer behaviour, Consumer choice, Technological change, Innovations |
| JEL: | D11 D12 D91 O31 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:unumer:2009005&r=upt |
| By: | Arghyrou, Michael G (Cardiff Business School); Gregoriou, Andros; Pourpourides, Panayiotis M. (Cardiff Business School) |
| Abstract: | Market imperfections are the main explanation offered by the existing literature for violations of the Law of One Price and Purchasing Power Parity (PPP) among industrialised countries. We argue that even in perfectly frictionless markets risk aversion driven by exchange rate uncertainty causes a wedge between the domestic and foreign price of a totally homogeneous good. We test this hypothesis on a unique data set from a real-world market with minimum imperfections; and aggregate data for bilateral US dollar exchange rates in the G7 area. The empirical findings validate our hypothesis, thus providing a new, additional to market-imperfections, solution to the PPP puzzles. |
| Keywords: | Law of one price; purchasing power parity; risk aversion; exchange rate uncertainty |
| JEL: | F31 F41 |
| Date: | 2009–01 |
| URL: | http://d.repec.org/n?u=RePEc:cdf:wpaper:2009/2&r=upt |
| By: | Novarese, Marco |
| Abstract: | This papers contributes to the stream of research on rule based behavior, and rationality. A bounded rational agent can deal just with a reduced number of variables, neglecting part of the overall complexity. This is usually taken as just a limitation: agents cannot deal with all relevant information and use biased decisional shortcuts. The stream of research on Ecological rationality, yet, evidences the possible advantage of using a limited amount of information. The present paper takes a similar, but not identical, point of view. I propose an idea based on some contributions on the ecology of the mind by Gregory Bateson. Learning requires to recognize a series of situations as identical and then to observe the effect of given variables in specific fixed contexts. Two situations can be considered identical only limiting considering part of the overall information and taking as unchanged a series of factors. This process determines an individual representation which have just to be coherent with the world. Only in abstract world contexts are objective situations. In the real world, they are just hypothesis to be continuously tested. This vision of bounds and learning has many implications for the debate on rationality and rule following. |
| Keywords: | Bounded rationality; ecological rationality; cognition; Gregory Bateson; contexts; learning; rules |
| JEL: | D83 |
| Date: | 2009–01–31 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:13100&r=upt |