nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2009‒07‒03
eleven papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Experienced Utility versus Decision Utility: Putting the 'S' in Satisfaction By Steven Carter; Michael McBride
  2. Attitudes toward Uncertainty among the Poor: Evidence from Rural Ethiopia By Akay, Alpaslan; Martinsson, Peter; Medhin, Haileselassie; Trautmann, Stefan T.
  3. Risk Aversion and Tacit Collusion in a Bertrand Duopoly Experiment By Lisa R. Anderson; Beth A. Freeborn; Jason P. Hulbert
  4. A Relationship between Risk and Time Preferences By Kota Saito
  5. Rule-Rationality and the Evolutionary Foundations of Hyperbolic Discounting By Hillel Bavli
  6. SYMMETRY, AMBIGUITY AND FREQUENCIES By Larry G. Epstein; Kyoungwon Seo
  7. Crash Risk in Currency Markets By Farhi, Emmanuel; Fraiberger, Samuel P.; Gabaix, Xavier; Rancière, Romain; Verdelhan, Adrien
  8. Starting an R&D Project under Uncertainty By Sabien Dobbelaere; Roland Iwan Luttens; Bettina Peters
  9. Preference Elicitation under Oath By Nicolas Jacquemet; Robert-Vincent Joule; Stéphane Luchini; Jason F. Shogren
  10. Inconsistent Incomplete Information: A Betting Experiment By Werner Güth; Loreto Llorente Erviti; Anthony Ziegelmeyer
  11. General correcting formula of forecasting? By Harin, Alexander

  1. By: Steven Carter (Department of Economics, University of California-Irvine); Michael McBride (Department of Economics, University of California-Irvine)
    Abstract: Recent research distinguishes an individual's decision utility, inferred from her observed choices, from her experienced utility, which more closely matches the notion of happiness. Using various estimation techniques with a unique experimental data set, we test whether post-choice satisfaction (experienced utility), like decision utility, is S-shaped with loss aversion around a given reference point. We also present a model which estimates the satisfaction function and reference point simultaneously. When pooling the data across individuals, we find an S-shaped satisfaction function in which the reference point depends on past payments, social comparisons, and subjective expectations. There is mixed evidence of loss aversion. At the individual level, there is substantial variation in satisfaction function shapes, although the S-shape is common. Though the two notions of utility are distinct, our findings imply that the two are related at a fundamental level.
    Keywords: Happiness; Utility; Experiment; Value function; Prospect theory
    JEL: C91 D70 I30
    Date: 2009–06
  2. By: Akay, Alpaslan (IZA); Martinsson, Peter (University of Gothenburg); Medhin, Haileselassie (University of Gothenburg); Trautmann, Stefan T. (Tilburg University)
    Abstract: We looked at risk and ambiguity attitudes among Ethiopian peasants in one of the poorest regions of the world and compared their attitudes to a standard Western university student sample elicited by the same decision task. Strong risk aversion and ambiguity aversion were found with the Ethiopian peasants. Ambiguity aversion was similar for peasants and students, but peasants were more risk averse. Testing for the effect of socio-economic variables on uncertainty attitudes showed that poor health increased both risk and ambiguity aversion.
    Keywords: risk attitudes, ambiguity attitudes, poverty, cultural differences
    JEL: D81 C93 O12
    Date: 2009–06
  3. By: Lisa R. Anderson (Department of Economics, College of William and Mary); Beth A. Freeborn (Department of Economics, College of William and Mary); Jason P. Hulbert (Department of Economics, College of William and Mary)
    Abstract: We investigate the relationship between collusive behavior in Bertrand oligopoly experiments and subject heterogeneity in risk preferences. We find that risk aversion is positively associated with tacit collusion when the goods are complements, but find no evidence of collusive behavior when the goods are substitutes. Furthermore, risk aversion is associated with lower prices with complement goods, but does not impact pricing behavior with substitute goods. In both treatments, we find that subjects tend to follow the price change of the other seller. In the complements treatment, however, this tendency increases with the degree of risk aversion.
    Keywords: Bertrand duopoly, risk aversion, collusion, experiment
    JEL: C9 L1
    Date: 2009–06–11
  4. By: Kota Saito
    Date: 2009–06–17
  5. By: Hillel Bavli
    Abstract: Recent studies involving intertemporal choice have prompted many economists to abandon the classical exponential discount utility function in favor of one characterized by hyperbolic discounting. Hyperbolic discounting, however, implies a reversal of preferences over time that is often described as dynamically inconsistent and ultimately irrational. We analyze hyperbolic discounting and its characteristic preference reversal in the context of rule-rationality, an evolutionary approach to rationality that proposes that people do not maximize utility in each of their acts; rather, they adopt rules of behavior that maximize utility in the aggregate, over all decisions to which an adopted rule applies. In this sense, people maximize over rules rather than acts. Rule-rationality provides a framework through which we may examine the rational basis for hyperbolic discounting in fundamental terms, and in terms of its evolutionary foundations. We conclude that although aspects of hyperbolic discounting may contain a certain destructive potential, it is likely that its evolutionary foundations are sound -- and its application may well be as justified and rational today as it was for our foraging ancestors.
    Date: 2009–06
  6. By: Larry G. Epstein (Boston University); Kyoungwon Seo (Department of Managerial Economics and Decision Sciences, Northwestern University)
    Abstract: We model a decision-maker who is facing a sequence of experiments, and whose perception is that outcomes are influenced by two factors - one that is well understood and fixed across experiments, and the other that is poorly understood and thought to be unrelated across experiments (the "error term"). Consequently, there is incomplete confidence that experiments are identical. We argue that a Bayesian model cannot capture the above, but that belief function utility can. Our formal contribution is to generalize the de Finetti Theorem on exchangeability to a framework where beliefs are represented by belief functions. Moreover, this is done while extending the scope of the bridge provided by de Finetti between subjectivist and frequentist approaches. In particular, a model of updating is provided.
    Date: 2009–05
  7. By: Farhi, Emmanuel; Fraiberger, Samuel P.; Gabaix, Xavier; Rancière, Romain; Verdelhan, Adrien
    Abstract: How much of carry trade excess returns can be explained by the presence of disaster risk? To answer this question, we propose a simple structural model that includes both Gaussian and disaster risk premia and can be estimated even in samples that do not contain disasters. The model points to a novel estimation procedure based on currency options with potentially different strikes. We implement this procedure on a large set of countries over the 1996-2008 period, forming portfolios of hedged and unhedged carry trade excess returns by sorting currencies based on their forward discounts. We find that disaster risk premia account for about 25% of expected carry trade excess returns in advanced countries.
    Keywords: carry trade; currency crisis; currency options; disaster risk; exchange rate; financial crisis
    JEL: F3 F31 G14
    Date: 2009–06
  8. By: Sabien Dobbelaere (VU University Amsterdam); Roland Iwan Luttens (SHERPPA, Ghent University, and CORE, Université Catholique de Louvain); Bettina Peters (Centre for European Economic Research (ZEW))
    Abstract: We study a two-stage R&D project with an abandonment option. Two types of uncertainty influence the decision to start R&D. Demand uncertainty is modelled as a lottery between a proportional increase and decrease in demand. Technical uncertainty is modelled as a lottery between a decrease and increase in the cost to continue R&D. We relate differences in uncertainty to differences in risk premia. We deduct testable hypotheses on the basis of which we empirically analyze the impact of uncertainty on the decision to start an R&D project. Using data for about 4000 German firms in manufacturing and services (CIS IV), our model predictions are strongly confirmed.
    Keywords: Investment under uncertainty; R&D; demand uncertainty; technical uncertainty; entry threat
    JEL: D21 D81 L12 O31
    Date: 2009–05–15
  9. By: Nicolas Jacquemet (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); Robert-Vincent Joule (Laboratoire de Psychologie Sociale - Université de Provence); Stéphane Luchini (GREQAM - Groupe de Recherche en Economie Quantitative d'Aix-Marseille); Jason F. Shogren (University of Wyoming - Department of Economics and Finance, Umeå University - Department of Economics)
    Abstract: Eliciting sincere preferences for non-market goods remains a challenge due to hypothetical bias - the so-called gap between hypothetical monetary values and real economic commitments. The gap arises because people either overstate hypothetical values or understate real commitments or a combination of both. Herein we examine whether the traditional real-world institution of the solenn oath can improve preference elicitation. Applying the social psychology theory on the oath as a truth-telling-commitment device, we ask our bidders to swear on their honour to give honest answers prior to participating in an incentive-compatible second-price auction. Results from our induced valuation testbed treatments suggest the oath-only auctions outperform all other auctions (real, hypothetical, and real-with-oath). In our homegrown valuation treatments eliciting preferences for dolphin protection, the oath-only design induced people to treat as binding both their budget constraint (i.e., lower values on the high end of the value distribution) and participation constraint (i.e., positive values rather than zero bids used to opt out of auction). Our oath-only results are robust to extra training on the auction and to consequential wording about the reason for the oath.
    Keywords: Oath, commitment, Vickrey auction, hypothetical bias, induced values, homegrown values.
    Date: 2009–06
  10. By: Werner Güth (Max Planck Institute Jena, Strategic Interaction Group); Loreto Llorente Erviti (Universidad Publica de Navarra, Pamplona); Anthony Ziegelmeyer (Max Planck Institute Jena, Strategic Interaction Group)
    Abstract: We study two person-betting games with inconsistent commonly know beliefs, using an experimental approach. In our experimental games, participants bet against one another, each bettor choosing one of two possible outcomes, and payoff odds are know at the time bets are placed. Bettors' beliefs are always commonly known. Participants play a series of betting games, in some of which the occurrence probabilities of the two outcomes differ between bettors (inconsistent beliefs) while in others the same occurrence probabilities prevail for both bettors (consistent beliefs). In the betting games with consistent commonly know beliefs, we observe that participants refrain from betting. In the betting games with inconsistent commonly know beliefs, we observe significant betting rates and the larger the discrepancy between the two bettors' subjective expectations the larger the volume of bets. Our experimental results contrast with the existing evidence on zero-sum betting games according to which participants' irrational inclination to bet is difficult to eliminate.
    Keywords: Betting, Common prior, Harsanyi consistency, Experimental Economics.
    JEL: C72 C92 D84
    Date: 2009–06–11
  11. By: Harin, Alexander
    Abstract: A general correcting formula of forecasting (as a framework for long-use and standardized forecasts) is proposed. The formula provides new forecasting resources and areas of application including economic forecasting.
    Keywords: forecasting; prediction; forecasting correction; planning;
    JEL: C53 E17 F17 H68 J11
    Date: 2009–06–15

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