nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2009‒11‒21
ten papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Consumer theory with bounded rational preferences By Gerasimou, Georgios
  2. Incentive Effects on Risk Attitude in Small Probability Prospects By Mathieu Lefebvre; Ferdinand Vieider; Marie-Claire Villeval
  3. Framing Effects as Violations of Extensionality By Sacha Bourgeois-Gironde; Raphaël Giraud
  4. The Impact of Risk Aversion and Stress on the Incentive Effect of Performance Pay By C. Bram Cadsby; Fei Song; Francis Tapon
  5. Framing effects of risk communication in health-related decision making. Learning from a discrete choice experiment By Florence Nguyen; Marie-Odile Carrere; Nora Moumjid
  6. The equity premium in 150 textbooks By Fernandez, Pablo
  7. Neo-additive capacities and updating By Eichberger, Jürgen; Grant, Simon; Lefort, Jean-Philippe
  8. Robust utility maximization for diffusion market model with misspecified coefficients By R. Tevzadze; T. Toronjadze
  9. Utility maximization in models with conditionally independent increments By Jan Kallsen; Johannes Muhle-Karbe
  10. Regret and the rationality of choices By Sacha Bourgeois-Gironde

  1. By: Gerasimou, Georgios
    Abstract: The neoclassical consumer maximizes utility and makes choices by completely preordering the feasible alternatives and weighing when indifferent. The consumer studied in this paper chooses by weighing when indifferent and also when indecisive, without necessarily preordering the alternatives or exhausting her budget. Preferences therefore need not be complete, transitive or non-satiated but are assumed strictly convex and "adaptive". The latter axiom is new and parallels that of ambiguity aversion in choice under uncertainty.
    Keywords: preferences: incomplete; intransitive; convex; adaptive; representation; demand.
    JEL: D11 D01
    Date: 2009–01–28
  2. By: Mathieu Lefebvre (University of Liège, CREPP; Boulevard du Rectorat, 7 Bâtiment 31, boîte 39, 4000 Liège, Belgium); Ferdinand Vieider (University Lyon 2, Lyon, F-69007, France; CNRS, GATE, 93, Chemin de Mouilles Ecully, F- 69130, France, and DIW, Berlin, Germany); Marie-Claire Villeval (University Lyon 2, Lyon, F-69007, France; CNRS, GATE, 93, Chemin de Mouilles Ecully, F- 69130, France, IZA, Bonn, Germany, and CCP, Aarhus, Denmark)
    Abstract: Most studies on the role of incentives on risk attitude report data obtained from within-subject experimental investigations. This may however raise an issue of sequentiality of effects as later choices may be influenced by earlier ones. This paper reports instead between-subject results on the effect of monetary stakes on risk attitudes for small probability prospects in a laboratory experiment. Under low stakes, we find the typical risk seeking behavior for small probabilities predicted by the prospect theory. But under high stakes, we provide some evidence that risk seeking behavior is dramatically reduced. This could suggest that utility is not consistently concave over the outcome space, but rather contains a convex section for very small amounts.
    Keywords: Risk attitude, Incentives, Decision, Experiment
    JEL: C91 D81 D89
    Date: 2009
  3. By: Sacha Bourgeois-Gironde (IJN - Institut Jean-Nicod - CNRS : UMR8129 - Ecole Normale Supérieure de Paris - ENS Paris - Ecole des Hautes Etudes en Sciences Sociales (EHESS)); Raphaël Giraud (CRESE - Université de Franche-Comté : EA)
    Abstract: Framing effects occur when different descriptions of the same decision problem give rise to divergent decisions. They can be seen as a violation of the decisiontheoretic version of the principle of extensionality (PE). The PE in logic means that two logically equivalent sentences can be substituted salva veritate. We explore what this notion of extensionality becomes in decision contexts. Violations of extensionality may have rational grounds. Based on some ideas proposed by the psychologist Craig McKenzie and colleagues, we contend that framing effects are justified when the selection of one particular frame conveys choice relevant information. We first discuss this idea from a philosophical point of view, and proceed next to formalize it first in the context of the Bolker–Jeffrey decision theory. Finally, we extend the previous analysis to non-expected utility theories using the Biseparable Preference model introduced by Ghirardato and Marinacci (2001) and therefore show that the analysis is independent of the assumptions of Bayesian decision theory.
    Keywords: framing-effects; extensionality; information processing; Bolker-Jeffrey decision model; biseparable preferences
    Date: 2009
  4. By: C. Bram Cadsby (Department of Economics, University of Guelph); Fei Song (Ted Rogers School of Business Management, Ryerson University); Francis Tapon (Department of Economics, University of Guelph)
    Abstract: We demonstrate that effectiveness of performance-contingent incentives is inversely related to individual risk-aversion levels through two mechanisms: 1) rational optimizing decisions about the amount of effort to supply when effort is positively correlated with risk exposure and 2) the possibly choke-inducing stress accompanying financial uncertainty. In two laboratory studies using real-effort tasks, we find a significant inverse relationship between productivity improvement under performance pay and risk-aversion levels. Moreover, we show that both mechanisms help explain this result. For about 25% of participants, performance actually deteriorates under performance pay, and the probability of such deterioration increases with risk aversion and stress.
    Keywords: risk aversion, performance pay, incentive, stress, choking under pressure, productivity, pay for performance, piece rate, experiment, compensation.
    JEL: C91 M52 J33
    Date: 2009
  5. By: Florence Nguyen (University of Lyon, Lyon, F-69003, France; CNRS, UMR 5824, GATE, Ecully, F-69130, France; ENS LSH, Lyon, F-69007, France ; Centre Leon Berard, Lyon, F-69003, France); Marie-Odile Carrere (University of Lyon, Lyon, F-69003, France; CNRS, UMR 5824, GATE, Ecully, F-69130, France; ENS LSH, Lyon, F-69007, France ; Centre Leon Berard, Lyon, F-69003, France); Nora Moumjid (University of Lyon, Lyon, F-69003, France; CNRS, UMR 5824, GATE, Ecully, F-69130, France; ENS LSH, Lyon, F-69007, France ; Centre Leon Berard, Lyon, F-69003, France)
    Abstract: Background How to communicate uncertainty is a major concern in medicine and in health economics. We aimed at studying the framing effects of risk communication on stated preferences in a discrete choice experiment (DCE) performed to elicit women’s preferences for Hormone Replacement Therapy. Methods Two versions of the questionnaire were randomly administered to respondents. Multiple risks were expressed as natural frequencies using either a constant reference class (Design 1) or variable reference classes (Design 2). We first tested whether Design 1 would impose a lower cognitive burden than Design 2. We then examined whether the two designs resulted in different utility model estimates. Results Design 1 improved consistency (monotonicity and stability). However, rates of dominance or intransitive responses did not differ across designs. Design 1 decreased women’s sensitivity to the risk of fractures and increased their sensitivity to the risk of breast cancer as compared to all other attributes. Discussion Framing effects of risk communication on stated preferences may be a major problem in the design of DCEs. More research is needed to determine whether our findings are replicable and to further investigate the normative question of how to improve risk communication in health-related decision-making.
    Keywords: Framing effects, Risk communication, Discrete choice experiment
    JEL: C12 I19 D83
    Date: 2009
  6. By: Fernandez, Pablo (IESE Business School)
    Abstract: I review 150 textbooks on corporate finance and valuation published between 1979 and 2009 by authors such as Brealey, Myers, Copeland, Damodaran, Merton, Ross, Bruner, Bodie, Penman, Arzac¿ and find that their recommendations regarding the equity premium range from 3% to 10%, and that 51 books use different equity premia in various pages. The 5-year moving average has declined from 8.4% in 1990 to 5.7% in 2008 and 2009. Some confusion arises from not distinguishing among the four concepts that the phrase equity premium designates: the Historical, the Expected, the Required and the Implied equity premium. 129 of the books identify Expected and Required equity premium and 82 identify Expected and Historical equity premium. Finance textbooks should clarify the equity premium by incorporating distinguishing definitions of the four different concepts and conveying a clearer message about their sensible magnitudes.
    Keywords: equity premium puzzle; required equity premium; expected equity premium;
    JEL: G12 G31 M21
    Date: 2009–10–11
  7. By: Eichberger, Jürgen; Grant, Simon; Lefort, Jean-Philippe
    Abstract: This paper shows that, for CEU preferences, the axioms consquentialism, state independence and conditional certainty equivalent consistency under updating characterise a family of capacities, called Genralised Neo-Additive Capacities (GNAC). This family contains as special cases among others neo-additive capacities as introduced by Chateauneuf, Eichberger, and Grant(2007), Hurwicz capacities, and ε-contaminations. Moreover, we will show that the convex version of a GNAC is the only capacity for which the core of the Full-Bayesian Updates of a capacity, introduced by Jaffray (1992), equals the set of Bayesian updates of the probability distributions in the core of the original capacity.
    Keywords: Ambiguity; Updating; Choquet Expected Utility; neo-additive capacities; Conditional Certainty Equivalent Consistency
    JEL: D81 D82
    Date: 2009–11–04
  8. By: R. Tevzadze; T. Toronjadze
    Abstract: The paper studies the robust maximization of utility of terminal wealth in the diffusion financial market model. The underlying model consists with risky tradable asset, whose price is described by diffusion process with misspecified trend and volatility coefficients, and non-tradable asset with a known parameter. The robust utility functional is defined in terms of a HARA utility function. We give explicit characterization of the solution of the problem by means of a solution of the HJBI equation.
    Date: 2009–11
  9. By: Jan Kallsen; Johannes Muhle-Karbe
    Abstract: We consider the problem of maximizing expected utility from terminal wealth in models with stochastic factors. Using martingale methods and a conditioning argument, we determine the optimal strategy for power utility under the assumption that the increments of the asset price are independent conditionally on the factor process.
    Date: 2009–11
  10. By: Sacha Bourgeois-Gironde (IJN - Institut Jean-Nicod - CNRS : UMR8129 - Ecole Normale Supérieure de Paris - ENS Paris - Ecole des Hautes Etudes en Sciences Sociales (EHESS))
    Abstract: Regrat helps to optimize decision-behaviour. It can be defined as a rational emotion. Several recent neurobiological studies have confirmed the interface between emotion and cognition at which regret is located and documented its role in decision behaviour. The data give credibility to the incorporation of regret in decision-theory that had been proposed by economists in the 1980s. However, finer distinctions are required in order to get a better grasp of how regret and behaviour influence each other. Regret can be defined as a predictive error signal but this signal does not necessarily transpose into a decision-weight influencing behaviour. Clinical studies on several types of patients show that the processing of an error-signal and its influence on subsequent behaviour can be dissociated. We propose a general understanding of how regret and decision-making are connected in terms of regret being modulated by rational antecedents of choice. Regret and the modification of behaviour on its basis will depend on the criteria of rationality involved in decision-making. We indicate current and prospective lines of research in order to refine our views on how regret contributes to optimal decision-making.
    Keywords: regret, predictive error-signal, decision-weight, addiction, paradoxes of rationality
    Date: 2009

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