nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2010‒01‒23
eight papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Risk Aversion and Optimal Reserve Prices in First and Second-Price Auctions, Second Version By Audrey Hu; Steven A. Matthews; Liang Zou
  2. On the Descriptive Value of Loss Aversion in Decisions under Risk By Eyal Ert; Ido Erev
  3. On the genesis of Hedonic Adaptation By Perez Truglia, Ricardo Nicolas
  4. Can intentions spoil the kindness of a gift? - An experimental study By Christina Strassmair
  5. What money can't buy: allocations with priority lists, lotteries and queues By Daniele Condorelli
  6. Puzzle solver By Christian, Mueller-Kademann
  7. Bounding Rationality by Discounting Time By Lance Fortnow; Rahul Santhanam
  8. Risk Premiums and Macroeconomic Dynamics in a Heterogeneous Agent Model By Ferre de Graeve; Maarten Dossche; Marina Emiris; Henri Sneessens; Raf Wouters

  1. By: Audrey Hu (Tinbergen Institute University of Amsterdam); Steven A. Matthews (Department of Economics, University of Pennsylvania); Liang Zou (Faculty of Economics and Business, University of Amsterdam)
    Abstract: This paper analyzes the effects of buyer and seller risk aversion in first and second-price a uctions. The setting is the classic one of symmetric and independent private values, with ex ante homogeneous bidders. However, the seller is able to optimally set the reserve price. In both auctions the seller’s optimal reserve price is shown to decrease in his own risk aversion, and more so in the first-price auction. Thus, greater seller risk aversion increases the ex post efficiency of both auctions, and especially that of the first-price auction. The seller’s optimal reserve price in the first-price, but not in the second-price, auction decreases in the buyers’ risk aversion. Thus, greater buyer risk aversion also increases the ex post efficiency of the first but not the second-price auction. At the interim stage, the first-price auction is preferred by all buyer types in a lower interval, as well as by the seller.
    Keywords: first-price auction, second-price auction, risk aversion, reserve price
    JEL: D44
    Date: 2009–04–22
  2. By: Eyal Ert (Harvard Business School); Ido Erev (Faculty of Industrial Engineering and Management, Technion - Israel Institute of Technology.)
    Abstract: Five studies are presented that explore the assertion that losses loom larger than gains. The first two studies reveal equal sensitivity to gains and losses. For example, half of the participants preferred the gamble "1000 with probability 0.5; -1000 otherwise" over "0 with certainty." Studies 3, 4, and 5 address the apparent discrepancy between these results and the evidence for loss aversion documented in previous research. The results reveal that only under very specific conditions does the pattern predicted by the loss aversion assertion emerge. This pattern does not emerge in short experiments or in the first 10 trials of long experiments. Nor does it emerge in long experiments with two-outcome symmetric gambles, or in long experiments with asymmetric multi-outcome gambles. The observed behavior, in these settings, reflects risk neutrality in choice among low-magnitude mixed gambles.
    JEL: C91 D01
    Date: 2010–01
  3. By: Perez Truglia, Ricardo Nicolas
    Abstract: Some sensations, in addition to guide behavior, serve an extra and even more important role: as warning or defense mechanisms (e.g. pain, fever). Additionally, intense sensations are costly from a fitness point of view. With only these two biological facts we show that Nature must design utility functions with regulation mechanisms such as hedonic adaptation or expectation-based preferences. Even though they are rarely incorporated into economic models, such mechanisms are widely recognized and documented in many fields such as neuroscience and psychology. Using such utility functions economists will not only provide more accurate welfare predictions, but we will also increase the number of behavioral phenomena that we are able to explain. Finally, we provide as an application a model of the psychological defenses.
    Keywords: hedonic adaptation; evolution; expectations; decision utility; experienced utility
    JEL: B52 I00
    Date: 2009–07–29
  4. By: Christina Strassmair (University of Munich)
    Abstract: Consider a situation where person A undertakes acostly action that benefits person B. This behavior seems altruistic. However, if A expects a reward in return from B, then A's action may be motivated by expected rewards rather than by pure altruism. The question we address in this experimental study is how B reacts to A's intentions. We vary the probability that the second mover in a trust game can reciprocate and analyze effects on second mover behavior. Our results suggest that expected rewards do not spoil the perceived kindness of an action and the action's rewards.
    Keywords: social preferences, intentions, beliefs, psychological game theory, experiment
    JEL: C91 D64
    Date: 2009–10
  5. By: Daniele Condorelli
    Abstract: I study the welfare optimal allocation of a number of identical and indivisible objects to a set of heterogeneous risk-neutral agents under the hypothesis that money is not available. Agents have independent private values, which represent the maximum time that they are will- ing to wait in line to obtain a good. A priority list, which ranks agents according to their expected values, is optimal when hazard rates of the distributions of values are increasing. Queues, which allocates the ob- ject to those who wait in line the longest, are optimal in a symmetric setting with decreasing hazard rates.
    Keywords: rationing; queues; priority lists; lotteries.
    JEL: D45 D82 H42
    Date: 2009–11
  6. By: Christian, Mueller-Kademann
    Abstract: This paper presents a model for asset markets with a subjectively rational solution for the price of the traded asset. Traders cannot act objectively rational and an increase in the number of traders does not enlarge the information set neccessary for determining the “true” price. Consequentely, many well-known “puzzles” vanish as there is no objective truth to which data could live up. An empirical test is conducted which demonstrates the relevance of the argument across time, space, and markets.
    Keywords: rational expectations; uncertainty; Tobin tax; financial crisis
    JEL: C53 F47 F31
    Date: 2009–10–15
  7. By: Lance Fortnow; Rahul Santhanam
    Abstract: Consider a game where Alice generates an integer and Bob wins if he can factor that integer. Traditional game theory tells us that Bob will always win this game even though in practice Alice will win given our usual assumptions about the hardness of factoring. We define a new notion of bounded rationality, where the payoffs of players are discounted by the computation time they take to produce their actions. We use this notion to give a direct correspondence between the existence of equilibria where Alice has a winning strategy and the hardness of factoring. Namely, under a natural assumption on the discount rates, there is an equilibriumwhere Alice has a winning strategy iff there is a linear-time samplable distribution with respect to which Factoring is hard on average. We also give general results for discounted games over countable action spaces, including showing that any game with bounded and computable payoffs has an equilibrium in our model, even if each player is allowed a countable number of actions. It follows, for example, that the Largest Integer game has an equilibrium in our model though it has no Nash equilibria or E-Nash equilibria.
    Keywords: Bounded rationality; Discounting; Uniform equilibria; Factoring game
    JEL: C72 D58
    Date: 2009–11–16
  8. By: Ferre de Graeve; Maarten Dossche; Marina Emiris; Henri Sneessens; Raf Wouters (CREA, University of Luxembourg)
    Abstract: We analyze financial risk premiums and real economic dynamics in a DSGE model with three types of agents - shareholders, bondholders and workers - that differ in participation in the capital market and in attitude towards risk and intertemporal sub- stitution. Aggregate productivity and distribution risks are transferred across these agents via the bond market and via an efficient labor contract. The result is a combi- nation of volatile returns to capital and a highly cyclical consumption process for the shareholders, which are two important ingredients for generating high and counter- cyclical risk premiums. These risk premiums are consistent with a strong propagation mechanism through an elastic supply of labor, rigid real wages and a countercyclical la- bor share. Based on the empirical estimates for the two sources of real macroeconomic risk, the model generates significant and plausible time variation in both bond and equity risk premiums. Interestingly, the single largest jump in both the risk premium and the price of risk is observed during the current recession.
    JEL: E32 E44 G12
    Date: 2009

This nep-upt issue is ©2010 by Alexander Harin. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.