nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2010‒06‒11
eight papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Merging of Opinions under Uncertainty By Monika Bier; Daniel Engelage
  2. Experimental Comparison of Multi-Stage and One-Stage Contests By Roman M. Sheremeta
  3. Endowment Effects in Contests By Curtis R. Price; Roman M. Sheremeta
  4. An Exact Connection between two Solvable SDEs and a Non Linear Utility Stochastic PDEs By Nicole El Karoui; Mohamed M'Rad
  5. On Abel's Concept of Doubt and Pessimism By Elyès Jouini; Clotilde Napp
  6. Characterization of Time-Consistent Sets of Measures in Finite Trees By Monika Bier
  7. Unbiased Disagreement in financial markets, waves of pessimism and the risk return tradeoff By Elyès Jouini; Clotilde Napp
  8. Welfare Bounds in a Growing Population By Duygu Yengin

  1. By: Monika Bier (Institute of Mathematical Economics, Bielefeld University); Daniel Engelage (Bonn Graduate School of Economics (BGSE), University of Bonn)
    Abstract: We consider long-run behavior of agents assessing risk in terms of dynamic convex risk measures or, equivalently, utility in terms of dynamic variational preferences in an uncertain setting. By virtue of a robust representation, we show that all uncertainty is revealed in the limit and agents behave as expected utility maximizer under the true underlying distribution regardless of their initial risk anticipation. In particular, risk assessments of distinct agents converge. This result is a generalization of the fundamental Blackwell-Dubins Theorem, cp. [Blackwell & Dubins, 62], to convex risk. We furthermore show the result to hold in a non-time-consistent environment.
    Keywords: Dynamic Convex Risk Measures, Multiple Priors, Uncertainty, Robust Representation, Time-Consistency, Blackwell-Dubins
    JEL: C61 C65 D81
    Date: 2010–05
  2. By: Roman M. Sheremeta (Argyros School of Business and Economics, Chapman University)
    Abstract: This article experimentally studies a two-stage elimination contest and compares its performance with a one-stage contest. Contrary to the theory, the two-stage contest generates higher revenue than the equivalent one-stage contest. There is significant over-dissipation in both stages of the two-stage contest and experience diminishes over-dissipation in the first stage but not in the second stage. Our experiment provides evidence that winning is a component in a subject’s utility. A simple behavioral model that accounts for a non-monetary utility of winning can explain significant over-dissipation in both contests. It can also explain why the two-stage contest generates higher revenue than the equivalent one-stage contest.
    Keywords: rent-seeking, contest, contest design, experiments, risk aversion, over-dissipation
    JEL: C72 C91 D72
    Date: 2009–07
  3. By: Curtis R. Price (Department of Economics & Finance, College of Business, University of Southern Indiana); Roman M. Sheremeta (Argyros School of Business and Economics, Chapman University)
    Abstract: We design an experiment to test if the manner in which subjects receive the endowment has any bearing on the amount of overbidding in contests. We find that overbidding is significantly higher when subjects are given a large per-experiment endowment rather than when the endowment is given per-period. Risk-aversion and non-monetary utility of winning play important roles in explaining our findings.
    Keywords: rent-seeking, contest, experiments, overbidding, endowment
    JEL: C72 C91 D72
    Date: 2009–07
  4. By: Nicole El Karoui (CMAP - Centre de Mathématiques Appliquées - CNRS : UMR7641 - Polytechnique - X, PMA - Laboratoire de Probabilités et Modèles Aléatoires - CNRS : UMR7599 - Université Pierre et Marie Curie - Paris VI - Université Paris-Diderot - Paris VII); Mohamed M'Rad (CMAP - Centre de Mathématiques Appliquées - CNRS : UMR7641 - Polytechnique - X)
    Abstract: The paper proposes a new approach to consistent stochastic utilities, also called forward dynamic utility, recently introduced by M. Musiela and T. Zariphopoulou. These utilities satisfy a property of consistency with a given incomplete financial market which gives them properties similar to the function values of classical portfolio optimization. First, we derive a non linear stochastic PDEs that satisfy consistent stochastic utilities processes of Itô type and their dual convex conjugates. Then, under some assumptions of regularity and monotony on the stochastic flow associated with the optimal wealth as function of the initial capital, and on the optimal state price dual process, we characterize all consistent utilities for a given increasing optimal wealth process from the composition of the dual optimal process and the inverse of the optimal wealth. This allows us to reduce the resolution of fully nonlinear second order utility SPDE to the existence of monotone solutions of two stochastic differential equations. We also, express the volatility of consistent utilities as an operator of the first and the second order derivatives of the utility in terms of the optimal primal and dual policies.
    Keywords: forward utility; performance criteria; horizon-unbiased utility; consistent utility; progressive utility; portfolio optimization; optimal portfolio; duality; minimal martingale measure; Stochastic flows SDE; Stochastic partial differential equations;
    Date: 2010–04–01
  5. By: Elyès Jouini (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS : UMR7534 - Université Paris Dauphine - Paris IX); Clotilde Napp (DRM - Dauphine Recherches en Management - CNRS : UMR7088 - Université Paris Dauphine - Paris IX)
    Abstract: In this paper, we characterize subjective probability beliefs leading to a higher equilibrium market price of risk. We establish that Abel's result on the impact of doubt on the risk premium is not correct (see Abel, A., 2002. An exploration of the effects of pessimism and doubt on asset returns. Journal of Economic Dynamics and Control, 26, 1075-1092). We introduce, on the set of subjective probability beliefs, market price of risk dominance concepts and we relate them to well known dominance concepts used for comparative statics in portfolio choice analysis. In particular, the necessary first order conditions on subjective probability beliefs in order to increase the market price of risk for all nondecreasing utility functions appear as equivalent to the monotone likelihood ratio property.
    Keywords: Pessimism, optimism, doubt, stochastic dominance, risk premium, market price of risk, riskiness, portfolio dominance, monotone likelihood ratio
    Date: 2008–11
  6. By: Monika Bier (Institute of Mathematical Economics, Bielefeld University)
    Abstract: In this paper we give an alternative characterization for time-consistent sets of measures in a discrete setting. For each measure p in a time-consistent set P we get a distinct set of predictable processes which in return describe the p uniquely. This implies we get a one-to-one correspondence between time-consistent sets of measures and sets of predictable processes with specifc features.
    Keywords: Multiple Priors, Time-Consistency, Ambiguity, Uncertainty Aversion
    JEL: D81
    Date: 2010–05
  7. By: Elyès Jouini (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS : UMR7534 - Université Paris Dauphine - Paris IX); Clotilde Napp (DRM - Dauphine Recherches en Management - CNRS : UMR7088 - Université Paris Dauphine - Paris IX)
    Abstract: Can investors with irrational beliefs be neglected as long as they are rational on average ? Do their trades cancel out with no consequences on prices, as implicitly assumed by traditional models? We consider a model with irrational investors, who are rational on average. We obtain waves of pessimism and optimism that lead to countercyclical market prices of risk and procyclical risk-free rates. The variance of the state price density is greatly increased. The long run risk-return relation is mod- i…ed; in particular, the long run market price of risk might be higher than both the instantaneous and the rational ones.
    Keywords: irrational investors, rational on average
    Date: 2010
  8. By: Duygu Yengin (School of Economics, University of Adelaide)
    Abstract: We study the allocation of collectively owned indivisible goods when monetary transfers are possible. We restrict our attention to incentive compatible mechanisms which allocate the goods efficiently. Among these mechanisms, we characterize those that respect welfare lower bounds. The main characterization involves the identical-preferences lower-bound: each agent should be at least as well off as in an hypothetical economy where all agents have the same preference as hers, no agent envies another, and the budget is balanced. This welfare lower-bound grants agents equal rights/responsibilities over the jointly owned resources but insures agents against the heterogeneity in preferences. We also study the implications of imposing variable population axioms together with welfare bounds.
    Keywords: collective ownership, allocation of indivisible goods and money, NIMBY problems, imposition of tasks, the Groves mechanisms, the identical-preferences lower-bound, individual rationality, the stand-alone lower-bound, k-fairness, population monotonicity
    JEL: C79 D61 D63
    Date: 2010–05

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