nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2010‒08‒14
eight papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Random queues and risk averse users By De Palma, André; Fosgerau, Mogens
  2. Disappointment Cycles By David Dillenberger; Kareen Rozen
  3. Dynamic Disappointment Aversion: Don't Tell Me Anything Until You Know For Sure By Shiri Artstein-Avidan; David Dillenberger
  4. Choice probability generating functions By Fosgerau, Mogens; McFadden, Daniel; Bierlaire, Michel
  5. Do Emotions Improve Labor Market Outcomes? By Lorenz Goette; David Huffman
  6. Financial amplification of foreign exchange risk premia By Tobias Adrian; Erkko Etula; Jan J. J. Groen
  7. Pricing Scheme Choice: How Process Affects Outcome By Natalia Shestakova
  8. Analysing currency risk premia in the Czech Republic, Hungary, Poland and Slovakia By András Rezessy

  1. By: De Palma, André; Fosgerau, Mogens
    Abstract: We analyse Nash equilibrium in time of use of a congested facility. Users are risk averse with general concave utility. Queues are subject to varying degrees of random sorting, ranging from strict queue priority to a completely random queue. We define the key "no residual queue" property, which holds when there is no queue at the time the last user arrives at the queue, and prove that this property holds in equilibrium under all queueing regimes considered. The no residual queue property leads to simple results concerning the equilibrium utility of users and the timing of the queue.
    Keywords: Congestion; Queuing; Risk aversion; Endogenous arrivals
    JEL: D00 D80
    Date: 2010
  2. By: David Dillenberger (University of Pennsylvania); Kareen Rozen (Cowles Foundation, Yale University)
    Abstract: We propose a model of history dependent disappointment aversion (HDDA), allowing the attitude of a decision-maker (DM) towards disappointment at each stage of a T-stage lottery to evolve as a function of his history of disappointments and elations in prior stages. We establish an equivalence between the existence of an HDDA representation and two documented cognitive biases. First, the DM overreacts to news: after suffering a disappointment, the DM lowers his threshold for elation and becomes more risk averse; similarly, after an elating outcome, the DM raises his threshold for elation and becomes less risk averse. This makes disappointment more likely after elation and vice-versa, leading to statistically cycling risk attitudes. Second, the DM displays a primacy effect: early outcomes have the strongest effect on risk attitude. Hence disappointment cycles moderate with experience. "Gray areas" in the elation-disappointment assignment are connected to optimism and pessimism in determining endogenous reference points.
    Keywords: History dependent disappointment aversion, Disappointment cycles, Overreaction to news, Primacy effect, Endogenous reference dependence, Optimism, Pessimism
    JEL: D81 D91
    Date: 2010–08
  3. By: Shiri Artstein-Avidan (School of Mathematical Sciences, Tel Aviv University); David Dillenberger (Department of Economics, University of Pennsylvania)
    Abstract: We show that for a disappointment-averse decision maker, splitting a lottery into several stages reduces its value. To do this, we extend Gul.s (1991) model of disappointment aversion into a dynamic setting while keeping its basic characteristics intact. The result depends solely on the sign of the coefficient of disappointment aversion. It can help explain why people often buy periodic insurance for moderately priced objects, such as electrical appliances and cellular phones, at much more than the actuarially fair rate.
    Keywords: Disappointment aversion, recursive preferences, compound lotteries
    JEL: D80 D81
    Date: 2010–07–28
  4. By: Fosgerau, Mogens; McFadden, Daniel; Bierlaire, Michel
    Abstract: This paper establishes that every random utility discrete choice model (RUM) has a representation that can be characterized by a choice-probability generating function (CPGF) with specific properties, and that every function with these specific properties is consistent with a RUM. The choice probabilities from the RUM are obtained from the gradient of the CPGF. Mixtures of RUM are characterized by logarithmic mixtures of their associated CPGF. The paper relates CPGF to multivariate extreme value distributions, and reviews and extends methods for constructing generating functions for applications. The choice probabilities of any ARUM may be approximated by a cross-nested logit model. The results for ARUM are extended to competing risk survival models.
    Keywords: Discrete choice; random utility; mixture models; duration models; logit; generalised extreme value; multivariate extreme value
    JEL: C14 C35
    Date: 2010
  5. By: Lorenz Goette; David Huffman
    Abstract: Traditionally, models of economic decision-making assume that individuals are rational and emotionless. This chapter argues that the neglect of emotion in economic models explains their inability to predict important aspects of the labor market. We focus on one example: the scarcity of nominal wage cuts. [IZA Discussion Paper No. 1895]
    Keywords: wage rigidity, affect, emotions, money illusion, loss aversion
    Date: 2010
  6. By: Tobias Adrian; Erkko Etula; Jan J. J. Groen
    Abstract: Theories of systemic risk suggest that financial intermediaries’ balance-sheet constraints amplify fundamental shocks. We provide supporting evidence for such theories by decomposing the U.S. dollar risk premium into components associated with macroeconomic fundamentals and a component associated with financial intermediaries’ balance sheets. Relative to the benchmark model with only macroeconomic state variables, balance sheets amplify the U.S. dollar risk premium. We discuss applications to systemic risk monitoring.
    Keywords: Systemic risk ; Intermediation (Finance) ; Foreign exchange ; Assets (Accounting)
    Date: 2010
  7. By: Natalia Shestakova
    Abstract: Standard price discrimination theories are based on the assumption that consumers use their future demand estimates to evaluate net utility of each pricing scheme and choose the scheme with the highest value. However, some evidence suggests that consumers might not always behave this way. The experiment presented in this paper shows that indeed a substantial proportion of subjects choose not to evaluate the net utility of the offered pricing schemes. Instead, they select from pricing schemes based on a comparison of the schemes' parameters. Interestingly, this selection approach leads to the correct pricing-scheme choice when subjects are not well aware of their demand, and to the incorrect choice when they are. The results call for alternative theories of price discrimination and corresponding policy implications.
    Keywords: Choice process; heuristics; price discrimination; experiment
    JEL: D42 D83
    Date: 2010–07
  8. By: András Rezessy (Joint Research Centre of the European Commission)
    Abstract: The paper estimates currency risk premia for the Czech Republic, Hungary, Poland and Slovakia. Three different approaches are applied: a constant premium approach based on rational expectations, while time-varying premia are estimated with a method using financial market analysts’ surveys and also with a Kalman filter technique. A novelty in this paper is a crosscheck based on the three different approaches applied and also making use of implied and historical volatilities. The results highlight the importance of such a crosscheck: in the case of the Czech and the Slovak koruna and the Polish zloty this exercise reveals severe problems with the results, which otherwise would not have been discovered. On the other hand, the estimation methods produce convincing results for the Hungarian forint. The estimated Hungarian premium series reflect the major events that intuitively may have shaped currency risk in the country. A possible reason for these findings is a high signal-to-noise ratio in the case of Hungary where the risk premium has been large and exhibited substantial shifts through time. Finally, the strong comovement of the premium series obtained with the Kalman-filter and the survey data for the Hungarian forint also indicates that the survey expectations are largely in line with both the riskpremium- extended UIP and the rational expectations hypothesis, which is theoretically important as the UIP relates exchange rate expectations to the interest rate differential.
    Keywords: risk premium, exchange rate, Kalman filter, survey data
    JEL: C30 C42 F31 G15
    Date: 2010

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