nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2010‒10‒02
eight papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Stability of Risk Preference Measures: Results from a Field Experiment on French Farmers By Couture, Stéphane; Reynaud, Arnaud
  2. The Framing of Games and the Psychology of Play By Martin Dufwenberg; Simon Gaechter; Heike Hennig-Schmidt
  3. On Cross-risk Vulnerability By Yannick Malevergne; Rey Beatrice
  4. Generalized Disappointment Aversion, Long Run Volatility Risk and Asset Prices By Bonomo, Marco; Garcia, René; Meddahi, Nour; Tédongap, Roméo
  5. Preserving preference rankings under non-financial background risk By Yannick Malevergne; Rey Beatrice
  6. Expected Utility theory and the tyranny of catastrophic risks By Buchholz, Wolfgang; Schymura, Michael
  7. Aggregation of incomplete ordinal preferences with approximate interpersonal comparisons By Pivato, Marcus
  8. Ambiguous Information and Market Entry: An Experimental Study By Brandts, Jordi; Yao, Lan

  1. By: Couture, Stéphane; Reynaud, Arnaud
    Abstract: We compare three different elicitation methods for measuring risk attitudes of French farmers in a field experiment setting. We consider two experiments based on the lottery choices initially proposed by Holt and Laury (2002) and by Eckel and Grossman (2002,2008), a risk-taking psychological questionnaire and a self-reporting of perceived risk attitudes for different domains. The main empirical results from this within-subject study are the following. First, within the class of lottery choices, risk preference measures are affected by the type of mechanism used. In particular, farmers appear to be more risk averse using the Eckel and Grossman lottery than using the Holt and Laury one. However attitudes towards risk are significantly correlated across lotteries which means that the ranking of risk preferences seems to be preserved. Second, risk preferences appear to be context-dependent. French farmers are highly risk averse for decisions belonging to financial and ethical domains. They report a higher willingness to take risk for professional decisions. Lastly, using the psychological questionnaire, we find that the risk attitude elicited through lottery choices often correlates with risk attitude toward investments. These findings contribute to the literature which addresses the stability of risk preferences across elicitation methods.
    Keywords: Risk preferences, psychological economics, field experiment, experimental economics
    JEL: C91 D8 J16 Q12
    Date: 2010–05–03
  2. By: Martin Dufwenberg; Simon Gaechter; Heike Hennig-Schmidt
    Abstract: Psychological game theory can provide rational-choice-based framing effects; frames influence beliefs, beliefs influence motivations. We explain this theoretically and explore empirical relevance experimentally. In a 2×2 design of one-shot public good games we show that frames affect subject’s first- and second-order beliefs, and contributions. From a psychological gametheoretic framework we derive two mutually compatible hypotheses about guilt aversion and reciprocity under which contributions are related to second- and first-order beliefs, respectively. Our results are consistent with either.
    Keywords: framing, psychological game theory, guilt aversion, reciprocity, public good games, voluntary cooperation
    JEL: C91 C72 D64 Z13
    Date: 2010–09
  3. By: Yannick Malevergne (COACTIS - Université Lumière - Lyon II : EA4161 - Université Jean Monnet - Saint-Etienne); Rey Beatrice (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429)
    Abstract: We introduce the notion of cross-risk vulnerability to generalize the concept of risk vulnerability introduced by Gollier and Pratt [Gollier, C., Pratt, J.W. 1996. Risk vulnerability and the tempering effect of background risk. Econometrica 64, 1109–1124]. While risk vulnerability captures the idea that the presence of an unfair financial background risk should make risk-averse individuals behave in a more risk-averse way with respect to an independent financial risk, cross-risk vulnerability extends this idea to the impact of a non-financial background risk on the financial risk. It provides an answer to the question of the impact of a background risk on the optimal coinsurance rate and on the optimal deductible level. We derive necessary and sufficient conditions for a bivariate utility function to exhibit cross-risk vulnerability both toward an actuarially neutral background risk and toward an unfair background risk. We also analyze the question of the sub-additivity of risk premia and show to what extent cross-risk vulnerability provides an answer.
    Keywords: Risk aversion; Risk vulnerability; Multivariate risk; Background risk
    Date: 2009–10–01
  4. By: Bonomo, Marco; Garcia, René; Meddahi, Nour; Tédongap, Roméo
    Abstract: We propose an asset pricing model where preferences display generalized disappointment aversion (Routledge and Zin, 2009) and the endowment process involves long-run volatility risk. These preferences, which are embedded in the Epstein and Zin (1989) recursive utility framework, overweight disappointing results as compared to expected utility, and display relatively larger risk aversion for small gambles. With a Markov switching model for the endowment process, we derive closed-form solutions for all returns moments and predictability regressions. The model produces first and second moments of price-dividend ratios and asset returns and return predictability patterns in line with the data. Compared to Bansal and Yaron (2004), we generate: i) more predictability of excess returns by price-dividend ratios; ii) less predictability of consumption growth rates by price-dividend ratios. Differently from the Bansal and Yaron model, our results do not depend on a value of the elasticity of intertemporal substitution greater than one.
    JEL: G1 G12 G11 C1 C5
    Date: 2010–06
  5. By: Yannick Malevergne (COACTIS - Université Lumière - Lyon II : EA4161 - Université Jean Monnet - Saint-Etienne); Rey Beatrice (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429)
    Abstract: We investigate the impact of a non-financial background risk ˜" on the preference rankings between two independent financial risks ˜z1 and ˜z2 for an expected-utility maximizer. More precisely, we provide necessary and sufficient conditions for the alternative (x0 + ˜z1, y0 + ˜") to be preferred to (x0 + ˜z2, y0 + ˜") whenever (x0 + ˜z1, y0) is preferred to (x0 + ˜z2, y0). Utility functions that preserve the preference rankings are fully characterized. Their practical relevance is discussed in light of recent results on the constraints for the modeling of the preference for the disaggregation of harms.
    Keywords: Multivariate risk, Background risk, Disaggregation of harms, Risk independence
    Date: 2010
  6. By: Buchholz, Wolfgang; Schymura, Michael
    Abstract: Expected Utility theory is not only applied to individual choices but also to ethical decisions, e.g. in cost-benefit analysis of climate change policy measures that affect future generations. In this context the crucial question arises whether EU theory is able to deal with 'catastrophic risks', i.e. risks of high, but very unlikely losses, in an ethically appealing way. In this paper we show that this is not the case. Rather, if in the framework of EU theory a plausible level of risk aversion is assumed, a 'tyranny of catastrophic risk' (TCR) emerges, i.e. project evaluation may be dominated by the catastrophic event even if its probability is negligibly small. With low degrees of risk aversion, however the catastrophic risk eventually has no impact at all when its probability goes to zero which is ethically not acceptable as well. -- Die Erwartungsnutzentheorie (EUT) kann nicht nur für Entscheidungen auf individueller Ebene angewandt werden, sondern auch aggregiert in ethischen Entscheidungssituationen, wie zum Beispiel in Kosten-Nutzen-Analysen bei der Evaluierung klimapoltischer Politik die vor allem zukünftige Generationen betreffen. In diesem Zusammenhang stellt sich die Frage, inwiefern die die EUT mit katastrophalen Ereignissen mit extrem niedriger Wahrscheinlichkeit umgehen kann. In unserer Arbeit zeigen wir die Schwierigkeiten der EUT beim Umgang mit katastrophalen Ereignissen auf. Falls man eine hinreichende Risikoaversion annimmt, tritt eine 'Tyrannei der katastrophalen Risken' (TCR) auf. Die Projektevaluation kann dann von extrem unwahrscheinlichen Ereignissen dominiert werden. Falls die angenommene Risikoaversion sehr gering ist, kann es passieren, das solche katastrophalen Ereignisse überhaupt keinen Einfluss auf das Ergebnis haben, was aus ethischer Perspektive genauso bedenklich ist. Der Artikel trägt bei zu der Literatur über die Paradoxien der EUT, wie z.B. dem Allais-Paradoxon oder Martin Weitzmans 'dismal theorem'. Wir behandeln den spezifischen Fall von katastrophalen Ereignissen mit sehr hohen Schäden und sehr geringer Eintrittswahrscheinlichkeit, wie es etwa beim Klimawandel der Fall sein kann. Nach einem einleitenden Teil zeigen wir in heuristischer Art und Weise, dass es aus ethischen Gründen notwendig sein kann, die Zahlungsbereitschaft zur Vermeidung von Extremereignissen nach oben zu begrenzen. Wir formalisieren dann die sogenannte 'Tyrannei der katastrophalen Risiken' (TCR) und zeigen auf, dass das Auftreten der TCR fundamental von der Wahl der zugrunde liegenden Nutzenfunktion abhängt. Wir folgern, dass man eine unrealistisch niedrige Risikoaversion annehmen müsste, um die TCR zu vermeiden. Am Ende bennenen wir die Alternativen zur EUT, die allerdings katastrophale Risiken noch mehr berücksichtigen und so das Problem der TCR noch verschärfen können.
    Keywords: utilitarianism,Expected Utility theory,catastrophic risks
    JEL: Q54
    Date: 2010
  7. By: Pivato, Marcus
    Abstract: We develop a model of preference aggregation where people's psychological characteristics are mutable (hence, potential objects of individual or social choice), their preferences may be incomplete, and approximate interpersonal comparisons of well-being are possible. Formally, we consider preference aggregation when individual preferences are described by an incomplete, yet interpersonally comparable, preference order on a space of psychophysical states. Within this framework we characterize three preference aggregators: the `Suppes-Sen' preorder, the `approximate maximin' preorder, and the `approximate leximin' preorder.
    Keywords: interpersonal comparisons; well-being; ordinal; maximin; leximin; egalitarian; Suppes-Sen; incomplete preference
    JEL: I30 D70 D63
    Date: 2010–09–21
  8. By: Brandts, Jordi; Yao, Lan
    Abstract: We study experimentally how entry into a market with uncertain capacity is affected by the type of information potential entrants have available. Our focus is on behavior in a two-market entry game. In the risky information market there are two possible market capacities, both known to occur with probability 1/2. In the ambiguous information market the two possible market capacities effectively occur with probability 1/2 but participants are only told that there is uncertainty about capacities. We find that average entry is higher under ambiguous information than under risky information. To control for comparison effects and the effects of strategic interaction in the two market environment we also study a two-lottery individual decision problem and one market entry games with ambiguous and risky information. For these two cases the experimental results show no difference between information conditions. Our results are consistent with the notion that complex strategic interaction leads to higher market entry under ambiguous information.
    Keywords: Market entry games; Experiment; Risk; Ambiguity.
    JEL: D81 C92 M2 L1 C72
    Date: 2010–08–14

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