nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2010‒12‒11
ten papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Salience theory of choice under risk By Pedro Bordado; Nicola Gennaioli; Andrei Shleifer
  2. Fairness in Risky Environments: Theory and Evidence By Vitezslav Babicky; Andreas Ortmann; Silvester Van Koten
  3. Aging and decision making: How aging affects decisions under uncertainty By Sproten, Alec; Diener, Carsten; Fiebach, Christian; Schwieren, Christiane
  4. Risk Preferences Under Extreme Poverty: A Field Experiment By Gustavo Adolfo Caballero Orozco
  5. On the construction of social preferences in lab experiments By Borgloh, Sarah; Dannenberg, Astrid; Aretz, Bodo
  6. Explicit ruin formulas for models with dependence among risks By Hansjoerg Albrecher; Corina Constantinescu; Stéphane Loisel
  7. It pays to pay - Big Five personality influences on co-operative behaviour in an incentivized and hypothetical prisoner's dilemma game By Jan-Erik Lönnqvist; Markku Verkasalo; Gari Walkowitz
  8. Neglected risks, financial innovation, and financial fragility By Nicola Gennaioli; Andrei Shleifer; Robert Vishny
  9. Uncertainty in conflicts By Juan David Prada-Sarmiento
  10. Inflation risk premia in the US and the euro area By Peter Hördahl; Oreste Tristani

  1. By: Pedro Bordado; Nicola Gennaioli; Andrei Shleifer
    Abstract: We present a theory of choice among lotteries in which the decision maker's attention is drawn to (precisely defined) salient payoffs. This leads the decision maker to a context-dependent representation of lotteries in which true probabilities are replaced by decision weights distorted in favor of salient payoffs. By endogenizing decision weights as a function of payoffs, our model provides a novel and unified account of many empirical phenomena, including frequent risk-seeking behavior, invariance failures such as the Allais paradox, and preference reversals. It also yields new predictions, including some that distinguish it from Prospect Theory, which we test.
    Date: 2010–04
  2. By: Vitezslav Babicky; Andreas Ortmann; Silvester Van Koten
    Abstract: Theories of fairness have typically used the assumption of ex-ante known pie size. Pie size, however, is rarely known ex ante. Using three simple allocation problems generally known as dictator, ultimatum and trust games, we explore the influence of ex-ante unknown pie size of varying degrees of risk on individual behavior. We derive theoretical predictions for two of these games using utility functions that capture additively separable constant relative risk aversion and inequity aversion. We test the theoretical predictions experimentally on two different subject pools: students of Czech Technical University and employees of Prague City Hall. We control for the risk attitude of our subjects through a variant of the Holt-Laury assessment instrument. We find statistically significant differences in giving behavior as a function of the degree of risk, and the degree of risk aversion, across individuals. We also find differences across the two subject pools but show that, once we control for various socio-demographic and cognitive characteristics, these differences evaporate. We discuss the policy and methodological implications of the results of our artefactual field experiment, as well as the implications for theories of fairness of reciprocity and their experimental test.
    Keywords: fairness, risk aversion, subject pool effects, economics experiments.
    JEL: C90 C91 C92 D81
    Date: 2010–10
  3. By: Sproten, Alec; Diener, Carsten; Fiebach, Christian; Schwieren, Christiane
    Abstract: In an aging society, it becomes more and more important to understand how aging affects decision making. Older adults have to face many situations that require consequential financial decisions. In the present study, we examined the effects of aging on decisions in two domains of uncertainty: risk and ambiguity. For this purpose, a group of young and older adults played a card game which was composed of risky and ambiguous conditions. In the risk condition, participants knew the probabilities to win or loose the game (i.e. full information), whereas in the ambiguous condition, these probabilities were unknown (thus, there was lack of information). When confronted with risky decisions, the behaviour of older and young adults (measured by the number of times participants chose a gamble instead of a sure amount of money) did not differ. In contrast, under ambiguity, there were significant age-effects in decision making: older people were less ambiguity-averse than young subjects. We conclude that there exist differences in uncertainty-processing between young and older adults, and discuss possible explanations of these differences.
    Keywords: Age differences; experiment; risk and uncertainty
    JEL: J14 C91
    Date: 2010–12–03
  4. By: Gustavo Adolfo Caballero Orozco
    Abstract: Until now, the dominant belief concerning the relationship between poverty and risk aversion is that the poor are more risk averse. If the poor are more risk averse, then they will choose “low risk–low return” activities that trap them in poverty. However, both empirical and experimental evidence show no clear pattern such as would suggest that the poor are somehowmore averse to risk than others; at times, they even seem to embrace risk, while at other times, there seems to be no difference. Focus has tended to be on extreme behaviors, as these are related to sub-optimal decisions such as have even raised questions whether an individual can be simultaneously both poor and rational. Amongst all the available empirical evidence, there is one bit of evidence of special interest—changes in behavior whenever subsistence is at risk. This paper emerges from the fact that recent experimental evidence in both psychology and economics suggests that certain decisions made under risk respond to reference points.We develop a theory within the traditional streamof rational choices, whereby the references are set by only observable variables, such as prices and family size. According to this theory, extremely poor individuals respond to the income reference that guarantees the consumption of the necessary calories so as to ensure a healthy and longer life. Being in the neighborhood of this reference can incentivize both the seeking of high risk, whenever below the reference, and an aversion to high risk, when above. An experimental exercise was conducted involving 92 individuals from households living in poverty and extreme poverty wherein they participated in a baseline risk experiment that was the one we analyzed. Inasmuch as the treatment was not randomly assigned, but instead was determined based on households’ per-capita incomes, a quasi-experimental approach was used to analyze the results. We use a regression discontinuity design, andfind evidence suggesting that being presented with the opportunity of avoiding undernourishmentsignificantly decreases a household’s risk aversion.
    Date: 2010–11–15
  5. By: Borgloh, Sarah; Dannenberg, Astrid; Aretz, Bodo
    Abstract: This paper studies the construction of social preferences in the lab. Experimental subjects have the opportunity to donate to a charity and to allocate money in a conventional dictator game. The results show that charitable donations and dictator game allocations are positively correlated. The correlation is only significant, however, if the dictator game follows the donation decision. Furthermore, while donation behavior is independent from the order of play, dictator game behavior is not. In line with the constructive-preference approach, we argue that preferences are instable and sensitive to outside influences when subjects are confronted with a new decision situation, while in a well-known situation preferences are more stable. --
    Keywords: social preferences,charitable donations,dictator game,experiment
    JEL: C91 C93 D01 D64
    Date: 2010
  6. By: Hansjoerg Albrecher (UNIL - Université de Lausanne - Université de Lausanne); Corina Constantinescu (UNIL - Université de Lausanne - Université de Lausanne, SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429); Stéphane Loisel (UNIL - Université de Lausanne - Université de Lausanne, SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429)
    Abstract: We show that a simple mixing idea allows to establish a number of explicit formulas for ruin probabilities and related quantities in collective risk models with dependence among claim sizes and among claim inter-occurrence times. Examples include compound Poisson risk models with completely monotone marginal claim size distributions that are dependent according to Archimedean survival copulas as well as renewal risk models with dependent inter-occurrence times.
    Date: 2010–11–24
  7. By: Jan-Erik Lönnqvist (Faculty of Behavioural Sciences, University of Helsinki, Finland); Markku Verkasalo (Faculty of Behavioural Sciences, University of Helsinki, Finland); Gari Walkowitz (Department of Management, University of Cologne, Germany)
    Abstract: The authors investigated how the presence or absence of monetary incentives in a prisoner's dilemma game may influence research outcomes. Specifically, the predictive power of the Big Five personality traits on decisions in an incentivized (N = 60) or hypothetical (N = 60) prisoner's dilemma game was investigated. Participants were less generous in the incentivized game. More importantly, personality predicted decisions only in the incentivized game, with low Neuroticism and high Openness to Experience predicting more cooperative transfers. The influence of Neuroticism on behaviour in the incentivized game was mediated by risk attitude. The results are consistent with other results suggesting that the Big Five are relevant predictors of moral behaviour, and with results suggesting that the determinants of hypothetical decisions are different from the determinants of real decisions, with the latter being more revealing of one's true preferences. The authors argue that psychologists, contrary to prevailing praxis, should consider making their participants' decisions more real. This could allow psychologists to more convincingly generalize laboratory findings into contexts outside of the laboratory.
    Keywords: Big Five, Prisoner's dilemma, Social dilemma, Moral behaviour, Incentives, Stake size
    Date: 2010–11
  8. By: Nicola Gennaioli; Andrei Shleifer; Robert Vishny
    Abstract: We present a standard model of financial innovation, in which intermediaries engineer securities with cash flows that investors seek, but modify two assumptions. First, investors (and possibly intermediaries) neglect certain unlikely risks. Second, investors demand securities with safe cash flows. Financial intermediaries cater to these preferences and beliefs by engineering securities perceived to be safe but exposed to neglected risks. Because the risks are neglected, security issuance is excessive. As investors eventually recognize these risks, they fly back to safety of traditional securities and markets become fragile, even without leverage, precisely because the volume of new claims is excessive.
    Date: 2010–04
  9. By: Juan David Prada-Sarmiento
    Abstract: This paper theoretically assesses the role that uncertainty plays in the intensity of conflicts. The standard two-player rent-seeking contest model (Tullock, 1980) is extended to allow for privately known subjective values of the prize. The conflict is modeled as a Bayesian game on which each player’s valuation is drawn independently from arbitrary distributions. We find sufficient conditions for when first-order and second-order stochastic refinements in the distributions cause predictable movements in the conflict’s dissipation. We focus on arbitrary contest success functions and arbitrary independent distributions for each player, allowing us to extend our analysis beyond the case of symmetric equilibria.
    Date: 2010–10–04
  10. By: Peter Hördahl (Bank for International Settlements, Centralbahnplatz 2, CH-4002, Basel, Switzerland.); Oreste Tristani (European Central Bank, DG Research, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: We use a joint model of macroeconomic and term structure dynamics to estimate inflation risk premia in the United States and the euro area. To sharpen our estimation, we include in the information set macro data and survey data on inflation and interest rate expectations at various future horizons, as well as term structure data from both nominal and index-linked bonds. Our results show that, in both currency areas, inflation risk premia are relatively small, positive, and increasing in maturity. The cyclical dynamics of long-term inflation risk premia are mostly associated with changes in output gaps, while their high-frequency fluctuations seem to be aligned with variations in inflation. However, the cyclicality of inflation premia differs between the US and the euro area. Long term inflation premia are countercyclical in the euro area, while they are procyclical in the US. JEL Classification: E43, E44.
    Keywords: Term structure of interest rates, inflation risk premia, central bank credibility.
    Date: 2010–12

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