nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2011‒01‒23
six papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Responsibility Effects in Decision Making under Risk By Pahlke, Julius; Strasser, Sebastian; Vieider, Ferdinand M.
  2. Least Concave Ordinal Utility Function and The Marshallian Cardinal Utility By Taradas Bandyopadhyay; Tapan Biswas
  3. Investor Preferences for Oil Spot and Futures based on Mean-Variance and Stochastic Dominance By Hooi Hooi Lean; Michael McAleer; Wing-Keung Wong
  4. Price versus tradable quantity regulation. Uncertainty and endogenous technology choice By Halvor Briseid Storrøsten
  5. Money Illusion and Rational Expectations: New Evidence from Well Known Survey Data By Novella Maugeri
  6. Keeping Negotiations in the Dark: Environmental Agreements under Incomplete Information By Ana Espinola-Arredondo; Felix Munoz-Garcia

  1. By: Pahlke, Julius; Strasser, Sebastian; Vieider, Ferdinand M.
    Abstract: We systematically explore decision situations in which a decision maker bears responsibility for somebody else's outcomes as well as for her own in situations of payoff equality. In the gain domain we confirm the intuition that being responsible for somebody else's payoffs increases risk aversion. This is however not attributable to a 'cautious shift' as often thought. Indeed, looking at risk attitudes in the loss domain, we find an increase in risk seeking under responsibility. This raises issues about the nature of various decision biases under risk, and to what extent changed behavior under responsibility may depend on a social norm of caution in situations of responsibility versus naive corrections from perceived biases. To further explore this issue, we designed a second experiment to explore risk-taking behavior for gain prospects offering very small or very large probabilities of winning. For large probabilities, we find increased risk aversion, thus confirming our earlier finding. For small probabilities however, we find an increase of risk seeking under conditions of responsibility. The latter finding thus discredits hypotheses of a social rule dictating caution under responsibility, and can be explained through flexible self-correction models predicting an accentuation of the fourfold pattern of risk attitudes predicted by prospect theory. An additional accountability mechanism does not change risk behavior, except for mixed prospects, in which it reduces loss aversion. This indicates that loss aversion is of a fundamentally different nature than probability weighting or utility curvature. Implications for debiasing are discussed.
    Keywords: risk attitude; other-regarding preferences; prospect theory; agency; social norms
    JEL: D81
    Date: 2010–11–15
  2. By: Taradas Bandyopadhyay (Department of Economics, University of California Riverside, USA; The Rimini Centre for Economic Analysis (RCEA), Italy); Tapan Biswas (Business School, University of Hull, UK; The Rimini Centre for Economic Analysis (RCEA), Italy)
    Abstract: This paper examines the conditions under which the Marshallian type of cardinal utility function can be derived from a class of ordinal utility functions.
    Date: 2011–01
  3. By: Hooi Hooi Lean (School of Social Sciences, Universiti Sains Malaysia); Michael McAleer (Erasmus University Rotterdam, Tinbergen Institute, The Netherlands, and Institute of Economic Research, Kyoto University); Wing-Keung Wong (Department of Economics, Hong Kong Baptist University)
    Abstract: This paper examines investor preferences for oil spot and futures based on mean-variance (MV) and stochastic dominance (SD). The mean-variance criterion cannot distinct the preferences of spot and market whereas SD tests leads to the conclusion that spot dominates futures in the downside risk while futures dominate spot in the upside profit. It is also found that risk-averse investors prefer investing in the spot index, whereas risk seekers are attracted to the futures index to maximize their expected utilities. In addition, the SD results suggest that there is no arbitrage opportunity between these two markets. Market efficiency and market rationality are likely to hold in the oil spot and futures markets.
    Keywords: Stochastic dominance, risk averter, risk seeker, futures market, spot market.
    JEL: C14 G12 G15
    Date: 2011–01
  4. By: Halvor Briseid Storrøsten (Statistics Norway)
    Abstract: This paper shows that tradable emissions permits and an emissions tax have a risk-related technology choice effect. We first examine the first- and second-order moments in the probability distributions of optimal abatement and production under the two instruments. The two instruments will, in general, lead to different expected aggregate production levels when technology choice is endogenous, given that regulation is designed to induce equal expected aggregate emissions. Moreover, either regulatory approach may induce larger variance in optimal production and optimal abatement levels, depending on the specification of the stochastic variables. Finally, because firms’ valuation of a flexible technology increases if the variance in abatement is inflated and vice versa, either of the two instruments may induce the most flexible technology. Specifically, a tax encourages the most flexibility if and only if abatement costs and the equilibrium permit price have sufficiently strong positive covariance compared with the variance in the price on the good produced.
    Keywords: Regulation; Technology choice; Uncertainty; Investment.
    JEL: H23 Q55 Q58
    Date: 2011–01
  5. By: Novella Maugeri
    Abstract: This paper provides further evidence in favor of less than fully rational expectations by making use two instruments, one quite well known, and the other more novel, namely survey data on inflation expectations and Smooth Transition Error Correction Models (STECMs). We use the so called ‘probabilistic approach’ to derive a quantitative measure of expected inflation from qualitative survey data for France, Italy and the UK. The United States are also included by means of the Michigan Survey of Consumers’ expectations series. First, we perform the standard tests to assess the ‘degree of rationality’ of consumers’ inflation forecasts. Afterwards, we specify a STECM of the forecast error, and we quantify the strategic stickiness in the long-run adjustment process of expectations stemming from money illusion. Our evidence is that consumers’ expectations do not generally conform to the prescriptions of the rational expectations hypothesis. In particular, we find that the adjustment process towards the long-run equilibrium is highly nonlinear and it is asymmetric with respect to the size of the past forecast errors. We interpret these findings as supporting the money illusion hypothesis.
    Keywords: Nonlinear error correction, inflation expectations, sticky expectations
    JEL: C22 D84 E31
    Date: 2010–12
  6. By: Ana Espinola-Arredondo; Felix Munoz-Garcia (School of Economic Sciences, Washington State University)
    Abstract: This paper investigates the role of uncertainty as a tool to support cooperation in international environmental agreements. We consider two layers of uncertainty. Under unilateral uncertainty treaties become successful with positive probability in the signaling game, even under parameter conditions for which no agreement is reached under complete information. Under bilateral uncertainty, a separating equilibrium emerges where the leader participates in the treaty only when its environmental concerns are high. We show that the agreement is signed for larger sets of parameter values under unilateral uncertainty. We then show that further layers of uncertainty might enhance social welfare.
    Keywords: Signaling games; Unilaterial uncertainty; Bilateral uncertainty; Non-binding negotiations
    JEL: C72 D62 Q28
    Date: 2010–12

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