nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2011‒02‒26
ten papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Risk Aversion under Preference Uncertainty By Roman Kraeussl; Andre Lucas; Arjen Siegmann
  2. A Variation on Ellsberg By Kfir Eliaz; Pietro Ortoleva
  3. Can we measure Individual Risk Attitudes in a Survey? By Xiaohao Ding; Joop Hartog; Yuze Sun
  4. A Rank Dependent Scheduling Model By Paul R. Koster; Erik T. Verhoef
  5. Ambiguity aversion solves the conflict between efficiency and incentive compatibility By Luciano De Castro; Nicholas C. Yannelis
  6. Who Is (More) Rational? By Syngjoo Choi; Shachar Kariv; Wieland Müller; Dan Silverman
  7. Decision Making with Imperfect Knowledge of the State Space By Mengel Friederike; Tsakas Elias; Vostroknutov Alexander
  8. The role of the reference alternative in the specification of asymmetric discrete choice models By Lorenzo Masiero; John M. Rose
  9. Is utility transferable? A revealed preference analysis By Laurens CHERCHYE; Thomas DEMUYNCK; Bram DE ROCK
  10. The equity premium and the risk free rate in a production economy. A new perspective By Aase, Knut K.

  1. By: Roman Kraeussl (VU University Amsterdam); Andre Lucas (VU University Amsterdam); Arjen Siegmann (VU University Amsterdam)
    Abstract: We show that if an agent is uncertain about the precise form of his utility function, his actual relative risk aversion may depend on wealth even if he knows his utility function lies in the class of constant relative risk aversion (CRRA) utility functions. We illustrate the consequences of this result for asset allocation: poor agents that are uncertain about their risk aversion parameter invest less in risky assets than wealthy investors with identical risk aversion uncertainty.
    Keywords: risk aversion; preference uncertainty; risk-taking; asset allocation
    JEL: D81 D84 G11
    Date: 2010–11–29
  2. By: Kfir Eliaz; Pietro Ortoleva
    Abstract: Ellsberg's experiment involved a gamble with no ambiguity (N) and a gam- ble where the prize that could be won is objectively known, but the winning probability depends on the (ambiguous) urn's composition (P). We extend this by including a gamble where the winning probability is objectively known, but the prize depends on the urn's composition (C), and also gambles where both the probability and the prize depend on the urn's composition, and can either be correlated positively (D) or negatively (M). Among transitive subjects who prefer N to P, 40% prefer D to N, 74% prefer D to P, 97% prefer D to M, and the modal ranking (about 39%) satises D<N<P,C. We show that this behav- ior is compatible with the Max-Min Expected Utility model if every prior in the set of priors has a high enough variance, a property that we call `skeptical pessimism.'
    Keywords: Ellsberg Paradox, Uncertainty Aversion, Ambiguity Aversion, MaxMin Expected Utility.
    Date: 2011
  3. By: Xiaohao Ding (Peking University); Joop Hartog (University of Amsterdam); Yuze Sun (Peking University)
    Abstract: We combine a survey and an experiment with real pay-out among Peking University students to measure and validate individual risk attitudes. The experiment involves choosing between a cash payment and playing a lottery. The survey questions ask for the reservation price of a hypothetical lottery and self-assessment of risk attitude on a 0-10 scale. We confirm familiar findings: risk aversion dominates, women are more risk averse than men, risk aversion decreases with increasing parental income, risk attitudes are domain-specific. Correlations between survey measures and experimental measures, are in the right direction, but not very high. The survey measures are valid indicators of experimentally measured risk attitude, but with substantial noise remaining. Heterogeneity in levels and structure of risk attitude is large.
    Keywords: risk attitude; survey question; experimental validation
    JEL: D12
    Date: 2010–03–03
  4. By: Paul R. Koster (VU University Amsterdam); Erik T. Verhoef (VU University Amsterdam)
    Abstract: This paper proposes an analytical framework for scheduling decisions of road travelers that takes into account probability weighting using rank dependent utility theory. The fundamental difference with the standard scheduling model based on expected utility is that the probabilities of arrivals are treated in a non-linear way. This paper shows how scheduling decisions are affected by the weighted probabilities of the traveler. We derive the costs of non-optimal chosen departure times because of probability weighting and show that if the parameterized probability weighting function is
    Keywords: scheduling model; value of reliability; rank dependent utility
    JEL: R40 R41 R42 R49 D81
    Date: 2010–07–16
  5. By: Luciano De Castro; Nicholas C. Yannelis
    Date: 2011
  6. By: Syngjoo Choi; Shachar Kariv; Wieland Müller; Dan Silverman
    Abstract: Revealed preference theory offers a criterion for decision-making quality: if decisions are high quality then there exists a utility function that the choices maximize. We conduct a large-scale field experiment that enables us to test subjects' choices for consistency with utility maximization and to combine the experimental data with a wide range of individual socioeconomic information for the subjects. There is considerable heterogeneity in subjects' consistency scores: high-income and high-education subjects display greater levels of consistency than low-income and low-education subjects, men are more consistent than women, and young subjects are more consistent than older subjects. We also find that consistency with utility maximization is strongly related to wealth: a standard deviation increase in the consistency score is associated with 15-19 percent more wealth. This result conditions on socioeconomic variables including current income, education, and family structure, and is little changed when we add controls for past income, risk tolerance and the results of a standard personality test used by psychologists.
    JEL: C93 D01 D12 D81
    Date: 2011–02
  7. By: Mengel Friederike; Tsakas Elias; Vostroknutov Alexander (METEOR)
    Abstract: We conduct an experiment to study how imperfect knowledge of the state space affects subsequent choices under uncertainty with perfect knowledge of the state space. Participants in our experiment choose between a sure outcome and a lottery in 32 periods. All treatments are exactly identical in periods 17 to 32 but differ in periods 1 to 16. In the early periods of the “Risk Treatment” there is perfect information about the lottery; in the “Ambiguity Treatment” participants perfectly know the outcome space but not the associated probabilities; in the “Unawareness Treatment” participants have imperfect knowledge about both outcomes and probabilities. All three treatments induce strong behavioural differences in periods 17 to 32. In particular participants who have been exposed to an environment with very imperfect knowledge of the state space subsequently choose lotteries with high (low) variance less (more) often compared to other participants. Estimating individual risk attitudes from choices in periods 17 to 32 we find that the distribution of risk attitude parameters across our treatments can be ranked in terms of first order stochastic dominance. Our results show how exposure to different degrees of uncertainty can have long-lasting effects on individuals’ risk-taking behaviour.
    Keywords: microeconomics ;
    Date: 2011
  8. By: Lorenzo Masiero (Institute for Economic Research (IRE), Faculty of Economics, University of Lugano, Switzerland); John M. Rose (Institute of Transport and Logistics Studies (ITLS), Faculty of Economics and Business, The University of Sydney, Australia)
    Abstract: Within the discrete choice modelling literature, there has been growing interest in including reference alternatives within stated choice survey tasks. Recent studies have investigated asymmetric utility specifications by estimating discrete choice models that include different parameters according to gains and losses relative to the values of the reference attributes. This paper analyses asymmetric discrete choice models by comparing specifications expressed as deviations from the reference point and specifications expressed in absolute values. The results suggest that the selection of the appropriate asymmetric model specification should be based on the type of the stated choice experiment.
    Keywords: stated choice experiments, reference alternative, preference asymmetry, willingness to pay
    JEL: C25
    Date: 2011–01
  9. By: Laurens CHERCHYE; Thomas DEMUYNCK; Bram DE ROCK
    Abstract: We provide a revealed preference analysis of the transferable utility hypothesis, which is widely used in economic models. First, we establish revealed preference conditions that must be satisfied for observed group behavior to be consistent with Pareto efficiency under transferable utility. Next, we show that these conditions are easily testable by means of integer programming methods. The tests are entirely nonparametric, which makes them robust with respect to specification errors. Finally, we demonstrate the practical usefulness of our conditions by means of an application to Spanish consumption data. To the best of our knowledge, this is the first empirical test of the transferable utility hypothesis.
    Date: 2011–02
  10. By: Aase, Knut K. (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)
    Abstract: We study a competitive equilibrium in a production economy, i.e., a system of prices at which firms’ profit maximizing production decisions and individuals’ preferred affordable consumption choices equate supply and demand in every market. We derive the equilibrium price of the firm and the equilibrium short term interest rate, the optimal consumption in society, as well as the risk premium on equity. Both a linear, and a nonlinear production technology are considered. For the linear one applied to the Standard and Poor’s composite stock price index for the last century, a risk premium of 0.062 corresponds to a relative risk aversion of 2.27. The model provides a riskfree interest rate for the period of 0.8%. The nonlinear model, however, highlights a hedging demand for the investors related to the real economy, which would, if taken into account, make the stock market of the last century less risky than it was perceived to be.
    Keywords: Competitive equilibrium; production economy
    JEL: G00
    Date: 2011–02–21

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