nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2011‒05‒24
ten papers chosen by
Alexander Harin
Modern University for the Humanities

  1. In search of a characterization of the preference for safety under the Choquet model. By Michèle Cohen; Isaac Meilijson
  2. A Contextual Risk Model for the Ellsberg Paradox By Diederik Aerts; Sandro Sozzo
  3. Ambiguity and the historical equity premium. By Fabrice Collard; Sujoy Mukerji; Kevin Sheppard; Jean-Marc Tallon
  4. Risk Attitude & the Structure of Decision Making: Evidence from the Hog Industry By Franken, Jason R.V.; Pennings, Joost M.E.; Garcia, Philip
  5. Dealing with negative marginal utilities in the discrete choice modelling of labour supply By Liégeois, Philippe; Islam, Nizamul
  6. Does Gender Affect Investors' Appetite for Risk?: Evidence from Peer-to-Peer Lending By Nataliya Barasinska
  7. Team Incentives and Reference-Dependent Preferences By Kohei Daido; Takeshi Murooka
  8. Contextual Risk and Its Relevance in Economics By Diederik Aerts; Sandro Sozzo
  9. Learning by Doing, Risk Aversion and Use of Risk Management Strategies By Uematsu, Hiroki; Ashok, Mishra K.
  10. Acreage Decision under Price & Yield Uncertainty By Lee, Youngjae; Kennedy, Lynn; Brian, Hilbun

  1. By: Michèle Cohen (Centre d'Economie de la Sorbonne - Paris School of Economics); Isaac Meilijson (School of Mathematical Sciences - Tel Aviv University)
    Abstract: Victor prefers safety more than Ursula if whenever Ursula prefers some constant to some uncertain act, so does Victor. This paradigm, whose Expected Utility version takes the form of Arrow & Pratt's more risk averse concept, will be studied in the Choquet Uncertainty model, letting u and ? (v and ?) be Ursula's (Victor's) utility and capacity. A necessary and sufficient condition (A) on the pairs (u, ?) and (v, ?) will be presented for dichotomous weak increased uncertainty aversion, the preference by Victor of a constant over a dichotomous act whenever such is the preference of Ursula. This condition, pointwise inequality between a function defined in terms of v (u-1(?)) and another defined purely in terms of the capacities, preserves the flavor of the "more pessimism than greediness" characterization of monotone risk aversion by Chateauneuf, Cohen & Meilijson in the Rank-dependent Utility Model and its extension by Grant & Quiggin to the Choquet Utility Model. A sufficient condition (B) in terms of the capacities only, satisfied in particular if ? (?) = f (? (?)) for some convex f, will be presented for more simplicity seeking, the preference by Victor over any act for some dichotomous act, that leaves Ursula indifferent. Condition A is thus a characterization of weak increased uncertainty aversion for convex f. An example will be exhibited disproving the more far reaching conjecture under which the dichotomous case implies the general case.
    Keywords: Choquet Utility, greediness, pessimism, Rank-dependent Utility, Risk aversion uncertainty.
    JEL: D81
    Date: 2011–05
  2. By: Diederik Aerts; Sandro Sozzo
    Abstract: The Allais and Ellsberg paradoxes show that the expected utility hypothesis and Savage's Sure-Thing Principle are violated in real life decisions. The popular explanation in terms of 'ambiguity aversion' is not completely accepted. On the other hand, we have recently introduced a notion of 'contextual risk' to mathematically capture what is known as 'ambiguity' in the economics literature. Situations in which contextual risk occurs cannot be modeled by Kolmogorovian classical probabilistic structures, but a non-Kolmogorovian framework with a quantum-like structure is needed. We prove in this paper that the contextual risk approach can be applied to the Ellsberg paradox, and elaborate a 'sphere model' within our 'hidden measurement formalism' which reveals that it is the overall conceptual landscape that is responsible of the disagreement between actual human decisions and the predictions of expected utility theory, which generates the paradox. This result points to the presence of a 'quantum conceptual layer' in human thought which is superposed to the usually assumed 'classical logical layer'.
    Date: 2011–05
  3. By: Fabrice Collard (Department of Economics - University of Bern); Sujoy Mukerji (Department of Economics and University College - University of Oxford); Kevin Sheppard (Department of Economics and Oxford-Man Institute of Quantitative Finance - University of Oxford); Jean-Marc Tallon (Centre d'Economie de la Sorbonne - Paris School of Economics)
    Abstract: This paper assesses the quantitative impact of ambiguity on the historically observed equity premium. We consider a Lucas-tree pure-exchange economy with a single agent where we introduce two key non-standard assumptions. First, the agent's beliefs about the dividend/consumption process is ambiguous. Second, the agent's preferences are sensitive to this ambiguity. We further extend the model to allow for uncertainty about the magnitude of the persistence of the latent state. The agent's beliefs are ambiguous due to the uncertainty about the conditional mean of the probability distribution on consumption and dividends in the next period. This results in an endogenously volatile and (counter-) cyclical equity premium. We calibrate the level of ambiguity aversion to match only the first moment of the risk-free rate in data, and ambiguity to match the uncertainty conditional on the historical growth path, and evaluate the model using moderate levels of risk aversion. We find that this simple modification of Lucas-tree model accounts for a large part of the historical equity premium, both in terms of its level and variation over time.
    Keywords: Equity premium, ambiguity.
    JEL: G12 E21 D81 C63
    Date: 2011–05
  4. By: Franken, Jason R.V.; Pennings, Joost M.E.; Garcia, Philip
    Abstract: We investigate the importance of an appropriate representation of behavior, risk attitude, and related characteristics for owner-managers making marketing decisions. We assess whether managerial/firm characteristics directly affect the decisions or if their influence occurs indirectly through impacts on risk aversion. The findings, which support an indirect effect, indicate that failure to represent the relationship between risk aversion, other characteristics, and behavior appropriately can mask the effect of risk aversion. A more complete understanding of the structure of decision making may assist economists and policymakers in designing and targeting mechanisms to transfer risk.
    Keywords: behavior, contract, hogs, marketing, risk attitude, Agribusiness, Institutional and Behavioral Economics, Marketing, Q13,
    Date: 2011–07–26
  5. By: Liégeois, Philippe; Islam, Nizamul
    Abstract: In discrete choice labour supply analysis, it is often reasonably expected that utility is increasing with income. Yet, analyses based on discrete choice models sometimes mention that, when no restriction is imposed a priori in the statistical optimization program, the monotonicity condition is not fully satisfied ex post. Obviously, the standard statistical optimization program might be completed with conditions (one per individual) imposing positive marginal utilities. Unfortunately, such a high-dimensional program most often appears to be rather time-consuming in order to be solved, if not practically unsolvable. In order to overcome this drawback, some authors impose general parametric restrictions a priori (hence reducing de facto the dimension of the parameter set), which is sufficient to lead to positive marginal utilities ex post. However, those restrictions might sometimes appear to be unnecessarily too severe and then generate a sub-optimal set of estimated values for the parameters of the utility function. Alternatively, we show that it may be easy to avoid unnecessary restrictions. The high-dimensional program including conditions for positive marginal utilities for all can sometimes be equivalently replaced by a one-dimensional one. At the end, no observation is hopefully showing negative marginal utility anymore at optimum.
    Date: 2010–10–01
  6. By: Nataliya Barasinska
    Abstract: This study investigates the role of gender in financial risk-taking. Specifically, I ask whether female investors tend to fund less risky investment projects than males. To answer this question, I use real-life investment data collected at the largest German market for peer-to-peer lending. Investors' utility is assumed to be a function of the projects expected return and its standard deviation, whereas standard deviation serves as a measure of risk. Gender differences regarding the responses to projects' risk are tested by estimating a random parameter regression model that allows for variation of risk preferences across investors. Estimation results provide no evidence of gender differences in investors' risk propensity: On average, male and female investors respond similarly to the changes in the standard deviation of expected return. Moreover, no differences between male and female investors are found with respect to other characteristics of projects that may serve as a proxy for projects' risk. Significant gender differences in investors' tastes are found only with respect to preferred investment duration, purpose of investment project and borrowers' age.
    Keywords: gender, investment choice, risk preferences
    JEL: G11 G21 J16
    Date: 2011
  7. By: Kohei Daido (School of Economics, Kwansei Gakuin University); Takeshi Murooka (Department of Economics, University of California, Berkeley)
    Abstract: This paper examines a multi-agent moral hazard model in which agents have expectation-based reference-dependent preferences `a la K˝oszegi and Rabin (2006, 2007). The agents’ utilities depend not only on their realized outcomes but also on the comparisons of their realized outcomes with their reference outcomes. Due to loss aversion, the agents have a first-order aversion to wage uncertainty. Thus, reducing their expected losses by partially compensating for their failure may be beneficial for the principal. When the agent is loss averse and the project is hard to achieve, the optimal contract is based on team incentives which exhibit either joint performance evaluation or relative performance evaluation. Our results provide a new insight: team incentives serve as a loss-sharing device among agents. This model can explain the empirical puzzle of why firms often pay a bonus to low-performance employees as well as high-performance employees.
    Keywords: Moral Hazard, Team Incentives, Reference-Dependent Preferences, Loss Aversion, Joint Performance, Evaluation, Relative Performance Evaluation
    JEL: D86 M12 M52
    Date: 2011–05
  8. By: Diederik Aerts; Sandro Sozzo
    Abstract: Uncertainty in economics still poses some fundamental problems illustrated, e.g., by the Allais and Ellsberg paradoxes. To overcome these difficulties, economists have introduced an interesting distinction between 'risk' and 'ambiguity' depending on the existence of a (classical Kolmogorovian) probabilistic structure modeling these uncertainty situations. On the other hand, evidence of everyday life suggests that 'context' plays a fundamental role in human decisions under uncertainty. Moreover, it is well known from physics that any probabilistic structure modeling contextual interactions between entities structurally needs a non-Kolmogorovian quantum-like framework. In this paper we introduce the notion of 'contextual risk' with the aim of modeling a substantial part of the situations in which usually only 'ambiguity' is present. More precisely, we firstly introduce the essentials of an operational formalism called 'the hidden measurement approach' in which probability is introduced as a consequence of fluctuations in the interaction between entities and contexts. Within the hidden measurement approach we propose a 'sphere model' as a mathematical tool for situations in which contextual risk occurs. We show that a probabilistic model of this kind is necessarily non-Kolmogorovian, hence it requires either the formalism of quantum mechanics or a generalization of it. This insight is relevant, for it explains the presence of quantum or, better, quantum-like, structures in economics, as suggested by some authors, and can serve to solve the aforementioned paradoxes.
    Date: 2011–05
  9. By: Uematsu, Hiroki; Ashok, Mishra K.
    Abstract: Using a national survey, double hurdle models are estimated to examine the impact of farmersâ risk attitude on use of production and marketing contracts. Risk averse farmers are less likely to use contracts but risk attitude does not have any significant impact on the intensity at which contracts are adopted.
    Keywords: Risk attitude, Double hurdle model, production contracts, marketing contracts, Agribusiness, Crop Production/Industries, Farm Management, Livestock Production/Industries, Marketing, Risk and Uncertainty, Q10, Q13, D81,
    Date: 2011
  10. By: Lee, Youngjae; Kennedy, Lynn; Brian, Hilbun
    Keywords: Agribusiness, Community/Rural/Urban Development, Crop Production/Industries, Institutional and Behavioral Economics, Production Economics, Risk and Uncertainty,
    Date: 2011–07–24

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