nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2011‒09‒05
seven papers chosen by
Alexander Harin
Modern University for the Humanities

  1. The Nature of Risk Preferences: Evidence from Insurance Choices By Barseghyan, Levon; Molinari, Francesca; O'Donoghue, Ted; Teitelbaum, Joshua C.
  2. Risk Aversion or Risk Management?: How Measures of Risk Aversion Affect Firm Entry and Firm Survival By Cho, In Soo; Orazem, Peter
  3. Smooth Ambiguity Aversion in the Small and in the Large By Loïc Berger
  4. Does Ambiguity Aversion Raise the Optimal Level of Effort? A Two-Period Model By Loïc Berger
  5. Policy-related small.area estimation By LONGFORD Nicholas Tibor
  6. The Economics of Lotteries: A Survey of the Literature By Kent Grote; Victor Matheson
  7. Does consultation improve decision making? By Alessia Isopi; Daniele Nosenzo; Chris Starmer

  1. By: Barseghyan, Levon (Cornell University); Molinari, Francesca (Cornell University); O'Donoghue, Ted (Cornell University); Teitelbaum, Joshua C. (Georgetown University)
    Abstract: We use data on households' deductible choices in auto and home insurance to estimate a structural model of risky choice that incorporates "standard" risk aversion (concave utility over final wealth), loss aversion, and nonlinear probability weighting. Our estimates indicate that nonlinear probability weighting plays the most important role in explaining the data. More specifically, we find that standard risk aversion is small, loss aversion is nonexistent, and nonlinear probability weighting is large. When we estimate restricted models, we find that nonlinear probability weighting alone can better explain the data than standard risk aversion alone, loss aversion alone, and standard risk aversion and loss aversion combined. Our main findings are robust to a variety of modeling assumptions.
    JEL: D01 D12 D81 G22
    Date: 2011–07
  2. By: Cho, In Soo; Orazem, Peter
    Abstract: The link between measured risk aversion and the decision to become an entrepreneur is well established, but the link between risk preferences and entrepreneurial success is not. Standard theoretical models of occupational choice under uncertainty imply a positive correlation between an individual’s degree of risk aversion and the expected return from an entrepreneurial venture at the time of entry. Because the expected return is the risk neutral equivalent value, a higher expected return implies a higher survival probability, and so more risk averse entrepreneurs should survive more frequently than their less risk averse counterparts. We test that prediction using successive entry cohorts of young entrepreneurs in the National Longitudinal Survey of Youth 1979 (NLSY79). The empirical results soundly reject the prediction: the most successful entrepreneurs are the least risk averse. This surprising finding calls into question the interpretation of common measures of risk aversion as measures of taste for risk. Instead, measured risk attitudes perform as if they are indicators of entrepreneurial ability– the least risk averse are apparently those who can best assess and manage risks. Indeed, our interpretation is consistent with the work of recent experimental studies that find that the less risk averse have higher cognitive ability.
    JEL: J24 L24 M1
    Date: 2011–08–24
  3. By: Loïc Berger
    Abstract: In this paper I use the smooth ambiguity model developed by Klibanoff, Marinacci, and Mukerji (2005) to define the concepts of ambiguity and uncertainty premia in a way analogous to what Pratt (1964) did in the risk theory literature. I show that those concepts may be useful to quantify the effect ambiguity has on the welfare of economic agents. I also provide local approximations of these premia and show the link that exists between them when comparing different degrees of ambiguity aversion not only in the small, but also in the large.
    Keywords: ambiguity aversion; non-expected utility; uncertainty
    JEL: D81 D91
    Date: 2011–08
  4. By: Loïc Berger
    Abstract: I consider two-period self-insurance and self-protection models in the presence of ambiguity that either affects the loss or the probabilities, and analyze the effect of ambiguity aversion. I show that in most common situations, ambiguity prudence is a sufficient condition to observe an increase in the level of effort. I proposes an interpretation of the model in the context of climate change, such that self-insurance and self-protection are respectively seen as adaptation and mitigation efforts a policymaker should provide to deal with an uncertain catastrophic event, and interpret the results obtained as an expression of the Precautionary Principle.
    Keywords: non-expected utility; self-protection; self-insurance; ambiguity prudence; precautionary principle
    JEL: D61 D81 D91 Q58
    Date: 2011–08
  5. By: LONGFORD Nicholas Tibor
    Abstract: A method of small-area estimation with a utility function is developed. The utility characterises a policy planned to be implemented in each area, based on the area’s estimate of a key quantity. It is shown that the commonly applied empirical Bayes and composite estimators are inefficient for a wide range of utility functions. Adaptations for limited budget to implement the policy are explored. An argument is presented for a closer integration of estimation and (regional) policy making.
    Keywords: Composition; empirical Bayes; expected loss; borrowing strenght; exploiting similarity; small-area estimation; utility function
    JEL: C13 C14 C44
    Date: 2011–07
  6. By: Kent Grote (Department of Economics and Business, Lake Forest College); Victor Matheson (Department of Economics, College of the Holy Cross)
    Abstract: Lotteries represent an important source of government revenues in many states and countries, so they are of interest to public finance economists. In addition, lotteries provide researchers interested in microeconomic theory and consumer behavior with a type of experimental lab that allows economists to explore these topics. This paper surveys the existing literature on lotteries organized around these two central themes. The first section examines the microeconomic aspects of lotteries including consumer decision-making under uncertainty, price and income elasticities of demand for lottery tickets, cross-price elasticities of lottery ticket to each other and to other gambling products, consumer rationality and gambling, and the efficiency of lottery markets. The second section covers topics related to public finance and public choice including the revenue potential of lotteries, the tax efficiency and dead-weight loss of lottery games, the horizontal and vertical equity of lotteries, earmarking and the fungibility of lottery revenues, and individual state decisions to participate in participate in public lotteries.
    Keywords: lotto, lottery, public finance, gambling
    JEL: D81 H71 L83
    Date: 2011–08
  7. By: Alessia Isopi (School of Economics, University of Nottingham); Daniele Nosenzo (School of Economics, University of Nottingham); Chris Starmer (School of Economics, University of Nottingham)
    Abstract: This paper reports an experiment designed to test whether prior consultation within a group affects subsequent individual decision making in tasks where demonstrability of correct solutions is low. In our experiment subjects considered two paintings created by two different artists and were asked to guess which artist made each painting. We observed answers given by individuals under two treatments: in one, subjects were allowed the opportunity to consult with other participants before making their private decisions; in the other there was no such opportunity. Our primary findings are that subjects in the first treatment evaluate the opportunity to consult positively but they perform significantly worse and earn significantly less.
    Keywords: Consultation; Decision making; Group decisions; Individual decisions
    JEL: C91 C92 D80
    Date: 2011–07

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