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on Utility Models and Prospect Theory |
| By: | Sanjit Dhami; Ali al-Nowaihi |
| Abstract: | In a seminal paper, Becker (1968) showed that the most efficient way to deter crime is to impose the severest possible penalty (to maintain adequate deterrence) with the lowest possible probability (to economize on costs of enforcement). We shall call this the Becker proposition (BP). The BP is derived under the assumptions of expected utility theory (EU). However, EU is heavily rejected by the evidence. A range of non-expected utility theories have been proposed to explain the evidence. The two leading alternatives to EU are rank dependent utility (RDU) and cumulative prospect theory (CP). The main contributions of this paper are: (1) We formalize the BP in a more satisfactory manner. (2) We show that the BP holds under RDU and CP. (3) We give a formal behavioral approach to crime and punishment that could have applicability to a wide range of problems in the economics of crime. |
| Keywords: | Crime and punishment; non-linear weighting of probabilities; cumulative prospect theory; rank dependent utility; probability weighting functions; punishment functions. |
| JEL: | D03 D81 K42 |
| Date: | 2011–09 |
| URL: | http://d.repec.org/n?u=RePEc:lec:leecon:11/41&r=upt |
| By: | Guillaume Carlier (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS : UMR7534 - Université Paris IX - Paris Dauphine); Rose-Anne Dana (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS : UMR7534 - Université Paris IX - Paris Dauphine) |
| Abstract: | An exchange economy in which agents have convex incomplete preferences defined by families of concave utility functions is considered. Sufficient conditions for the set of efficient allocations and equilibria to coincide with the set of efficient allocations and equilibria that result when each agent has a utility in her family are provided. Welfare theorems in an incomplete preferences framework therefore hold under these conditions and efficient allocations and equilibria are characterized by first order conditions. |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-00661903&r=upt |
| By: | Attema, Arthur; Brouwer, Werner |
| Abstract: | The numerous reports on preference reversals in preference elicitations pose a great challenge to empirical economics. Many studies have found that different procedures may generate substantially different preferences. However, little is known about whether one procedure is more susceptible to preference reversals than another. Therefore, taking the preference reversals as a robust behavioral pattern, guidelines are called for to provide directions regarding a preferred preference elicitation task. This paper puts forward a new test of the internal consistency of choice and matching tasks, based on “internal preference reversals”. We replicate the preference reversal phenomenon and find a significant higher consistency within choice tasks than within matching tasks. |
| Keywords: | preference reversal; internal consistency; scale compatibility; loss aversion; choice; matching |
| JEL: | C91 B41 I10 |
| Date: | 2012–01–20 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:36100&r=upt |
| By: | Wataru Tamura; |
| Abstract: | We study disclosure of information about the multidimensional state of the world when uninformed receivers' actions affect the sender's utility. Given a disclosure rule, the receivers form an expectation about the state following each message. Under the assumption that the senderfs expected utility is written as the expected value of a quadratic function of those conditional expectations, we identify conditions under which full and no disclosure is optimal for the sender and show that a linear transformation of the state is optimal if it is normally distributed. We apply our theory to advertising, political campaigning, and monetary policy. |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:dpr:wpaper:0828&r=upt |
| By: | Masato Ubukata; Toshiaki Watanabe |
| Abstract: | This article evaluates the predictive performance of the market variance risk premium (VRP) in Japan on the Nikkei 225 returns, credit spreads, and the composite index of coincident indicators. Different measures such as expected and ex-post VRPs, which are constructed from model-free implied and realized variances, are used to verify the predictability. Moreover, the VRP is estimated by the Bollerslev, Gibson and Zhou (2011) method using Japanese macroeconomic variables to approximate the dynamics of the representative investor's relative risk aversion. The main empirical findings are: (i) the ex-post VRP, which is defined as the difference between implied and ex-post realized variances, is useful in predicting the Nikkei 225 returns, whereas the expected VRPs, which are the differences between implied and current or model-based realized variances, lose their predictive ability, (ii) the expected and ex-post VRPs provide significant predictability of credit spreads and the composite index of coincident indicators, (iii) the VRP involving Japanese macroeconomic variables contains plausible business cycle dynamics of the Japanese economy. |
| Keywords: | Variance Risk Premium, Predictability, Realized Variance, Implied Variance, Relative Risk Aversion |
| JEL: | C22 G17 |
| Date: | 2011–12 |
| URL: | http://d.repec.org/n?u=RePEc:hst:ghsdps:gd11-214&r=upt |
| By: | Gianluca Femminis (DISCE,Università Cattolica) |
| Abstract: | A simple dynamic general equilibrium model of savings and investment is populated by agents with Kreps-Porteus preferences. Households are heterogeneous in their risk aversion, which explains the negative relationship between aggregate investment and aggregate uncertainty. Agents trade a riskless assets to share the aggregate risk, so that in equilibrium a higher uncertainty induces the low risk-averse individuals to increase their position in the risky asset, and the highly risk averse agents to increase their share of safe bonds. This portfolio effect increases the certainty-equivalent future returns; in response to this rise, savings and investment decrease due to a limited willingness to substitute consumption over time. |
| Keywords: | Aggregate investment; uncertainty; risk aversion; heterogeneity. |
| JEL: | D92 E22 |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:ctc:serie6:itemq1260&r=upt |
| By: | József Sákovics (University of Edinburgh) |
| Abstract: | I prove that as long as we allow the marginal utility for money lamda to vary between purchases (similarly to the budget) then the quasi-linear and the ordinal budget-constrained models rationalize the same data. However, we know that lamda is approximately constant. I provide a simple constructive proof for the necessary and sufficient condition for the constant lambda rationalization, which I argue should replace the Generalized Axiom of Revealed Preference in empirical studies of consumer behavior. |
| Date: | 2012–01–18 |
| URL: | http://d.repec.org/n?u=RePEc:edn:esedps:212&r=upt |
| By: | B. Arruñada; M. Casari; F. Pancotto |
| Abstract: | Through an experiment, we investigate how the level of rationality relates to concerns for equality and efficiency. Subjects perform dictator games and a guessing game. More rational subjects are not more frequently of the selfregarding type. When performing a comparison within the same degree of rationality, self-regarding subjects show more strategic sophistication than other subjects. |
| JEL: | C91 C92 D63 |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:bol:bodewp:wp805&r=upt |
| By: | Mathias Erlei; Heike Schenk-Mathes (Abteilung für Volkswirtschaftslehre, Technische Universität Clausthal (Department of Economics, Technical University Clausthal)) |
| Abstract: | We conducted six treatments of a standard moral hazard experiment with hidden action. All treatments had identical Nash equilibria. However, the behavior in all treatments and periods was inconsistent with established agency theory (Nash equilibrium). In the early periods of the experiment, behavior differed significantly between treatments. This difference largely vanished in the final periods. We used logit equilibrium (LE) as a device to grasp boundedly rational behavior and found the following: (1) LE predictions are much closer to subjects’ behavior in the laboratory; (2) LE probabilities of choosing between strategies and experimental behavior show remarkably similar patterns; and (3) profit‐maximizing contract offers according to the LE are close to those derived from regressions. |
| Keywords: | experiment, logit equilibrium, moral hazard, hidden action |
| JEL: | C72 C92 J31 L14 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:tuc:tucewp:0006&r=upt |
| By: | Pedro Bordalo; Nicola Gennaioli; Andrei Shleifer |
| Abstract: | We provide a novel account of experimental evidence for the endowment effect using the salience mechanism (Bordalo, Gennaioli, and Shleifer, 2011). The two-stage procedure implemented in experiments implies that the endowed good and other goods are evaluated in different contexts. We describe conditions under which the standard effect occurs, but also account for recent evidence such as a reverse endowment effect for bads and a role for reference prices in modulating the WTA-WTP gap. |
| JEL: | D03 D81 |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17761&r=upt |
| By: | Bruno Biais (Toulouse School of Economics (CNRS-CRM, IDEI), 21 Allée de Brienne, 31000 Toulouse, France.); Florian Heider (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Marie Hoerova (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.) |
| Abstract: | We analyze optimal hedging contracts and show that although hedging aims at sharing risk, it can lead to more risk-taking. News implying that a hedge is likely to be loss-making undermines the risk-prevention incentives of the protection seller. This incentive problem limits the capacity to share risks and generates endogenous counterparty risk. Optimal hedging can therefore lead to contagion from news about insured risks to the balance sheet of insurers. Such endogenous risk is more likely to materialize ex post when the ex ante probability of counterparty default is low. Variation margins emerge as an optimal mechanism to enhance risk-sharing capacity. Paradoxically, they can also induce more risk-taking. Initial margins address the market failure caused by unregulated trading of hedging contracts among protection sellers. JEL Classification: G21, G22, D82. |
| Keywords: | Insurance, moral hazard, counterparty risk, margin requirements, derivatives. |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20111413&r=upt |
| By: | Berg, J. van den; Kaymak, U.; Almeida, R.J. |
| Abstract: | We consider function approximation by fuzzy systems. Fuzzy systems are typically used for approximating deterministic functions, in which the stochastic uncertainty is ignored. We propose probabilistic fuzzy systems in which the probabilistic nature of uncertainty is taken into account. Furthermore, these systems take also fuzzy uncertainty into account by their fuzzy partitioning of input and output spaces. We discuss an additive reasoning scheme for probabilistic fuzzy systems that leads to the estimation of conditional probability densities, and prove how such fuzzy systems compute the expected value of this conditional density function. We show that some of the most commonly used fuzzy systems can compute the same expected output value and we derive how their parameters should be selected in order to achieve this goal. |
| Keywords: | fuzzy set;additive reasoning;function approximation;fuzzy partitioning;probabilistic fuzzy system |
| Date: | 2011–12–13 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:eureri:1765030923&r=upt |
| By: | A. BANERJI (Department of Economics, Delhi School of Economics, Delhi, India); NEHA GUPTA (Department of Economics, Delhi School of Economics, Delhi, India) |
| Abstract: | In this paper, we provide a novel experimental auction design that exploits an exogenous variation in the probability of winning to test for the presence of expectations-based reference dependent preferences. We prove that (i) in this design, (which is a one parameter modification of a Becker-de Groote-Marschak (BDM) auction), a lower probability of winning will cause a loss averse agent to bid lower, for a large range of intrinsic values for the object. Data from an experiment demonstrate the existence of this effect. The effect would be absent if preferences were 'standard', or if the status quo was the reference point. Thus we contribute to the nascent literature that empirically documents the importance of expectations as a source of reference points. (ii) We further prove that the experimental design enables unique identification of participants' value distribution and loss averse than men. Finally, as a contribution to experimental methodology, we prove that the BDM mechanism will underestimate loss averse participants' values, we quantify the underestimation, and we suggest methods to bound this bias. |
| Keywords: | Auctions, Expectations, Loss Aversion, Reference dependence |
| JEL: | C91 D03 D44 |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:cde:cdewps:206&r=upt |
| By: | Yuki Tanaka (National Graduate Institute for Policy Studies); Alistair Munro (National Graduate Institute for Policy Studies) |
| Abstract: | Experiments measuring risk and time preferences in developing countries have tended to have relatively small samples and geographically concentrated sampling. This large-scale field experiment uses a Holt-Laury mechanism to elicit the preferences of 1289 randomly selected subjects from 94 villages covering six out of seven agro-climatic zones across rural Uganda. As in previous studies we find evidence of risk aversion and loss aversion amongst most subjects. In addition we find significant heterogeneity in risk attitudes across agro-climatic zones. Especially, the farmers in the agro-climatically least favourable zone, the uni-modal rainfall zone, are the most risk averse, loss averse and impatient. We also find significant relationships between risk attitudes and village level predictors such as the distance to town and the road conditions. After controlling for the village level factors, we find that the level of schooling still positively correlates with the individual’s level of loss tolerance and patience. The main results are not altered by allowing for probability weighting in subjects’ choices. Overall the results provide clear evidence that within one country there may be significant regional variations in risk and time attitudes. We conjecture that the agro-climatic conditions that affect farmers’ livelihoods may also affect their risk and time preferences and village level development in infrastructure could improve the household perception of investment related policies. |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:ngi:dpaper:11-19&r=upt |