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on Utility Models and Prospect Theory |
| By: | Takayuki Osogami |
| Abstract: | We demonstrate a limitation of discounted expected utility, a standard approach for representing the preference to risk when future cost is discounted. Specifically, we provide an example of the preference of a decision maker that appears to be rational but cannot be represented with any discounted expected utility. A straightforward modification to discounted expected utility leads to inconsistent decision making over time. We will show that an iterated risk measure can represent the preference that cannot be represented by any discounted expected utility and that the decisions based on the iterated risk measure are consistent over time. |
| Date: | 2012–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1202.3755&r=upt |
| By: | Giuseppe Ciccarone; Enrico Marchetti |
| Abstract: | We add some elements of prospect theory to an analytically tractable version of Lucas’s “islands†model and show that the inclusion of reference dependence, declining sensitivity and loss aversion into the agents’ utility function leads to three main results. First, the equilibrium labor supply and the natural level of output are negatively affected by the presence of behavioral elements, whereas the cyclical response of output to a monetary shock remains unaltered. Second, the expected utility of a representative agent is generally lower than that obtained when loss aversion is absent. Third, the presence of loss aversion eliminates the paradoxical increase in expected utility that may be generated, in the standard model, by an increase in monetary policy uncertainty. |
| Keywords: | Prospect Theory, Behavioral economics, Signal extraction. |
| JEL: | E32 E52 D81 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:sap:wpaper:wp148&r=upt |
| By: | Hippolyte D'Albis (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne); Emmanuel Thibault (TSE - Toulouse School of Economics - Toulouse School of Economics) |
| Abstract: | We consider a life-cycle model with bequest motives, and assume that the individual does not know his/her survival probability and has maxmin utility preferences; we show that it is optimal not to annuitize but to purchase pure life insurance policies instead. |
| Keywords: | Demand for annuities; Uncertain survival probabilities; Uncertainty aversion; Maxmin |
| Date: | 2012–05 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:hal-00670320&r=upt |
| By: | Larsson, Lars-Göran (Department of Economics, School of Business, Economics and Law, Göteborg University) |
| Abstract: | See paper |
| Keywords: | Properties of expected consumer demand functions; Microeconomics; Consumer theory; Consumer behaviour; Choice described in random terms; Expected individual and market demand. |
| JEL: | C60 D01 D11 |
| Date: | 2012–02–15 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:gunwpe:0527&r=upt |
| By: | Bertrand Wigniolle (Centre d'Economie de la Sorbonne - Paris School of Economics) |
| Abstract: | This paper shows that it is possible to extend the scope of the existence of rational bubbles when uncertainty is introduced associated with rank-dependent expected utility. This RDU assumption can be viewed as a transformation of probabilities depending on the pessimism/optimism of the agent. The results show that pessimism favors the existence of deterministic bubbles, when optimism may promote the existence of stochastic bubbles. Moreover, under pessimism, the RDU assumption may generate multiple bubbly equilibria. The RDU assumption also leads to new conditions ensuring the (absence of) Pareto-optimality of the competitive equilibrium without bubbles. These conditions still govern the existence of bubbles. |
| Keywords: | Rational bubbles, RDU preferences. |
| JEL: | D81 D9 G1 |
| Date: | 2012–02 |
| URL: | http://d.repec.org/n?u=RePEc:mse:cesdoc:12005&r=upt |
| By: | Matthew Polisson; John Quah |
| Abstract: | We show that an agent maximizing some utility function on a discrete (as opposed to continuous) consumption space will obey the generalized axiom of revealed preference (GARP) so long as the agent obeys cost efficiency. Cost efficiency will hold if there is some good, outside the set of goods being studied by the modeler, that can be consumed by the agent in continuous quantities. An application of Afriat's Theorem then guarantees that there is a strictly increasing utility function on the discrete consumption space that rationalizes price and demand observations in that space. |
| Keywords: | Generalized axiom of revealed preference; Afriat's Theorem; discrete demand; utility maximization |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:lec:leecon:12/02&r=upt |
| By: | Scott Robertson |
| Abstract: | This paper provides approximations to utility indifference prices for a contingent claim in the large position size limit. Results are valid for general utility functions and semi-martingale models. It is shown that as the position size approaches infinity, all utility functions with the same rate of decay for large negative wealths yield the same price. Practically, this means an investor should price like an exponential investor. In a sizeable class of diffusion models, the large position limit is seen to arise naturally in conjunction with the limit of a complete model and hence approximations are most appropriate in this setting. |
| Date: | 2012–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1202.4007&r=upt |
| By: | Paolo Vitale (Universitˆ degli studi di Chieti e Pescara and LUISS Guido Carli University of Rome) |
| Abstract: | We discuss how Whittle's (Whittle, 1990) approach to risk-sensitive optimal control problems can be applied in economics and finance. We show how his analysis of the class of Linear Exponential Quadratic Gaussian problems can be extended to accommodate time-discounting, while preserving its simple and general recursive solutions. We apply Whittle's methodology investigating two specific problems in financial and monetary policy. |
| Keywords: | Risk-aversion, Linear Exponential Quadratic Gaussian, Optimal Control. |
| JEL: | C61 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:lui:casmef:1203&r=upt |
| By: | Hsee, Christopher K. (University of Chicago); Rottenstreich, Yuval (New York University); Stutzer, Alois (University of Basel) |
| Abstract: | Standard economic analysis assumes that people make choices that maximize their utility. Yet both popular discourse and other fields assume that people sometimes fail to make optimal choices and thus adversely affect their own happiness. Most social sciences thus frequently describe some patterns of decision as suboptimal. We review evidence of suboptimal choices that arise for two reasons. First, people err in predicting the utility they may accrue from available choice options due to the evaluation mode. Second, people choose on the basis of salient rules that are unlikely to maximize utility. Our review is meant to highlight the possibility of a research program that combines economic analysis with measures of experienced individual well-being to improve people's happiness. |
| Keywords: | suboptimal choice, individual well-being, experienced utility, evaluation mode, salient rule, utility misprediction |
| JEL: | D01 D11 D60 D91 |
| Date: | 2012–02 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp6346&r=upt |
| By: | Menachem Brenner; Yehuda Izhakian |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:ste:nystbu:11-10&r=upt |
| By: | V. I. Yukalov; D. Sornette |
| Abstract: | Decision making of agents who are members of a society is analyzed from the point of view of quantum decision theory. This generalizes the approach, developed earlier by the authors for separate individuals, to decision making under the influence of social interactions. The generalized approach not only avoids paradoxes, typical of classical decision making based on utility theory, but also explains the error-attenuation effects observed for the paradoxes occurring when decision makers, who are members of a society, consult with each other increasing in this way the available mutual information. |
| Date: | 2012–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1202.4918&r=upt |
| By: | Schurer, S.;; Yong, J.; |
| Abstract: | Fixed effects models are the gold standard in empirical well-being research, however, their applicability is limited to controlling for intercept heterogeneity and identifying effects of timevarying variables. This paper investigates the usefulness of random coecient models in con- trolling for heterogeneity in well-being and the marginal utility of income, and explores whether these forms of heterogeneity depend on the Big-Five personality traits. Using unique Australian longitudinal data that have personality measures available in two time periods we show that a Mundlak-adjusted random coeffcient model yields almost identical results as the mixed effects model, making it a powerful modelling alternative when interest lies in multiple forms of heterogeneity. Big-Five personality explains 10 percent of the variation in intercept heterogeneity and 6-7 percent of the variation in the marginal utility of income. For women, we suggest that the marginal utility of income is significantly linked to personality, implying important gender-differences in the expected effectiveness of financial incentives to influence behaviour. |
| Keywords: | Subjective well-being, Marginal utility of income, Heterogeneity, Personality, Random coeffcient models. |
| JEL: | I31 D00 C23 |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:yor:hectdg:12/01&r=upt |
| By: | Menachem Brenner; Yehuda Izhakian; Orly Sade |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:ste:nystbu:11-06&r=upt |
| By: | Anthony Ziegelmeyer (Max Planck Institute of Economics, Jena); Christoph March (Paris School of Economics); Sebastian Krügel (Max Planck Institute of Economics, Jena, IMPRS "Uncertainty") |
| Abstract: | Weizsäcker (2010) estimates the payoff of actions to test rational expectations and to measure the success of social learning in information cascade experiments. He concludes that participants perform poorly when learning from others and that rational expectations are violated. We show that his estimated payoffs rely on estimates of the publicly known prior and signal qualities which may lead the formulated test of rational expectations to generate false positives. We rely on the true values of the prior and signal qualities to estimate the payoff of actions. We confirm that the rational expectations hypothesis is rejected, but we measure a much larger success of social learning. |
| Keywords: | Information Cascades, Laboratory Experiments, Quantal Response Equilibrium |
| JEL: | C92 D82 |
| Date: | 2012–02–20 |
| URL: | http://d.repec.org/n?u=RePEc:jrp:jrpwrp:2012-006&r=upt |