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on Utility Models and Prospect Theory |
| By: | Miriam Krieger; Thomas Mayrhofer |
| Abstract: | We study risk aversion and prudence in medical treatment decisions. In a laboratory experiment, we investigate the frequency and intensity of second- and third-order risk preferences, as well as the effect of the medical decision context. Risk preferences are assessed through treatment thresholds (the indifference point between not treating and treating). Under diagnostic risk, medical decision theory predicts lower thresholds for risk-averse than risk-neutral decision makers. Given a comorbidity risk, prudent individuals have an even lower threshold. Our results demonstrate risk-averse and prudent behavior in medical decisions, which reduce the (average) treatment threshold by 41% relative to risk neutrality (from 50.0% to 29.3% prevalence rate). Risk aversion accounts for 3/4 of this effect, prudence for 1/4. The medical decision framing does not affect risk aversion, but is associated with more and stronger prudent behavior. These findings have consequences for treatment thresholds, diagnostics, and QALYs, and thus for clinical guidelines. |
| Keywords: | Medical decision making; treatment thresholds; risk aversion; prudence; laboratory experiment |
| JEL: | I10 C91 D81 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:rwi:repape:0321&r=upt |
| By: | D Peel; Ivan Paya; T M Niguez; J Perote |
| Abstract: | Economic growth models under uncertainty and rational agents with CRRA utility have been shown to provide quite fragile explanations of consumers.choice as equlib- rium comsumption paths (expected utility) are drastically dependant on distributional assumptions. We show that assuming a SNP distribution for random consumption provides stability to general equilibrium models as expected utility exists for any value of the marginal rate of substitution over time. |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:lan:wpaper:2342&r=upt |
| By: | Christoph Kuzmics (Institute of Mathematical Economics, Bielefeld University) |
| Abstract: | If a decision maker, in a world of uncertainty a la Anscombe and Aumann (1963), can choose acts according to some objective probability distribution (by throwing dice for instance) from any given set of acts, then there is no set of acts that allows an experimenter to test more than the Axiom of EUOL (that the DM evaluates objective lotteries with an expected utility function). In fact there is no (common) experimental design that allows an experimenter to test more than EUOL. For any decision problem (or set of decision problems), for any preference relation that satisfies the Axiom EUOL, and for any optimal choice (or collection of choices) given this preference relation, there is another preference relation that satisfies EUOL plus the Savage axioms, for which this choice is also optimal. |
| Keywords: | ambiguity, decision theory, Knightian uncertainty, experiments |
| JEL: | C72 C81 C90 D01 D03 D81 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:bie:wpaper:462&r=upt |
| By: | Ana Conte (University of Westminster, London, UK, and Max-Planck-Institute of Economics, Jena); John D. Hey (University of York, UK) |
| Abstract: | The recent spate of theoretical models of behaviour under ambiguity can be partitioned into two sets : those involving multiple priors (in which the probabilities of the various events are not known but probabilities can be attached to the various possible values for the probabilities) and those not involving multiple priors. This paper concentrates on the first set and provides an experimental investigation into recently proposed theories. Using an appropriate experimental interface, in which the probabilities on the various possibilities are explicitly stated, we examine the fitted and predictive power of the various theories. We first estimate subject-by-subject, and then we estimate and predict using a mixture model over the contending theories. The individual estimates suggest that 25% of our 149 subjects have behaviour consistent with Expected Utility, 54% with the Smooth Model (of Klibanoff et al, 2005), 12% with Rank Dependent Expected Utility and 9% with the Alpha Model (of Ghirardato et al 2004); these figures are very close to the mixing proportions obtained from the mixture estimates. However, if we classify our subjects through the posterior probabilities (given all the evidence) of each of them being of the various types: using the estimates we get 36%, 19%, 28% and 11% (for EU, Smooth, Rank Dependent and Alpha); while using the predictions 36%, 19%, 33% and 16%. Interestingly the older models (EU and RD) seem to fare relatively better, suggesting that representing ambiguity through multiple priors is not perceived as the correct representation by subjects. |
| Keywords: | Alpha Model, Ambiguity, Expected Utility, Mixture Models, Rank Dependent Expected Utility, Smooth Model |
| JEL: | D81 C91 C23 |
| Date: | 2012–01–13 |
| URL: | http://d.repec.org/n?u=RePEc:jrp:jrpwrp:2011-068&r=upt |
| By: | Cosmin Ilut; Martin Schneider |
| Abstract: | This paper considers business cycle models with agents who dislike both risk and ambiguity (Knightian uncertainty). Ambiguity aversion is described by recursive multiple priors preferences that capture agents' lack of confidence in probability assessments. While modeling changes in risk typically requires higher-order approximations, changes in ambiguity in our models work like changes in conditional means. Our models thus allow for uncertainty shocks but can still be solved and estimated using first-order approximations. In our estimated medium-scale DSGE model, a loss of confidence about productivity works like 'unrealized' bad news. Time-varying confidence emerges as a major source of business cycle fluctuations. |
| JEL: | E32 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17900&r=upt |
| By: | Drichoutis, Andreas; Nayga, Rodolfo |
| Abstract: | We revisit the claims about the biological underpinnings of economic behavior by specifically exploring if observed gender differences in risk/time preferences can be explained by natural fluctuations in progesterone/estradiol levels during the menstrual cycle and by prenatal exposure to testosterone levels. Results suggest that natural fluctuations in progesterone levels have a direct effect on discount rates and that estradiol/progesterone levels can indirectly affect time preferences by changing the curvature of the utility function. Using measured D2:D4 digit ratio, results imply that subjects with low digit ratio exhibit higher discount rates and risk loving preferences. |
| Keywords: | discount rates; risk aversion; lab experiment; menstrual cycle; D2:D4 ratio; hormones; estradiol; progesterone; testosterone |
| JEL: | D81 C91 |
| Date: | 2012–03–12 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:37320&r=upt |
| By: | Eduard Dubin; Olesya V. Grishchenko; Vasily Kartashov |
| Abstract: | We study the asset pricing implications of a general equilibrium Lucas endowment economy inhabited by two agents with habit formation preferences. Preferences are modeled either as internal or external habits. We allow for agents' heterogeneity in relative risk aversion and habit strength. We explicitly compute aggregate prices, such as equity premium, equity volatility, Sharpe ratio, interest rate volatility, and asset holdings for both types of preferences. Equilibrium quantities are computed using a recently developed algorithm of Dumas and Lyasoff (2011), which is refined to capture time nonseparability induced by habit. We obtain that internal habits provide for a considerable improvement in obtaining aggregate asset pricing quantities consistent with historically observed magnitudes as opposed to ``catching up with Joneses" preferences. |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2012-07&r=upt |
| By: | Vanessa Hartlaub; Thorsten Schneider |
| Abstract: | According to sociological theories on educational choice, risk aversion is the main driving force for class-specific educational decisions. Families from upper social classes have to opt for the academically most demanding, long-lasting courses to avoid an intergenerational status loss. Families from lower social classes by contrast, tend instead to opt for shorter tracks to reduce the risk of failing in a long-lasting and costly education and, as a consequence, entering the labor market without a degree. This argument is deeply rooted in the social structure. Yet, the importance of individual risk preferences for educational choice has been neglected in sociology of education. We discuss these different forms of risk in the context of social inequalities in educational decision-making and demonstrate how they influence the intentions for further education of students attending the most demanding, academically orientated secondary school type in Germany. According to our argument, children from upper social classes are structurally almost compelled to opt for the academically most demanding educational courses, virtually without having a choice in the matter. In contrast, working class children do have to make an active decision and, thus, individual risk aversion comes into play for these students.<br /> For our empirical analyses, we rely on data from the youth questionnaire of the German Socio-Economic Panel Study (SOEP) collected in the years 2003 to 2010, and estimate multinomial logit models. Our empirical findings underline the importance of the structural risk aversion. Students with a higher social background are not only less sensitive to their school performance, but individual risk aversion is also completely irrelevant to their educational plans. The opposite applies to students with a lower social background: the more risk-averse they are, the more likely they are to opt for a double qualification rather than just a purely academic university degree course. |
| Keywords: | Educational inequality, educational decision-making, risk aversion, tertiary education, vocational training |
| JEL: | I24 D81 Z13 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:diw:diwsop:diw_sp433&r=upt |
| By: | Neri, Claudia; Manski, Charles |
| Abstract: | We study first- and second-order subjective expectations (beliefs) in strategic decisionmaking.We propose a method to elicit probabilistically both first- and second-order beliefs and apply the method to a Hide-and-Seek experiment. We study the relationship between choice and beliefs in terms of whether observed choice coincides with the optimal action given elicited beliefs. We study the relationship between first- and second-order beliefs under a coherence criterion. Weak coherence requires that if an event is assigned, according to first-order beliefs, a probability higher/lower/equal to the one assigned to another event, then the same holds according to second-order beliefs. Strong coherence requires the probability assigned according to first- and second-order beliefs to coincide. Evidence of heterogeneity across participants is reported. Verbal comments collected at the end of the experiment shed light on how subjects think and decide in a complex environment that is strategic, dynamic and populated by potentially heterogeneous individuals. |
| Keywords: | Decision-making, beliefs, subjective expectations, experiments |
| JEL: | D81 D83 D84 C92 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:usg:econwp:2012:06&r=upt |
| By: | Geoffroy de Clippel (Dept. of Economics, Brown University); Kareen Rozen (Cowles Foundation, Yale University) |
| Abstract: | Theories of bounded rationality are typically characterized over an exhaustive data set. This paper aims to operationalize some leading theories when the available data is limited, as is the case in most practical settings. How does one tell if observed choices are consistent with a theory of bounded rationality if the data is incomplete? What information can be identified about preferences? How can out-of-sample predictions be made? Our approach is contrasted with earlier attempts to examine bounded rationality theories on limited data, showing their notion of consistency is inappropriate for identifiability and out-of-sample prediction. |
| Keywords: | Bounded rationality, Limited datasets |
| JEL: | D01 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:cwl:cwldpp:1853&r=upt |
| By: | Neri, Claudia |
| Abstract: | This paper investigates the role of subjective expectations (beliefs) within a double auction experiment. The experiment elicits agents' probabilistic subjective beliefs about the bidding choices of other market participants. Observed bidding choices often deviate from the predictions of the risk-neutral Bayesian Nash Equilibrium (BNE) model. Evidence suggests that the failure of the game to converge to equilibrium is due to subjective beliefs not converging to BNE beliefs. I show that subjective beliefs cannot be modeled either by BNE beliefs or by empirical/historical beliefs, and that elicited subjective beliefs help explain observed bidding choices. |
| Keywords: | Auctions, beliefs, subjective expectations, private information, experiments |
| JEL: | D44 D82 D83 D84 C90 C92 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:usg:econwp:2012:07&r=upt |
| By: | Subiza, Begoña (Universidad de Alicante, Departamento de Métodos Cuantitativos y Teoría Económica); Peris, Josep E. (Universidad de Alicante, Departamento de Métodos Cuantitativos y Teoría Económica) |
| Abstract: | If we analyze the notion of stability (von Neumann and Morgenstern, 1944) it seems a desirable property to be fulfilled by any choice function. Paradoxically, the usual Condorcet choice functions (maximal set, top cycle, uncovered set, minimal covering, ...) are not stable in the VNM sense. In this study, we show the relationship between stability and rational choice functions, and propose an alternative notion of stability (wich we call c-stability) that solves this incompatibility problem. This new notion is closely related to the admissible set defined in Kalai and Schmeidler (1977). |
| Keywords: | stable set; admissible set; Condorcet choice function |
| JEL: | D11 |
| Date: | 2012–03–13 |
| URL: | http://d.repec.org/n?u=RePEc:ris:qmetal:2012_005&r=upt |
| By: | Olesya V. Grishchenko; Jing-zhi Huang |
| Abstract: | ``Inflation-indexed securities would appear to be the most direct source of information about inflation expectations and real interest rates" (Bernanke, 2004). In this paper we study the term structure of real interest rates, expected inflation and inflation risk premia using data on prices of Treasury Inflation Protected Securities (TIPS) over the period 2000-2008. The approach we use to estimate inflation risk premium is arbitrage free, largely model free, and easy to implement. We also make distinction between TIPS yields and real yields and take into account explicitly the three-month indexation lag of TIPS in the analysis. In addition, we propose a new liquidity measure based on TIPS prices. Accounting for it, we find that the inflation risk premium is time-varying: it is negative (positive) in the first (second) half of the sample period. The average 10-year inflation risk premium ranges from -16 to 10 basis points over the full sample depending on the proxy used for expected inflation. More specifically, the estimates of the 10-year inflation risk premium range between 14 and 19 basis points for 2004-2008 period. |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2012-06&r=upt |
| By: | Luis José Blas Moreno Garrido (Dpto. Fundamentos del Análisis Económico); Ismael Rodríguez Lara (Universidad de Alicante) |
| Abstract: | We expand upon the previous models of inequity aversion of Fehr and Schmidt (1999) and Frohlich, Oppenheimer and Kurki (2004), which assume that dictators get disutility if the final allocation of the surplus deviates from the equal split (egalitarian principle) or from the subjects’ production (libertarian principle). In our model, dictators may also account for the way in which the surplus was generated. More precisely, our model incorporates the idea of the liberal egalitarian ethics into the analysis, making it possible for dictators to divide the surplus according to the accountability principle, which states that subjects should only be rewarded for factors under their control. This fairness ideal does not hold subjects responsible for factors beyond their control in the production of the surplus, an idea that is absent in the models of inequity aversion cited above. |
| Keywords: | social preferences, inequity aversion, inequality aversion, egalitarian principle, libertarian principle, accountability principle. |
| JEL: | D3 D63 |
| Date: | 2012–02 |
| URL: | http://d.repec.org/n?u=RePEc:ivi:wpasad:2012-04&r=upt |
| By: | Paulina Granados Zambrano |
| Abstract: | The recognition that information is, most of the time, incomplete and imperfect is essential in understanding the nature of the formation of beliefs. To understand human behavior in the area of (academic) performance, the beliefs individuals sustain about their ability become crucial. Before performing a certain task, the agent never knows his/her true ability. He/she only has an ex-ante notion of his/her believed ability and the truth is only revealed ex-post. Once the true ability is known and the payoffs realized, we observe different reactions that range from disappointment to happiness. The logical question is then, who would have preferred not to know the truth? This paper deals with the information acquisition decisions of individuals who face uncertainty about their own ability. At a theoretical level (Bénabou and Tirole, 2002), it has been shown that overconfident individuals (people with beliefs about themselves higher than reality) with time inconsistent preferences have more at stake when they face the decision of learning the truth about themselves than more pessimistic agents. To test this prediction, a field experiment is designed and implemented, where students face the decision of learning, or not, their true ability before performing a test. It will be shown that overconfident students indeed more often decide not to learn their true ability. |
| Keywords: | overconfidence; beliefs; ability; information acquisition; field experiment |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2012/04&r=upt |
| By: | Ignacio Monzón |
| Abstract: | This paper presents a model in which homogeneous rational agents choose between two competing technologies. Agents observe a private signal and a sample of other agents’ previous choices. The signal has both an idiosyncratic and an aggregate component of uncertainty. I derive the optimal decision rule when each agent observes the decision of exactly two agents. Due to aggregate uncertainty, aggregate behavior does not necessarily reflect the true state of nature. Nonetheless, agents still find others’ choices a good source of information, and they base their decisions partly on the behavior of others. Consequently, bad choices can be perpetuated in this environment: I show that aggregate uncertainty can lead to agents herding on the inferior technology with positive probability. I also present examples in which herding occurs for arbitrarily large sample sizes. |
| Keywords: | observational learning, social learning, word-of-mouth, herding |
| JEL: | C72 C79 D83 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:cca:wpaper:245&r=upt |
| By: | Philippe Bacchetta (University of Lausanne and Centre for Economic Policy Research and Hong Kong Institute for Monetary Research); Eric van Wincoop (University of Virginia and National Bureau of Economic Research and Hong Kong Institute for Monetary Research) |
| Abstract: | Recent episodes (October 2008, May 2010, August 2011) have witnessed huge spikes in equity price risk (implied volatility). Apart from their large size, several features characterize these risk panics. They are global phenomena, shared among a broad set of countries. There is substantial variation though in the extent to which individual countries are impacted, while the impact bears little relation to financial linkages with the epicenter of the crisis. In addition there is usually not a large shock to fundamentals that sets off these panics. We provide an explanation for these risk panic features in the context of a two-country model that allows for self-fulfilling shifts in risk. |
| Date: | 2012–02 |
| URL: | http://d.repec.org/n?u=RePEc:hkm:wpaper:062012&r=upt |
| By: | Christiaan Behrens (VU University Amsterdam); Mark Lijesen (VU University Amsterdam); Eric Pels (VU University Amsterdam); Erik Verhoef (VU University Amsterdam) |
| Abstract: | In this article we study patterns of vertical product differentiation in a multi-product monopoly using a random utility model. Prior research shows that applying such a model in a multi-product setting implies symmetric patterns of product differentiation in which all product variants of a single firm have the same characteristics. Assuming that preferences differ across consumers and allowing for unobserved demand heterogeneity, we numerically show the existence of asymmetric, fully differentiated, patterns of vertical product differentiation in which the monopolist maximises profits by setting prices and qualities. In particular, we show that the patterns of vertical product differentiation depend crucially on the level of unobserved demand heterogeneity and the observed dispersion of willingness to pay for quality. Only if unobserved demand heterogeneity is small relative to the observed dispersion, asymmetric, fully differentiated, equilibriums exist. Furthermore, we find in our model that the level of unobserved heterogeneity and the dispersion of willingness to pay for quality do not affect the relative welfare efficiency of the monopolist. |
| Keywords: | Vertical product differentiation; market segmentation; multi-product monopoly; random utility models |
| JEL: | D21 D42 L11 L12 |
| Date: | 2012–03–13 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:uvatin:20120023&r=upt |