nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2012‒08‒23
twenty-one papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Variation in Risk Seeking Behavior in a Natural Experiment on Large Losses Induced by a Natural Disaster By Lionel Page; David Savage; Benno Torgler
  2. Heterogeneous Ambiguity Attitudes: A Field Experiment Among Small-Scale Stock Investors in China. Review of Economic Design By Elizabeth Potamites; Bei Zhang
  3. Should I Stay or Should I Go?: A Laboratory Analysis of Investment Opportunities under Ambiguity By Paul Viefers
  4. Does Ambiguity Diversification Pay? By Yehuda Izhakian
  5. Insurance demand under ambiguity and conflict for extreme risks : Evidence from a large representative survey By Théodora Dupont-Courtade
  6. Viewing Risk Measures as information By Dominique Guegan; Wayne Tarrant
  7. The marginal utility of money: A modern Marshallian approach to consumer choice By Friedman, Daniel; Sákovics, József
  8. Ambiguous Life Expectancy and the Demand for Annuities By Hippolyte D'Albis; Emmanuel Thibault
  9. Stereotypes and Risk Attitudes: Evidence from the Lab and the Field By Leuermann, Andrea; Roth, Benjamin
  10. An application of General Maximum Entropy to Utility By Paulo Ferreira; Andreia Dionísio
  11. A Test Of Social Preferences Theory By Ioannou, Christos A.; Qi, Shi; Rustichini, Aldo
  12. Bounded rationality: psychology, economics and the financial crisis By Schilirò, Daniele
  13. Cooperation in a Risky Environment: Decisions from Experience in a Stochastic Social Dilemma By Florian Artinger; Nadine Fleischhut; M. Vittoria Levati; Jeffrey R. Stevens
  14. Risk and Inequality in a Social Decision Making Experiment By Ingrid M.T. Rohde; Kirsten I.M. Rohde
  15. Risks For the Long Run: Estimation with Time Aggregation By Ravi Bansal; Dana Kiku; Amir Yaron
  16. Nachfrageunsicherheit und Risikopolitik im Duopol By Broll, Udo; Pelster, Matthias; Wahl, Jack E.
  17. Does good advice come cheap? - On the assessment of risk preferences in the lab and the field By Leuermann, Andrea; Roth, Benjamin
  18. Second Order BSDEs with Jumps, Part II: Existence and Applications By M. Nabil Kazi-Tani; Dylan Possamai; Chao Zhou
  19. Quasi-Rational R&D Behavior in an Environment with Fundamental Uncertainty By Mathias Erlei; Anne-Kathrin Dimmig
  20. Bounded Rationality and Limited Datasets By Geoffroy de Clippel; Kareen Rozen
  21. Toward the Integration of Personality Theory and Decision Theory in the Explanation of Economic and Health Behavior By Rustichini, Aldo; DeYoung, Colin G.; Anderson, Jon; Burks, Stephen V.

  1. By: Lionel Page (Queensland University of Technology); David Savage (Queensland University of Technology); Benno Torgler (Queensland University of Technology)
    Abstract: This study explores people's risk attitudes after having suffered large real-world losses following a natural disaster. Using the margins of the 2011 Australian floods (Brisbane) as a natural experimental setting, we find that homeowners who were victims of the floods and face large losses in property values are 50% more likely to opt for a risky gamble {a scratch card giving a small chance of a large gain ($500,000) {than for a sure amount of comparable value ($10). This finding is consistent with prospect theory predictions of the adoption of a risk-seeking attitude after a loss.
    Keywords: Decision under Risk, Large Losses, Natural Experiment
    JEL: D03 D81 C93
    Date: 2012–07
  2. By: Elizabeth Potamites; Bei Zhang
    Keywords: Field Experiment, Ambiguity attitudes, Ambiguity aversion , Individual investors
    JEL: F Z
    Date: 2012–06–05
  3. By: Paul Viefers
    Abstract: This paper investigates the impact of uncertainty on an irreversible investment decisions in the laboratory. Subjects own the option to seize a claim on the future sum of realizations from an (ambiguous) random walk. I contrast model predicitions of the Subjective Expected Utility model (SEU, Savage, 1954) with model predictions made by Multiple-prior Expected Utility models (MEU, Gilboa & Schmeidler, 1989; Epstein & Schneider, 2003b). I present an experimental design that allows to identify behaviorally meaningful deviations from SEU. Observed behavior is at odds with the SEU prediction. On average, subjects in a treatment group, facing an ambiguous random walk, exhibit an ambiguity premium that presents a mark-up on average reservation profits in a control group. Hence, subjects shun to expose themselves to an ambiguous payoff process and invest later than participants facing a risky payoff process.
    Keywords: Ambiguity aversion, multiple priors, optimal stopping, irreversible investment
    JEL: D80 D83
    Date: 2012
  4. By: Yehuda Izhakian
    Date: 2012
  5. By: Théodora Dupont-Courtade (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: This paper investigates how the general public behaves when confronted with low probability events and ambiguity in an insurance context. It reports the results of a questionnaire completed by a large representative sample of the French population that aims at separating attitudes toward risk, imprecision and conflict and at determining if there is a demand for ambiguous and extreme event risks. The data show a strong distinction between two aspects of the problem : the decision of purchasing insurance and the willingness to pay. In the decision to insure, more than 25% of the respondents refuse to buy insurance and people are more willing to insure in a risky situation than in an ambiguous one. This certain taste for risk can be explained by the respondents' observable characteristics. In addition, it highlights a lack of confidence in the insurance markets. When it comes to willingness to pay, people exhibit ambiguity seeking behaviors. They are willing to pay more under risk than under ambiguity (embracing here imprecision and conflict), revealing that people consider ambiguous situations as inferior. Furthermore, respondents behave differently under imprecision and conflict. They exhibit a preference for consensual information and dislike conflicts. However, the willingness to pay is poorly correlated with observable characteristics.
    Keywords: Ambiguity; imprecision; conflict; decision making; extreme risk; insurance demand; willingness to pay
    Date: 2012–01
  6. By: Dominique Guegan (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Wayne Tarrant (Wingate University - Department of Mathematics)
    Abstract: Regulation and Risk management in banks depend on underlying risk measures. In general this is the only purpose that is seen for risk measures. In this paper, we suggest that the reporting of risk measures can be used to determine the loss distribution function for a financial entity. We demonstrate that a lack of sufficient information can lead to ambiguous risk situations. We give examples, showing the need for the reporting of multiple risk measures in order to determine a bank's loss distribution. We conclude by suggesting a regulatory requirement of multiple risk measures being reported by banks, giving specific recommendations.
    Keywords: Risk measure; Value at Risk; bank capital; Basel II accord
    Date: 2012–07–27
  7. By: Friedman, Daniel; Sákovics, József
    Abstract: We reformulate neoclassical consumer choice by focusing on lambda, the marginal utility of money. As the opportunity cost of current expenditure, lambda is approximated by the slope of the indirect utility function of the continuation. We argue that lambda can largely supplant the role of an arbitrary budget constraint in partial equilibrium analysis. The result is a better grounded, more flexible and more intuitive approach to consumer choice.
    Keywords: budget constraint, separability, value for money,
    Date: 2012
  8. 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 (Toulouse School of Economics - TSE, CDED - Université de Perpignan, IDEI - Université Toulouse I Capitole)
    Abstract: In this paper, ambiguity aversion to uncertain survival probabilities is introduced in a life-cycle model with a bequest motive to study the optimal demand for annuities. Provided that annuities return is sufficiently large, and notably when it is fair, positive annuitization is known to be optimal strategy of ambiguity neutral individuals. Conversely, we show that the demand for annuities decreases with ambiguity aversion and that there exists a finite degree of aversion above which the demand is non positive : the optimal strategy is then to either sell annuities short or to hold zero annuities if the former option is not available. To conclude, ambiguity aversion appears as a relevant candidate for explaining the annuity puzzle.
    Keywords: Demand for annuities; uncertain survival probabilities; ambiguity aversion
    Date: 2012–07
  9. By: Leuermann, Andrea; Roth, Benjamin
    Abstract: Recent studies have found correlations between risk attitudes and several sociodemographic characteristics. In this paper, we deploy an artefactual field experiment and study whether subjects - non-professionals and financial professionals - are aware of these correlations. This is largely confirmed by our results for all subject groups. We show that the subjects attach informational value to sociodemographic information when assessing others' risk attitudes. This provides external validity to the correlations found between risk preferences and sociodemographics. A person's self-assessment of risk attitudes is the most helpful device for the subjects' assessments of others, although experienced professionals make use of it to a minor extent than all other subjects.
    Keywords: Risk Preferences; Financial Advice; Artefactual Field Experiment; Behavioral Finance
    JEL: D81
    Date: 2012–08–03
  10. By: Paulo Ferreira (University of Évora, CEFAGE-UE); Andreia Dionísio (University of Évora, CEFAGE-UE)
    Abstract: Methodologies related with information theory have been increasingly used in studies in economics and management. In this paper we use Generalized Maximum Entropy as an alternative to the Ordinary Least Squares in the estimation of utility functions. We estimated linear, logarithmic and power utility functions as well as confidence intervals and in order to compare both methodologies. Results point to the greater accuracy of Generalized Maximum Entropy. Linear function seems to be the one with best goodness of fit.
    Keywords: generalized maximum entropy, prior, linera function, power function, logarithmic function.
    JEL: C10 D80
    Date: 2012
  11. By: Ioannou, Christos A.; Qi, Shi; Rustichini, Aldo
    Abstract: Theories of social preferences assume that individuals have a utility over monetary outcome profiles, that depends on their and other players' payments. Behavior in strategic interactions is explained as a Nash equilibrium of the game where final payoffs are paid in these utility units. These theories predict the estimated preferences to be independent of the subject's position in the game if in the experiment the allocation to a role is randomly determined, since subjects in each role have the same preferences ex-ante. We test and reject this hypothesis. We use the Quantal Response Equilibrium (QRE) of McKelvey and Palfrey (1995) to study first mover behavior in the Trust game. As standard in this literature we assume that first mover beliefs are consistent with the observed probability distribution of actions of the second movers. On the other hand, second mover behavior can be extrapolated without any a priori rational expectation assumptions. Our results show that the estimated preferences of first movers attach a significantly higher weight to their own payoff compared to the weight attached by second movers on their own payoff. This finding is inconsistent with the assumption that subjects approach a game with the same (that is, independent of the allocation to roles in the game) ex-ante preferences over monetary outcome profiles.
    Date: 2012–06–08
  12. By: Schilirò, Daniele
    Abstract: Classical mathematical algorithms often fail to identify in time when the international financial crises occur although, as the classical theory of choice would suggest, the economic agents are rational and the markets are or should be efficient and behave also rationally. This contribution does not pretend to give a complete answer to these questions, but it will highlight some well-known limits of the classical theory of rational choice. In particular, the present paper will focus on the concept of bounded rationality. The work also makes some references to behavioral economics and to the literature of behavioral finance which has given important contributions in explaining the behavior and the anomalies of financial markets. Finally, following the approch of Simon, the paper proposes an analytical model to describe the behaviour of agents which are rationally bounded, risk averse and loss averse, emphasizing the relationship between psychology and economics which helps to explain the crisis in financial markets.
    Keywords: Bounded rationality; rational choice; cognitive economics; behavioral finance; risk aversion
    JEL: D81 B52 D83 C60
    Date: 2012–07
  13. By: Florian Artinger (Max Planck Institute for Human Development, Berlin); Nadine Fleischhut (Max Planck Institute for Human Development, Berlin); M. Vittoria Levati (Max Planck Institute of Economics, Jena, and Department of Economics, University of Verona); Jeffrey R. Stevens (Department of Psychology, Nebraska)
    Abstract: Often in cooperative situations, many aspects of the decision-making environment are uncertain. We investigate how cooperation is shaped by the way information about risk is presented (from description or from experience) and by differences in risky environments. Drawing on research from risky choice, we compare choices in stochastic social dilemmas to those in lotteries with equivalent levels of risk. Cooperation rates in games vary with different levels of risk across decision situations with the same expected outcomes, thereby mimicking behavior in lotteries. Risk presentation, however, only affected choices in lotteries, not in stochastic games. Process data suggests that people respond less to probabilities in the stochastic social dilemmas than in the lotteries. The findings highlight how an uncertain environment shapes cooperation and call for models of the underlying decision processes.
    Keywords: Decisions from Experience, Social Dilemma, Cooperation, Risky Choice, Public Good.
    JEL: C72 C73 C92 D81
    Date: 2012–08–20
  14. By: Ingrid M.T. Rohde (Maastricht University, Bilgi Economics Lab of Istanbul); Kirsten I.M. Rohde (Erasmus School of Economics, Erasmus University Rotterdam)
    Abstract: As societies are increasingly concerned with social risks, it is important to evaluate risks not only from an individual perspective, but also from a societal one. Many increases in social risk involve a simultaneous increase in risk and inequality. This paper presents an experiment which disentangles concerns for risk and inequality in a social risk context. Subjects choose between different types of allocations of risks over 10 other participants. The allocations differ only in terms of dispersion. We disentangle four types of dispersion: ex ante inequality, ex post inequality, individual risk, and collective risk. The results show that people are averse towards ex ante inequality and individual risk, whereas they are ex post inequality and collective risk seeking.
    Keywords: inequality; risk; experiment
    JEL: D03 D63
    Date: 2012–04–26
  15. By: Ravi Bansal; Dana Kiku; Amir Yaron
    Abstract: The long-run risks (LRR) asset pricing model emphasizes the role of low-frequency movements in expected growth and economic uncertainty, along with investor preferences for early resolution of uncertainty, as an important economic-channel that determines asset prices. In this paper, we estimate the LRR model. To accomplish this we develop a method that allows us to estimate models with recursive preferences, latent state variables, and time-aggregated data. Time-aggregation makes the decision interval of the agent an important parameter to estimate. We find that time-aggregation can significantly affect parameter estimates and statistical inference. Imposing the pricing restrictions and explicitly accounting for time-aggregation, we show that the estimated LRR model can account for the joint dynamics of aggregate consumption, asset cash flows and prices, including the equity premia, risk-free rate and volatility puzzles.
    JEL: E2 G1 G12
    Date: 2012–08
  16. By: Broll, Udo; Pelster, Matthias; Wahl, Jack E.
    Abstract: Die vorliegende Arbeit untersucht ein Duopol bei unsicherer Nachfrage unter Risikoaversion. Die Produktion der gesamten Industrie fällt durch die Einführung von Nachfrageunsicherheit; der Marktpreis steigt wegen des schwächeren Wettbewerbs. Damit ist die Veränderung des Gewinns und des erwarteten Nutzens eines Unternehmers nicht eindeutig zu bestimmen. Zwar sinkt der erwartete Nutzen durch die Einführung des Risikos, jedoch kann dieser Effekt durch einen steigenden Gewinn, insbesondere bei wenig risikoaversen Unternehmen, kompensiert werden. Die Einführung eines Terminmarktes mit Basisrisiko kann für ein Unternehmen von Nachteil sein kann, unabhängig davon, ob der Terminmarkt eine perfekte oder imperfekte Absicherungsmöglichkeit bietet. Dies gilt jedoch nur dann, wenn sich der Terminmarkt in Backwardation befindet oder beide Unternehmen Zugang zu dem Terminmarkt erhalten. -- The paper studies an duopoly with risk averse firms exposed to demand uncertainty. A risk sharing market is introduced on which firms can trade in goods and services they produce and sell. This provides an analytical framework capable of examing different comparative static results. The model is static; it is assumed that both firms produce the same single output, know their cost functions with certainty, and maximize expected utility of profit.
    Keywords: Nachfrageunsicherheit,Duopol,Terminmarkt,Risikopolitik
    JEL: D21 D43
    Date: 2012
  17. By: Leuermann, Andrea; Roth, Benjamin
    Abstract: Advice is important for decision making, especially in the financial sector. We investigate how individuals assess risk preferences of others given sociodemographic information or pictures. Both non-professionals and financial professionals participate in this artefactual field experiment. Subjects mainly rely on the other's self-assessment of risk preferences and on gender when forming the belief about someone else's risk preferences. On average, subjects consider themselves to be more risk-tolerant than the person they evaluate. Subjects use their own risk attitude as a reference point for predicting others' risk preferences. This false consensus effect is less pronounced for young professionals than for senior and non-professionals. Furthermore, financial professionals predict risk preferences more accurately compared to non-professionals.
    Keywords: Risk Preferences; Financial Advice; Artefactual Field Experiment; Behavioral Finance
    JEL: D81 C91
    Date: 2012–08–03
  18. By: M. Nabil Kazi-Tani; Dylan Possamai; Chao Zhou
    Abstract: In this paper, we follow the study of second order BSDEs with jumps started in our accompanying paper [17]. We prove existence of these equations by a direct method, thus providing complete wellposedness for second order BSDEs. These equations are the natural candidates for the probabilistic interpretation of fully non-linear partial integro-differential equations, which is the point of our paper [18]. Finally, we give an application of second order BSDEs to the study of a robust exponential utility maximization problem under model uncertainty. The uncertainty affects both the volatility process and the jump measure compensator. We prove existence of an optimal strategy, and that the value function of the problem is the unique solution of a particular second order BSDE with jumps.
    Date: 2012–08
  19. By: Mathias Erlei; Anne-Kathrin Dimmig (Abteilung für Volkswirtschaftslehre, Technische Universität Clausthal (Department of Economics, Technical University Clausthal))
    Abstract: The objective of our paper is to study R&D investments and pricing behavior in an environment with fundamental uncertainty. We designed a multi-period experiment in which each period consisted of two stages, an R&D phase and a pricing stage. Participants in the experiment had almost no information about the underlying functions, parameters, and probabilities. Subjects’ behavior in the fundamentally uncertain environment of our experiment may best be characterized as some kind of procedural rationality which we call quasi-rationality. Pricing decisions are particularly close to equilibrium values. Although we do find some hints of the existence of behavioral effects in R&D decisions, only reinforcement effects are significant across both treatments and different model specifications. The introduction of patents has only a minor impact on R&D behavior. Overall, subjects learn to adapt remarkably well to a rather complex and fundamentally uncertain environment.
    Keywords: bounded rationality, duopoly, innovation, experiment, R&D competition
    JEL: C90 D81 L10 O31
    Date: 2012
  20. By: Geoffroy de Clippel; Kareen Rozen
    Date: 2012–08–15
  21. By: Rustichini, Aldo (University of Minnesota); DeYoung, Colin G. (University of Minnesota); Anderson, Jon (University of Minnesota, Morris); Burks, Stephen V. (University of Minnesota, Morris)
    Abstract: Trait-based personality psychology and economics have taken different approaches to understanding individual differences, with the former emphasizing variables derived from the factor analysis of trait assessments, and the latter emphasizing variables derived from formal decision theory. In a data set on trainee truckers in a large US company, we provide a systematic initial assessment of the empirical pattern of relationships between the elements from these two approaches by comparing the predictive power of measurements derived from personality theory and decision theory for several individual characteristics and outcomes, and relating the two sets of measurements to each other. We show that personality traits have a comparable or stronger predictive power than do economic preferences for several dependent variables, including credit score, job persistence, and heavy truck accidents. They also have strong predictive power for Body Mass Index (BMI) and smoking status. Further, decision theory and personality variables are meaningfully related. For example, we confirm that cognitive ability explains a substantial part of time preferences, and find that Neuroticism and cognitive ability together explain attitudes toward risk. In addition, Agreeableness and cognitive ability explain aspects of other-regarding behavior in a strategic setting.
    Keywords: personality theory, decision theory, strategic behavior, credit score, smoking, obesity, prisoners' dilemma, job performance, heavy truck accident, truckload, turnover, trucker
    JEL: D83 C72 C93
    Date: 2012–07

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