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on Utility Models and Prospect Theory |
| By: | Dagsvik, John K. (Research Department, Statistics Norway and the Frisch Centre for Economic Research) |
| Abstract: | This paper discusses how specification of probabilistic models for multistate duration data generated by individual choices should be justified on a priori theoretical grounds. Preferences are assumed represented by random utilities, where utilities are viewed as random also to the agent himself. First, the paper proposes a characterization of exogenous preferences, (that is, in the special case with no state dependence effects). The main assumption asserts that when preferences are exogenous the current and future indirect utilities are uncorrelated with current and past choices, given unobservables that are perfectly known to the agent. It is demonstrated that under rather weak and general regularity conditions this characterization yields an explicit structure of the utility function as a so-called Extremal stochastic process. Furthermore, from this utility representation it follows that the choice process is a Markov Chain (in continuous- or discrete time), with a particular functional form of the transition probabilities, as explicit functions of the parameters of the utility function and choice set. Subsequently, we show how the model can be extended to allow for structural state dependence effects, and how such state dependence effects can be identified. Moreover, it is discussed how a version of Chamberlain’s conditional estimation method applies in the presence of fixed effects. Finally, we discuss two examples of applications. |
| Keywords: | Duration models; Random utility models; Habit persistence; True state dependence; Extremal process; Markov chain |
| JEL: | C23 C25 C41 C51 D01 |
| Date: | 2012–05–20 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:osloec:2012_017&r=upt |
| By: | Geoffroy de Clippel; Kareen Rozen |
| 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: | # |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:bro:econwp:2012-7&r=upt |
| By: | Özgür Evren (New Economic School) |
| Abstract: | I characterize the class of (possibly incomplete) preference relations over lotteries which can be represented by a compact set of (continuous) expected utility functions that preserve both indifferences and strict preferences. This finding contrasts with the representation theorem of Dubra, Maccheroni and Ok (2004) which typically delivers some functions which do not respect strict preferences. For a preference relation of the sort that I consider in this paper, my representation theorem reduces the problem of recovering the associated choice correspondence over convex sets of lotteries to a scalar-valued, parametric optimization exercise. By utilizing this scalarization method, I also provide characterizations of some solution concepts. Most notably, I show that in an otherwise standard game with incomplete preferences, the collection of pure strategy equilibria that one can find using this scalarization method corresponds to a refinement of the notion of Nash equilibrium that requires the (deterministic) action of each player be undominated by any mixed strategy that she can follow, given others’ actions. |
| Keywords: | Incomplete preference relations; Expected Utility; Nash Equilibrium; Nonbinary Choice; Social Planning; Incomplete Knowledge |
| JEL: | D11 D81 C72 D61 |
| Date: | 2012–07 |
| URL: | http://d.repec.org/n?u=RePEc:cfr:cefirw:w0174&r=upt |
| By: | Tamini, Lota D. |
| Abstract: | This paper analyzes the impact of risk and ambiguity aversion - Knightian uncertainty - on the choice of optimal quality and timing of market entry. Irreversibility of the investment in product development is introduced in a continuous-time stochastic model applying the real option literature. We consider a market characterized by a duopoly with a Stackelberg-Nash game for quality choice. When the follower provides a higher-quality good, the level of quality is decreasing in ambiguity aversion while it is a non-monotonic function of the level of risk. For low levels of risk, the increase of product quality is an efficient response. Up to certain threshold level of risk, risk and ambiguity aversion reduce the optimal quality level and increase the value of waiting when the follower supplies a higher-quality good. The implication is that risk and ambiguity aversion allow the leader to make a sustainable monopoly profit. When the follower supplies a lower-quality good, there is no value for it to wait. It should therefore provide the lowest-quality good possible. In a vertically integrated supply chain firms provide higher quality, and the difference between vertically integrated and non-integrated firms is increasing in risk and ambiguity aversion. |
| Keywords: | Quality; Duopoly; Real option; Vertical integration; Risk; Knightian uncertainty |
| JEL: | D81 L13 L15 |
| Date: | 2012–08–23 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:40845&r=upt |
| By: | Tsakas Elias (METEOR) |
| Abstract: | We consider agents whose language can only express probabilistic beliefs that attach a rationalnumber to every event. We call these probability measures rational. We introduce the notion of arational belief hierarchy, where the first order beliefs are described by a rational measure overthe fundamental space of uncertainty, the second order beliefs are described by a rational measureover the product of the fundamental space of uncertainty and the opponent''s first order rationalbeliefs, and so on. Then, we derive the corresponding (rational) type space model, thus providinga Bayesian representation of rational belief hierarchies. Our first main result shows that thistype-based representation violates our intuitive idea of an agent whose language expresses onlyrational beliefs, in that there are rational types associated with non-rational beliefs over thecanonical state space. We rule out these types by focusing on the rational types that satisfycommon certainty in the event that everybody holds rational beliefs over the canonical statespace. We call these types universally rational and show that they are characterized by a boundedrationality condition which restricts the agents'' computational capacity. Moreover, theuniversally rational types form a dense subset of the universal type space. Finally, we show thatthe strategies rationally played under common universally rational belief in rationalitygenerically coincide with those satisfying correlated rationalizability. |
| Keywords: | microeconomics ; |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:umamet:2012004&r=upt |
| By: | Caroline Hillairet; Ying Jiao |
| Abstract: | We study the gain of an insider having private information which concerns the default risk of a counterparty. More precisely, the default time \tau is modelled as the first time a stochastic process hits a random barrier L. The insider knows this barrier (as it can be the case for example for the manager of the counterparty), whereas standard investors only observe its value at the default time. All investors aim to maximize the expected utility from terminal wealth, on a financial market where the risky asset price is exposed to a sudden loss at the default time of the counterparty. In this framework, the insider's information is modelled by using an initial enlargement of filtration and \tau is a stopping time with respect to this enlarged filtration. We prove that the regulator must impose short selling constraints for the insider, in order to exclude the value process to reach infinity. We then solve the optimization problem and we study the gain of the insider, theoretically and numerically. In general, the insider achieves a larger value of expected utility than the standard investor. But in extreme situations for the default and loss risks, a standard investor may in average outperform the insider, by taking advantage of an aggressive short selling position which is not allowed for the insider, but at the risk of big losses if the default finally occurs after the maturity. |
| Date: | 2012–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1208.5398&r=upt |
| By: | Dirk G Baur (Finance Discipline Group, UTS Business School, University of Technology, Sydney); Thomas K.J. McDermott (TRinity College Dublin) |
| Abstract: | We study two different safe haven assets, US government bonds and gold, and examine how the price changes of these assets can be used to infer investor behavior under uncertainty. We find that investors are ambiguity-averse, that is they buy gold when faced with extreme uncertainty about the state of the economy or the financial system and when they receive ambiguous signals. In contrast, investors buy US government bonds when faced with extreme but unambiguous signals. |
| Keywords: | safe haven; uncertainty; gold; bonds; Ellsberg decision rule; black swan event |
| JEL: | D03 D81 G01 G11 |
| Date: | 2012–08–01 |
| URL: | http://d.repec.org/n?u=RePEc:uts:wpaper:173&r=upt |
| By: | Geoffroy de Clippel |
| Abstract: | Implementation theory assumes that participants’ choices are rational,in the sense of being derived from the maximization of a contextindependent preference. The paper investigates implementation under complete information when the mechanism designer is aware that individuals suffer from cognitive biases that lead to violations of IIA, or cannot exclude the possibility of such “irrational” behavior. |
| Keywords: | # |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:bro:econwp:2012-6&r=upt |
| By: | Malakhov, Sergey |
| Abstract: | When expected savings on purchases are greater than the wage rate, the optimal search results in the negative marginal utility of leisure. The search transforms the classical backward bending effect and the leisure becomes complementary to the search. Consumers compensate “bad” leisure by status goods of exceptional quality on markets with high price dispersion. Status consumption complements “bad” conspicuous leisure and produces the Veblen effect as well as the “gardening aboard the boat” effect. |
| Keywords: | Veblen effect, search, status goods, negative utility, conspicuous leisure |
| JEL: | D11 D83 |
| Date: | 2012–08–20 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:40809&r=upt |
| By: | Sproul, Thomas W. |
| Keywords: | Financial Economics, |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:ags:aaea12:131060&r=upt |
| By: | M. Nabil Kazi-Tani; Dylan Possama\"i; Chao Zhou |
| Abstract: | We prove the existence of bounded solutions of quadratic backward SDEs with jumps, using a direct fixed point approach as in Tevzadze [35]. Under an additional standard assumption, we prove a uniqueness result, thanks to a comparison theorem. Then we study the properties of the corresponding $g$-expectations, we obtain in particular a non linear Doob-Meyer decomposition for $g$-submartingales and their regularity in time. As a consequence of this results, we obtain a converse comparison theorem for our class of BSDEs. We give applications for dynamic risk measures and their dual representation, and compute their inf-convolution, with some explicit examples. |
| Date: | 2012–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1208.5581&r=upt |
| By: | Abi ADAMS; Laurens CHERCHYE; Bram DE ROCK; Ewout VERRIEST |
| Abstract: | This paper develops a revealed preference methodology for exploring whether time inconsistencies in household choice are the product of nonstationarities at the individual level or the result of individual heterogeneity and renegotiation within the collective unit. An empirical application to household-level microdata highlights that an explicit recognition of the collective nature of choice allows the vast majority of household behaviour to be rationalised by theory that assumes preference stationarity at the individual level. For our particular short panel data set, simply permitting limited intrahousehold heterogeneity in time preferences allows the choices of 98.4% of the sample to be rationalised by a model that assumes exponential discounting at the individual level. We also find that couples characterized by lower divergence in spousal discount rates are older, more likely to have children and wealthier, which we take as indications of experiencing higher match quality. |
| Date: | 2012–08 |
| URL: | http://d.repec.org/n?u=RePEc:ete:ceswps:ces12.12&r=upt |
| By: | Derks Jean; Peters Hans; Sudhölter Peter (METEOR) |
| Abstract: | We consider several related set extensions of the core and the anticore of games with transferableutility. An efficient allocation is undominated if it cannot be improved, in a specific way, bysidepayments changing the allocation or the game. The set of all such allocations is called theundominated set, and we show that it consists of finitely many polytopes with a core-likestructure. One of these polytopes is the L1-center, consisting of all efficient allocations thatminimize the sum of the absolute values of the excesses. Theexcess Pareto optimal set contains the allocations that are Pareto optimal in the set obtained byordering the sums of the absolute values of the excesses of coalitions and the absolute values ofthe excesses of their complements. The L1-center is contained in the excess Pareto optimal set,which in turn is contained in the undominated set. For three-person games all these sets coincide.These three sets also coincide with the core for balanced games and with the anticore forantibalanced games. We study properties of these sets and provide characterizations in terms ofbalanced collections of coalitions. We also propose a single-valued selection from the excessPareto optimal set, the min-prenucleolus, which is defined as the prenucleolus ofthe minimum of a game and its dual. |
| Keywords: | microeconomics ; |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:umamet:2012003&r=upt |