nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2013‒05‒19
twenty-one papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Catastrophic Medical Expenditure Risk By Gabriela Flores; Owen O'Donnell
  2. Reconciling consumption inequality with income inequality By Vadym Lepetyuk; Christian A. Stoltenberg
  3. Social Preferences in Private Decisions By Jona Linde; Joep Sonnemans
  4. On the non-optimality of a Diamond-Dybvig contract in the Goldstein-Pauzner environment By Mahmoud Elamin
  5. Risk and Inequality in a Social Decision Making Experiment By Ingrid M.T. Rohde; Kirsten I.M. Rohde
  6. A reconciliation of time preference elicitation methods By Drichoutis, Andreas; Nayga, Rodolfo
  7. Reference Dependent Preferences and the EPK Puzzle By Maria Grith; Wolfgang Karl Härdle; Volker Krätschmer;
  8. An experimental investigation of risk sharing and adverse selection By Potters J.A.M.; Tausch F.; Riedl A.M.
  9. Bargaining and Wealth Accumulation By Byeongju Jeong
  10. Multi-Player Agents in Cooperative TU-Games By Rene van den Brink; Chris Dietz
  11. Consistency, Population Solidarity, and Egalitarian Solutions for TU-Games By Rene van den Brink; Youngsub Chun; Yukihiko Funaki; Boram Park
  13. Altruism and Relational Incentives in the Workplace By Dur, Robert; Tichem, Jan
  14. On the Core of Cost-Revenue Games: Minimum Cost Spanning Tree Games with Revenues By Arantza Estevez-Fernandez; Hans Reijnierse
  15. From Edgeworth to Econophysics: A Methodological Perspective By Drakopoulos, Stavros A.; Katselidis, Ioannis
  16. Facing Your Opponents: Social Identification and Information Feedback in Contests By Mago , Shakun; Samak , Anya; Sheremeta, Roman
  17. Over- and Under-Bidding in Tendering By Vincent van den Berg
  18. Advantaged Bidders in Franchise Auctions By Vincent van den Berg
  19. Social Relations and Relational Incentives By Robert Dur; Jan Tichem
  20. Economic Impacts of Cultural Diversity in the Netherlands: Productivity, Utility, and Sorting By Jessie Bakens; Peter Mulder; Peter Nijkamp
  21. Time-varying Combinations of Predictive Densities using Nonlinear Filtering By Monica Billio; Roberto Casarin; Francesco Ravazzolo; Herman K. van Dijk

  1. By: Gabriela Flores (Institute of Health Economics and Management, University of Lausanne, and Institute of Health Policy and Management, Erasmus University Rotterdam); Owen O'Donnell (Erasmus School of Economics, Erasmus University Rotterdam, and University of Macedonia, Greece)
    Abstract: Medical expenditure risk can pose a major threat to living standards. We derive decomposable measures of catastrophic medical expenditure risk from reference-dependent utility with loss aversion. We propose a quantile regression based method of estimating risk exposure from cross-section data containing information on the means of financing health payments. We estimate medical expenditure risk in seven Asian countries and find it is highest in Laos and China, and is lowest in Malaysia. Exposure to risk is generally higher for households that have less recourse to self-insurance, lower incomes, wealth and education, and suffer from chronic illness.
    Keywords: medical expenditures, catastrophic payments, downside risk, reference-dependent utility, Asia
    JEL: D12 D31 D80 I15
    Date: 2012–07–24
  2. By: Vadym Lepetyuk; Christian A. Stoltenberg
    Abstract: The rise in within-group consumption inequality in response to the increase in within-group income inequality over the last three decades in the U.S. is puzzling to expected-utility-based incomplete market models. The two-sided lack of commitment models exhibit too little consumption inequality while the standard incomplete markets models tend to predict too much consumption inequality. We show that a model with two-sided lack of commitment and chance attitudes, as emphasized by prospect theory, can explain the relationship and can avoid the systematic bias of the expected utility models. The chance attitudes, such as optimism and pessimism, imply that the households attribute a higher weight to high and low outcomes compared to their objective probabilities. For realistic values of risk aversion and of chance attitudes, the incentives for households to share the idiosyncratic risk decrease. The latter effect endogenously amplifies the increase in consumption inequality relative to the expected utility model, thereby improving the fit to the data.
    Keywords: Consumption (Economics) ; Income
    Date: 2013
  3. By: Jona Linde (University of Amsterdam, CREED); Joep Sonnemans (University of Amsterdam, CREED)
    Abstract: Social preference models were originally constructed to explain two things: why people spend money to affect the earnings of others and why the income of others influences reported happiness. We test these models in a novel experimental situation where participants face a risky decision that affects only their own earnings. In the social (individual) treatment participants do (not) observe the earnings of others. In the social treatment gambles therefore not only affect absolute but also relative earnings. Outcome-based social preference models therefore predict a treatment difference. We find that decisions are generally the same in both treatments, in line with rule-based social preference models, like procedural fairness.
    Keywords: fairness, social preferences, decision making under risk, experiment
    JEL: C91 D63 D81
    Date: 2012–01–09
  4. By: Mahmoud Elamin
    Abstract: I show, under intuitive conditions on the risk-averse utility function, the nonoptimality of the Diamond and Dybvig (1983) contract in the Goldstein and Pauzner (2005) environment. If marginal utility at zero is low enough, then Goldstein and Pauzner (2005)’s claim about the optimality of the Diamond and Dybvig (1983) contract is true. When it is not, the optimal contract insures the patient depositor against a project default. The contract may exhibit risk-sharing with the impatient depositor. Unlike when Goldstein and Pauzner (2005)’s claim is correct, relative risk aversion greater than 1 does not necessarily make the optimal bank contract run-prone. I present a condition under which it is.
    Date: 2013
  5. 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
  6. By: Drichoutis, Andreas; Nayga, Rodolfo
    Abstract: We reconcile �findings from the Multiple Price List method (Andersen et al., 2008) and the Convex Time Budget method (Andreoni and Sprenger, 2012a) that seem to have generated a heated debate in the time preference literature. Specifi�cally, we discuss the claims of Andreoni and Sprenger (2012b) that "risk preferences are not time preferences" and assert that this may have been premature given that subsequent fi�ndings from replication and extension studies refute their basic conjecture while another study off�ers an alternative explanation for their results (Andersen et al., 2011a). Although the CTB seems to perform better than the MPL method in terms of predictive validity, we also discuss recent econometric issues that question the validity of claims resulting from analysis of CTB data. We also raise an issue with non-EUT explanations of Andreoni and Sprenger's (2012b) results, since the payment mechanism is not incentive compatible if the isolation assumption is not invoked.
    Keywords: Intertemporal choice; discounting; curvature; convex time budget; risk; multiple price list
    JEL: C91 D81 D91
    Date: 2013–04–19
  7. By: Maria Grith; Wolfgang Karl Härdle; Volker Krätschmer;
    Abstract: Supported by several recent investigations, the empirical pricing kernel (EPK) puzzle might be considered a stylized fact. Based on an economic model with state dependent preferences for the financial investors, we want to emphasize a microeconomic view that succeeds in explaining the puzzle. We retain the expected utility framework in a one period model and illustrate the case when the state is defined with respect to a reference point. We further investigate how the model relates the shape of the EPK to the economic conditions.
    Keywords: Pricing kernel, aggregate agent, empirical pricing kernel, EPK puzzle, state dependent
    JEL: D04 D53 C02 G13
    Date: 2013–05
  8. By: Potters J.A.M.; Tausch F.; Riedl A.M. (GSBE)
    Abstract: Does adverse selection hamper the effectiveness of voluntary risk sharing? How do differences in risk profiles affect adverse selection? We experimentally investigate individuals' willingness to share risks with others. Across treatments we vary how risk profiles differ between individuals. We find strong evidence for adverse selection if individuals risk profiles can be ranked according to first-order stochastic dominance and only little evidence for adverse selection if risk profiles can only be ranked on the basis of second-order stochastic dominance. We observe the same pattern also for anticipated adverse selection. These results suggest that the degree to which adverse selection erodes voluntary risk sharing arrangements crucially depends on the form of risk heterogeneity.
    Keywords: Criteria for Decision-Making under Risk and Uncertainty;
    Date: 2013
  9. By: Byeongju Jeong
    Abstract: I present a model in which randomly matched pairs of people bargain over the division of output in each period. Output can be consumed or stored for later consumption. People are identical except possibly in wealth (i.e., the stored output). The one-period utility is linear except for the starvation disutility (i.e., the additional drop in utility under no consumption). The starvation disutility weakens the bargaining position of a poor person and strengthens that of a rich person in an otherwise symmetric bargaining, providing the incentive to accumulate wealth. Policies that deincentivize wealth accumulation (e.g., wealth tax, progressive income tax) can make both the rich and the poor become better off. matters.
    Keywords: bargain; wealth accumulation; starvation disutility; wealth tax; income tax;
    JEL: C78 D31 E21 H21
    Date: 2013–01
  10. By: Rene van den Brink (VU University Amsterdam); Chris Dietz (VU University Amsterdam)
    Abstract: A situation in which a finite set of agents can generate certain payoffs by cooperation can be described by a cooperative game with transferable utility (or simply a TU-game) where each agent is represented by one player in the game. In this paper, we assume that one agent can be represented by more than one player. We introduce two solutions for this multi-player agent game model, both being generalizations of the Shapley value for TU-games. The first is the agent-Shapley value and considers the agents in the most unified way in the sense that when an agent enters a coalition then it enters with all its players. The second is the player-Shapley value which takes all players as units, and the payoff of an agent is the sum of the payoffs over all its players. We provide axiomatic characterizations of these two solutions that differ only in a collusion neutrality axiom. The agent-Shapley value satisfies player collusion neutrality stating that collusion of two players belonging to the same agent does not change the payoff of this agent. On the other hand, the player-Shapley value satisfies agent collusion neutrality stating that after a collusion of two agents, the sum of their payoffs does not change. After axiomatizing the player- and agent-Shapley values we apply them to airport games and voting games.
    Keywords: Cooperative TU-game, Shapley value, multi-player agent, collusion neutrality, airport games
    JEL: C71
    Date: 2012–01–02
  11. By: Rene van den Brink (VU University Amsterdam); Youngsub Chun (Seoul National University); Yukihiko Funaki (Waseda University); Boram Park (Rutgers University)
    Abstract: A (point-valued) solution for cooperative games with transferable utility, or simply TU-games, assigns a payoff vector to every TU-game. In this paper we discuss two classes of equal surplus sharing solutions, one consisting of all convex combinations of the equal division solution and the CIS-value, and its dual class consisting of all convex combinations of the equal division solution and the ENSC-value. We provide several characterizations using either population solidarity or a reduced game consistency in addition to other standard properties.
    Keywords: TU-game, equal division solution, CIS-value, ENSC-value, population solidarity, consistency
    JEL: C71
    Date: 2012–12–07
  12. By: Erik T Verhoef (VU)
    Abstract: This paper considers second-best congestion pricing in the monocentric city, with endogenous residential density and endogenous labour supply. A spatial general equilibrium model is developed that allows consideration of the three-way interactions between urban density, traffic congestion and labour supply. Congestion pricing schemes are analyzed that are second-best ‘by design’ (and not because distortions exist elsewhere in the spatial economy), like cordon charging and flat kilometre charges. Both for Cobb-Douglas utility and for CES utility, the analyses suggest that the relative welfare losses from second-best pricing, compared to first-best pricing, are surprisingly small.
    Keywords: Traffic congestion; second-best pricing; urban structure; spatial general equilibrium
    JEL: R41 R48 D62
  13. By: Dur, Robert (Erasmus University Rotterdam); Tichem, Jan (Erasmus University Rotterdam)
    Abstract: This paper studies how altruism between managers and employees affects relational incentive contracts. To this end we develop a simple dynamic principal-agent model where both players may have feelings of altruism or spite toward each other. The con- tract may contain two types of incentives for the agent to work hard: a bonus and a threat of dismissal. We find that altruism undermines the credibility of a threat of dis- missal but strengthens the credibility of a bonus. Among others, these two mechanisms imply that higher altruism sometimes leads to higher bonuses, while lower altruism may increase productivity and players utility in equilibrium.
    Keywords: altruism, spite, incentives, relational contracts, efficiency wages, subjective performance evaluation, Nash bargaining
    JEL: D23 J33 M52 M55
    Date: 2013–04
  14. By: Arantza Estevez-Fernandez (VU University Amsterdam); Hans Reijnierse (CentER, Tilburg University)
    Abstract: In this paper, we analyze cost sharing problems arising from a general service by explicitly taking into account the generated revenues. To this cost-revenue sharing problem, we associate a cooperative game with transferable utility, called cost-revenue game. By considering cooperation among the agents using the general service, the value of a coalition is defined as the maximum net profit that the coalition may obtain by means of cooperation. As a result, a coalition may profit from not allowing all its members to get the service that generates the revenues. We focus on the study of the core of cost-revenue games. Under the assumption that cooperation among the members of the grand coalition grants the use of the service under consideration to all its members, it is shown that a cost-revenue game has a non-empty core for any vector of revenues if, and only if, the dual game of the cost game has a large core. Using this result, we investigate minimum cost spanning tree games with revenues. We show that if every connection cost can take only two values (low or high cost), then, the corresponding minimum cost spanning tree game with revenues has a non-empty core. Furthermore, we provide an example of a minimum cost spanning tree game with revenues with an empty core where every connection cost can take only one of three values (low, medium, or high cost).
    Keywords: Cost-revenue allocation problem, cooperative game, core, minimum cost spanning tree problem
    JEL: C71
    Date: 2012–09–27
  15. By: Drakopoulos, Stavros A.; Katselidis, Ioannis
    Abstract: Although most of the marginalist economists’ methodology was influenced by 19th century classical physics, the work of second generation marginalist Francis Ysidro Edgeworth represents the highest point of classical physics influence to the development of mainstream economic methodology. Edgeworth’s close parallelism between celestial and social mechanics expressed in his analogies between utility and energy and the principle of utility maximization to maximum energy, are important indications of the physics scientific ideal for economics. Subsequent leading theorists were not as explicit, although economic theory continued to be influenced by physics scientific ideal as the work of Pareto, Fisher and Samuelson indicates. However, the physics methodological framework has made a recent reappearance in the relatively new field of econophysics. Although there are methodological similarities, there are also important differences between mainstream economics and econophysics. Econophysicists’ emphasis to statistical mechanics rather to mechanical models, their reservations towards rational agent theory and their rejection of many standard assumptions of mainstream economics, are examples of such differences. This might also explain the resistance of mainstream economic theorists to incorporate econophysics into economics. The paper examines the above from a methodological viewpoint. It also discusses the possible reasons for this historical development and its implications for economic methodology.
    Keywords: Economic Method, Econophysics, Edgeworth
    JEL: A12 B00 B40
    Date: 2013–05
  16. By: Mago , Shakun; Samak , Anya; Sheremeta, Roman
    Abstract: We experimentally investigate the effect of social identification and information feedback on individual behavior in contests. In all treatments we find significant over-expenditure of effort relative to the standard theoretical predictions. Identifying subjects through photo display decreases wasteful effort. Providing information feedback about others’ effort does not affect the aggregate effort, but it decreases the heterogeneity of effort and significantly affects the dynamics of individual behavior. We develop a behavioral model which incorporates a non-monetary utility of winning and relative payoff maximization. The model explains significant over-expenditure of effort. It also suggests that decrease in ‘social distance’ between group members through photo display promotes pro-social behavior and decreases over-expenditure of effort, while improved information feedback decreases the heterogeneity of effort.
    Keywords: contest, information, identification, over-expenditure, experiments
    JEL: C72 C91 D72 D74
    Date: 2013–05–15
  17. By: Vincent van den Berg (VU University Amsterdam)
    Abstract: Consider a government tendering the right to operate, for example, an airport, telecommunication network, or utility. There is an 'incumbent bidder' who owns a complement or substitute facility, and one entering 'new bidder'. With a 'standard auction' on the payment to the government, the incumbent is willing to bid higher than its expected profit from the facility as winning implies that it is a monopolist instead of a duopolist. The incumbent is therefore more likely to win. However, it tends to have a lower expected surplus unless the new bidder can never win, which occurs with 'private values' when the facilities are strong complements or substitutes and always with 'common values'. The 'standard auction' leads to an unregulated outcome which hurts consumers as tendered facilities tend to have limited competition. The government could improve the outcome by endogenously regulating using a 'price auction' on the price to be a sked to consumers. Now, it depends who is advantaged: with complements, the incumbent bids below its marginal cost and is more likely to win; with substitutes, it bids above and is less likely to win. The same effects occur in auctions on service quality or number of users. In many settings, the advantaged bidder always wins, and this can greatly affect the competition for the field.
    Keywords: tendering, overbidding, advantaged bidders, network markets
    JEL: D43 D44 L51 R42
    Date: 2013–02–22
  18. By: Vincent van den Berg (VU University Amsterdam)
    Abstract: Consider a government that auctions a franchise for, e.g., an airport, telecommunication network, or utility. Consider an 'incumbent bidder' that owns a complement or substitute. With an auction on the transfer (i.e. payment) to the government, the incumbent is advantaged.If the government regulates the market with an auction on the price asked to consumers, it depends who is advantaged. With complements, the incumbent is advantaged: it can set a lower price on the new franchise, as this increases the profit of the other. With substitutes, the incumbent is disadvantaged. In many settings, the advantage bidder always wins.
    Keywords: Franchising, auctions, advantaged bidders, incumbent, private supply, regulatory auctions
    JEL: D43 L13 L51 R41 R42
    Date: 2012–11–02
  19. By: Robert Dur (Erasmus University Rotterdam, CESifo, and IZA); Jan Tichem (Erasmus University Rotterdam)
    Abstract: This paper studies how social relationships between managers and employees affect relational incentive contracts. To this end we develop a simple dynamic principal-agent model where both players may have feelings of altruism or spite toward each other. The contract may contain two types of incentives for the agent to work hard: a bonus and a threat of dismissal. We find that good social relationships undermine the credibility of a threat of dismissal but strengthen the credibility of a bonus. Among others, these two mechanisms imply that better social relationships sometimes lead to higher bonuses, while worse social relationships may increase productivity and players' utility in equilibrium.
    Keywords: Altruism, spite, social relations, incentives, relational contracts, efficiency wages, subjective performance evaluation, Nash bargaining
    JEL: D23 J33 M52 M55
    Date: 2012–05–16
  20. By: Jessie Bakens (VU University Amsterdam); Peter Mulder (VU University Amsterdam); Peter Nijkamp (VU University Amsterdam)
    Abstract: This paper identifies the role of cultural diversity in explaining spatial disparities in wages and housing prices across Dutch cities, using unique individual panel data of home owners. We distinguish between the effects of interactions-based productivity, consumption amenities and sorting of heterogeneous home owners while controlling for interactions between the labor and housing market. We find that an increase in the cultural diversity of the population positively impacts equilibrium wages and housing prices, particularly in the largest and most densely populated cities. This result is largely driven by spatial sorting of individuals in both the labor and housing market. After controlling for home owner heterogeneity we find that increasing cultural diversity no longer impacts local labor markets and negatively impacts local housing markets. The latter result is likely to be driven by a negative causal effect of increased cultural diversity on neighb orhood quality that outweighs a positive effect of increased cultural diversity in consumption goods.
    Keywords: cultural diversity, immigrants, local amenities, sorting, housing prices, productivity
    JEL: J31 R21 R23 R31
    Date: 2012–03–19
  21. By: Monica Billio (University of Venice, GRETA Assoc. and School for Advanced Studies in Venice); Roberto Casarin (University of Venice, GRETA Assoc. and School for Advanced Studies in Venice); Francesco Ravazzolo (Norges Bank and BI Norwegian Business School); Herman K. van Dijk (Erasmus University Rotterdam, VU University Amsterdam)
    Abstract: We propose a Bayesian combination approach for multivariate predictive densities which relies upon a distributional state space representation of the combination weights. Several specifications of multivariate time-varying weights are introduced with a particular focus on weight dynamics driven by the past performance of the predictive densities and the use of learning mechanisms. In the proposed approach the model set can be incomplete, meaning that all models can be individually misspecified. A Sequential Monte Carlo method is proposed to approximate the filtering and predictive densities. The combination approach is assessed using statistical and utility-based performance measures for evaluating density forecasts. Simulation results indicate that, for a set of linear autoregressive models, the combination strategy is successful in selecting, with probability close to one, the true model when the model set is complete and it is able to detect parameter instability when the model set includes the true model that has generated subsamples of data. For the macro series we find that incompleteness of the models is relatively large in the 70's, the beginning of the 80's and during the recent financial crisis, and lower during the Great Moderation. With respect to returns of the S&P 500 series, we find that an investment strategy using a combination of predictions from professional forecasters and from a white noise model puts more weight on the white noise model in the beginning of the 90's and switches to giving more weight to the professional forecasts over time.
    Keywords: Density Forecast Combination, Survey Forecast, Bayesian Filtering, Sequential Monte Carlo
    JEL: C11 C15 C53 E37
    Date: 2012–11–07

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