nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2013‒07‒28
eight papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Confucianism and Preferences: Evidence from Lab Experiments in Taiwan and China By Elaine Liu; Juanjuan Meng; Joseph Wang
  2. A Bayesian Model of Knightian Uncertainty By Al-Najjar, Nabil I.; Weinstein, Jonathan
  3. Environmental Protection, Rare Disasters, and Discount Rates By Robert J. Barro
  4. Uncertainty and absence of arbitrage opportunity By Yaroslav Ivanenko; Illya Pasichnichenko
  5. Risk Taking and Social Exposure By Valeria Faralla; Alessandro Innocenti; Eva Venturini
  6. Market experience is a reference point in judgments of fairness By Holger Herz; Dmitry Taubinsky
  7. Conditional Beliefs and Higher-Order Preferences By Lee, Byung Soo
  8. Speculative Trade Equilibria with Incorrect Price Anticipations By Alexander Zimper

  1. By: Elaine Liu (University of Houston); Juanjuan Meng (Peking University Guanghua School of Management); Joseph Wang (National Taiwan University)
    Abstract: This paper investigates how Confucianism affects individual decision making in Taiwan and in China and whether the Cultural Revolution in China, which denounced Confucian teaching, has had a long-lasting impact. We found that Chinese subjects in our experiments became less accepting of Confucian values, such that they became more risk loving, less loss averse, and more impatient after being primed with Confucianism, whereas Taiwanese subjects became more trustworthy and more patient after being primed by Confucianism. Combining the evidence from the incentivized laboratory experiments and subjective survey measures, we found evidence that Chinese subjects and Taiwanese subjects reacted differently to Confucianism.
    Keywords: social norm, Confucianism, time preferences, risk aversion, trust
    JEL: C91 Z10
    Date: 2013–07–18
  2. By: Al-Najjar, Nabil I. (Department of Managerial Economics and Decision Sciences, Kellog School of Management, Northwestern University Evanston, USA); Weinstein, Jonathan (Department of Managerial Economics and Decision Sciences, Kellog School of Management, Northwestern University Evanston, USA)
    Abstract: A long tradition suggests a fundamental distinction between situations of risk, where true objective probabilities are known, and unmeasurable uncertainties where no such probabilities are given. This distinction can be captured in a Bayesian model where uncertainty is represented by the agent's subjective belief over the parameter governing future income streams. Whether uncertainty reduces to ordinary risk depends on the agent's ability to smooth consumption. Uncertainty can have a major behavioral and economic impact, including precautionary behavior that may appear overly conservative to an outside observer. We argue that one of the main characteristics of uncertain beliefs is that they are not empirical, in the sense that they cannot be objectively tested to determine whether they are right or wrong. This can confound empirical methods that assume rational expectations.
    Keywords: Knightian uncertainty, consumption smoothing, uncertainty premium, rational expectations
    JEL: A10
    Date: 2013–07
  3. By: Robert J. Barro
    Abstract: Extremely low discount rates play a central role in the Stern Review’s evaluation of environmental protection, and this assumption has been criticized by many economists. The Review also stresses that great uncertainty is a critical element for optimal environmental policies. An appropriate model for this policy analysis requires sufficient risk aversion and fattailed uncertainty to get into the ballpark of explaining the observed equity premium. A satisfactory framework, based on Epstein-Zin/Weil preferences, also separates the coefficient of relative risk aversion (important for results on environmental investment) from the intertemporal elasticity of substitution for consumption (which matters little). Calibrations based on existing models of rare macroeconomic disasters suggest that optimal environmental investment can be a significant share of GDP even with reasonable values for the rate of time preference and the expected rate of return on private capital. The key parameters, yet to be pinned down, are the proportionate effect of environmental investment on the probability of environmental disaster and the baseline probability of environmental disaster.
    JEL: E1 G12 Q5
    Date: 2013–07
  4. By: Yaroslav Ivanenko; Illya Pasichnichenko
    Abstract: It is shown that absence of arbitrage opportunity in financial markets is a particular case of existence of uncertainty in decision system. Absence of arbitrage opportunity is considered in the sense of the Arrow-Debreu model of financial market with a riskless asset, while uncertainty (or ambiguity) is defined on the basis of the principle of internal coherence of M. Allais.
    Date: 2013–07
  5. By: Valeria Faralla; Alessandro Innocenti; Eva Venturini
    Abstract: The paper examines in the laboratory how risk-taking situations are affected by the conditions of observing other’s choices (observer) and being observed by others (source). By extending Yechiam et al.’s (2008) experimental design to the domain of gains we find that observers are more probable than sources to choose risky alternatives producing rare gains than equiprobable gains. The impact of social exposure is also analyzed and interpreted in the context of personality traits to assess how heterogeneity influences risky decisions.
    Keywords: risky shift, social exposure, personality traits.
    JEL: C91 D01 D81
    Date: 2013–07
  6. By: Holger Herz; Dmitry Taubinsky
    Abstract: People's desire for fair transactions can play an important role in negotiations, organizations, and markets. In this paper, we show that markets can also shape what people consider to be a fair transaction. We propose a simple and generally-applicable model of path-dependent fairness preferences, in which past experiences shape preferences, and we experimentally test the model's predictions. We find that previous exposure to competitive pressure substantially and persistently reduces subjects' fairness concerns, making them more likely to accept low offers. Consistent with our theory, we also find that past experience has little effect on subjects' inclinations to treat others unfairly.
    Keywords: Social preferences, reference points, fairness, bargaining
    JEL: C78 C91 D01 D03
    Date: 2013–07
  7. By: Lee, Byung Soo
    Abstract: In this paper, we establish the Bayesian foundations of type structures in which beliefs are lexicographic probability systems (LPS’s)—such as those used in Brandenburger et al. (2008)—rather than standard probability measures as in Mertens and Zamir (1985). This is a setting which the distinction between preferences hierarchies (Epstein and Wang, 1996) and beliefs hierarchies is meaningful and the former has conceptual advantages. Type structures in which beliefs are conditional probability systems (CPS’s) are found to describe fewer hierarchies than LPS type structures can if a nonredundancy requirement is imposed. The two families of type structures are found to be capable of describing the same set of hierarchies in the absence of such a requirement. The existence of “largest”—a notion closely related to universality—LPS/CPS type structures is also shown. Finally, we find that some coherent hierarchies cannot be types but those hierarchies may be needed to express epistemic conditions for iterated elimination of weakly dominated strategies.
    Keywords: Preferences hierarchies, type structure, weakly dominated strategies, epistemic game theory, lexicographic probability system, conditional probability system
    JEL: C72 D8 D80
    Date: 2013–07–17
  8. By: Alexander Zimper (Department of Economics, University of Pretoria)
    Abstract: This paper introduces an equilibrium concept for boundedly rational agents who base their demand-supply decisions on incorrect price anticipations. Formally, we differentiate between equilibrium and out-of-equilibrium states. If the agents attach zero prior probability to all out-of-equilibrium states, our equilibrium concept coincides with Radner's (1979) concept of rational expectations equilibria (=REE). In contrast to REE, however, there may exist strict incentives for speculative asset trade whenever boundedly rational agents regard out-of-equilibrium states as possible.
    Keywords: Bounded Rationality, Speculative Trade, Rational Expectations, Incorrect Prices
    JEL: D51 D53
    Date: 2013–07

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