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on Utility Models and Prospect Theory |
| By: | Krzysztof Kontek (Artal Investments); Michal Lewandowski (Warsaw School of Economics) |
| Abstract: | This paper introduces the concept of range-dependent utility. Instead of reference dependence which evaluates outcomes relative to some reference point, we postulate dependence on a given lottery (set of lotteries) outcomes range. In this way the decision maker is a fully rational expected utility maximizer only within a certain range. Range-dependent utility enables experimental results to be explained without recourse to the probability weighting function. Experimental data show that range-dependent utilities can be normalized to obtain decision utility - a single utility function able to describe decisions involving lotteries defned over diferent ranges. Both the data analysis as well as theoretical considerations concerning monotonicity indicate that the decision utility should be of S-shape |
| Keywords: | range-dependent utility, decision utility, Certainty Equivalent, quasilinear mean, Expected Utility Theory, Prospect Theory, Allais paradox, insurance and gambling |
| JEL: | D81 D03 C91 |
| Date: | 2013–01–13 |
| URL: | http://d.repec.org/n?u=RePEc:wse:wpaper:69&r=upt |
| By: | Amadeo Piolatto; Matthew Rablen |
| Abstract: | The standard expected utility model of tax evasion predicts that evasion is decreasing in the marginal tax rate (the Yitzhaki Puzzle). The existing literature disagrees on whether prospect theory overturns the puzzle. We disentangle four distinct elements of prospect theory and find loss aversion and probability weighting to be redundant in endogenous specification of the reference level. These classes include, as special cases, the most common specifications in the literature. New specifications of the reference level are needed, we conclude. |
| Keywords: | prospect theory, tax evasion, Yitzhaki puzzle, stigma, diminishing sensitivity, reference dependence, endogenous audit probability, endogenous reference level |
| JEL: | H26 D81 K42 |
| Date: | 2013–08 |
| URL: | http://d.repec.org/n?u=RePEc:ifs:ifsewp:13/25&r=upt |
| By: | Ekaterina Selezneva; Philippe Van Kerm |
| Abstract: | This paper exploits data from the German Socio-Economic Panel (SOEP) to re-examine the gender wage gap in Germany on the basis of inequality-adjusted measures of wage differentials which fully account for gender differences in pay distributions. The inequality-adjusted gender pay gap measures are significantly larger than suggested by standard indicators, especially in East Germany. Women appear penalized twice, with both lower mean wages and greater wage inequality. A hypothetical risky investment question collected in 2004 in the SOEP is used to estimate individual risk aversion parameters and benchmark the ranges of inequality-adjusted wage differentials measures. |
| Keywords: | Gender gap, wage differentials, wage inequality, expected utility, risk aversion, East and West Germany, SOEP, Singh-Maddala distribution, copula-based selection model |
| JEL: | D63 J31 J70 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:diw:diwsop:diw_sp579&r=upt |
| By: | Jean-Louis Arcand (GRADUATE INSTITUTE OF INTERNATIONAL AND DEVELOPMENT STUDIES - GRADUATE INSTITUTE OF INTERNATIONAL AND DEVELOPMENT STUDIES - GRADUATE INSTITUTE OF INTERNATIONAL AND DEVELOPMENT STUDIES); Linguère Mously MBAYE (CERDI - Centre d'études et de recherches sur le developpement international - CNRS : UMR6587 - Université d'Auvergne - Clermont-Ferrand I) |
| Abstract: | This paper aims to provide the first evidence concerning the relationship between time and risk preferences and illegal migration in an African context. Based upon our theoretical model and using a unique data set on potential migrants collected in urban Senegal, we evaluate a measure of time and risk preferences through the individual's intertemporal discount rate and coefficient of absolute risk aversion. Remarkably, our results show that these individual preferences matter in the willingness to migrate illegally and to pay a smuggler. |
| Keywords: | Illegal migration; Discount rate; Risk aversion; Africa; Senegal |
| Date: | 2013–08–30 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-00855937&r=upt |
| By: | Athanasios Yannacopoulos; Anastasios Xepapadeas |
| Abstract: | In view of the ambiguities and the deep uncertainty associated with climate change, we study the features of climate change policies that account for spatially structured ambiguity. Ambiguity related to the evolution of the natural system is introduced into a coupled economy-climate model with explicit spatial structure due to heat transport across the globe. We seek to answer questions about how spatial robust regulation regarding climate policies can be formulated; what the potential links of this regulation to the weak and strong version of the precautionary principle (PP) are; and how insights about whether it is costly to follow a PP can be obtained. We also study the emergence of hot spots, which are locations where local deep uncertainty may cause robust regulation to break down for the whole spatial domain, or the weak PP to be costly. |
| Keywords: | Ambiguity, Climate change, space, maxmin expected utility, robust control regulation, hot spots, precautionary principle |
| JEL: | Q54 Q58 D81 R11 |
| URL: | http://d.repec.org/n?u=RePEc:aue:wpaper:1332&r=upt |
| By: | Ernesto Reuben; Matthew Wiswall; Basit Zafar |
| Abstract: | Standard observed characteristics explain only part of the differences between men and women in education choices and labor market trajectories. Using an experiment to derive students' levels of overconfidence, and preferences for competitiveness and risk, this paper investigates whether these behavioral biases and preferences explain gender differences in college major choices and expected future earnings. In a sample of high-ability undergraduates, we find that competitiveness and overconfidence, but not risk aversion, are systematically related with expectations about future earnings: Individuals who are overconfident and overly competitive have significantly higher earnings expectations. Moreover, gender differences in overconfidence and competitiveness explain about 18 percent of the gender gap in earnings expectations. These experimental measures explain as much of the gender gap in earnings expectations as a rich set of control variables, including test scores and family background, and they are poorly proxied by these same control variables, underscoring that they represent independent variation. While expected earnings are related to college major choices, the experimental measures are not related with college major choice. |
| Keywords: | Career development - Sex differences ; Women - Education ; Universities and colleges ; Risk-taking (Psychology) ; Prediction (Psychology) ; Competition |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:627&r=upt |
| By: | Schroyen, Fred (Dept. of Economics, Norwegian School of Economics and Business Administration); Treich, Nicolas (Toulouse School of Economics) |
| Abstract: | Two wealth effects typically arise in any contest: i) wealth decreases the marginal cost of effort, but also ii) decreases the marginal benefit of winning the contest. In this paper, we introduce three types of strategic contest models depending on whether the first, second, or both wealth effects play a role: namely, a privilege contest, an ability contest, and a rent-seeking contest. Our theoretical analysis reveals that the effects of wealth and wealth inequality are strongly “contestdependent” and are complex in the sense that they depend on the decisiveness of the contest and on the higher-order derivatives of the utility functions of wealth. Our analysis thus does not support general claims that the rich should lobby more or that low economic growth and wealth inequality should lead to additional conflicts. |
| Keywords: | Conflict; contest; rent-seeking; wealth; risk aversion; lobbying; power; redistribution. |
| JEL: | C72 D72 D74 D81 |
| Date: | 2013–07–09 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:nhheco:2013_013&r=upt |
| By: | Luigi Guiso (EIEF and CEPR); Paola Sapienza (Northwestern University, NBER and CEPR); Luigi Zingales (University of Chicago, NBER and CEPR) |
| Abstract: | We use a repeated survey of a large sample of clients of an Italian bank to measure possible changes in investors’ risk aversion following the 2008 financial crisis. We find that both a qualitative and a quantitative measure of risk aversion increase substantially after the crisis. These changes are correlated with changes in portfolio choices, but do not seem to be correlated with “standard” factors that affect risk aversion, such as wealth, consumption habit, and background risk. This opens the possibility that psychological factors might be driving it. To test whether a scary experience (as the financial crisis) can trigger large increases in risk aversion, we conduct a lab experiment. We find that indeed students who watched a scary video have a certainty equivalent that is 27% lower than the ones who did not. Following a sharp drop in stock prices,a fear model predicts that individuals should sell stocks, while the habit model has the opposite implications; people should actively buy stocks to bring the risky assets to the new optimal level. We show that after the drop in stock prices in 2008 individuals rebalanced their portfolio in a way consistent to a fear model. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:eie:wpaper:1322&r=upt |
| By: | Kolsrud, Jonas (Department of Economics) |
| Abstract: | Reduced form estimations of precautionary saving with respect to labor market risk have hitherto failed to consider that a decrease of say unemployment probability or an increase in unemployment insurance (UI) generosity affects saving not only by reducing the expected variance in earnings but also by raising expected earnings. This paper studies the possibility of decomposing the treatment effect of UI on asset accumulation into two parts; one part where more generous UI leads to raised expected earnings and a second part where a more generous UI reduces the expected variation in earnings. The decomposition is applied to rich Swedish register data on both financial assets and debt. UI’s effect on assets is identified with a kinked policy rule in the UI scheme. First, increased UI generosity has a significant effect, both economically and statistically, on asset holdings; a one percentage point increase in UI benefits decrease net financial asset holdings by 1 percentage point. Second, decomposing the total effect UI has on asset accumulation shows that raised expected earnings increase savings while a decreased variation in earnings decrease saving. Not accounting for the effect on expected earnings on saving underestimates the impact UI has on precautionary saving by 70 percent. |
| Keywords: | Saving; wealth; unemployment benefit; unemployment; consumption smoothing |
| JEL: | D91 J64 J65 |
| Date: | 2013–08–13 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:uunewp:2013_014&r=upt |
| By: | Biais, Bruno; Hombert, Johan; Weill, Pierre-Olivier |
| Abstract: | Information collection, processing and dissemination financial institutions is challenging. This can delay the observation by traders of the exact capital charges and constraints of their institution. During this delay, traders face preference uncertainty. In this context, we study optimal trading strategies and equilibrium prices in a continuous centralized market. We focus on liquidity shocks, during which preference uncertainty is likely to matter most. Preference uncertainty generates allocative ineficiency, but need not reduce prices. Traders progressively learning about the preferences of their institution conduct round-trip trades, which generate excess volume relative to the frictionless market. In a cross section of liquidity shocks, the initial price drop is positively correlated with total trading volume. Across traders, the number of round-trips is negatively correlated with trading profits and average inventory. |
| JEL: | D8 G1 |
| Date: | 2013–07–16 |
| URL: | http://d.repec.org/n?u=RePEc:ide:wpaper:27434&r=upt |
| By: | Volker Benndorf; Dorothea Kübler; Hans-Theo Normann; |
| Abstract: | We study the voluntary revelation of private, personal information in a labor-market experiment with a lemons structure where workers can reveal their productivity at a cost. While rational revelation improves a worker's payoff, it imposes a negative externality on others and may trigger further unraveling. Our data suggest that subjects reveal their productivity less frequently than predicted in equilibrium. A loaded frame emphasizing personal information about workers' health leads to even less revelation. We show that three canonical behavioral models all predict too little rather than too much revelation: level-k reasoning, quantal-response equilibrium,and to a lesser extent inequality aversion. |
| Keywords: | information revelation, privacy, lemons market, level-k reasoning, quantal response equilibrium, inequality aversion |
| JEL: | C72 C90 C91 |
| Date: | 2013–09 |
| URL: | http://d.repec.org/n?u=RePEc:hum:wpaper:sfb649dp2013-040&r=upt |
| By: | John Duffy; Felix Munoz-Garcia |
| Abstract: | This paper investigates behavior in finitely repeated simultaneous and sequential-move prisoner's dilemma games when there is one-sided incomplete information and signaling about players' concerns for fairness, specifically, their preferences regarding "inequity aversion." In this environment, we show that only a pooling equilibrium can be sustained, in which a player type who is unconcerned about fairness initially cooperates in order to disguise himself as a player type who is concerned about fairness. This disguising strategy induces the uninformed player to cooperate in all periods of the repeated game, including the final period, at which point the player type who is unconcerned about fairness takes the opportunity to defect, i.e., he "backstabs" the uninformed player. Despite such last-minute defection, our results show that the introduction of incomplete information can actually result in a Pareto improvement under certain conditions. We connect the predictions of this "backstabbing" equilibrium with the frequently observed decline in cooperative behavior in the final period of finitely-repeated experimental games. |
| Keywords: | Prisoner\'s Dilemma, Social Preferences, Inequity Aversion, Incomplete Information, Siganling, Information Transmission |
| JEL: | C72 C73 D82 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:pit:wpaper:491&r=upt |
| By: | Daziano, Ricardo A.; Achtnicht, Martin |
| Abstract: | Previous literature on the distribution of willingness to pay has focused on its heterogeneity distribution without addressing exact interval estimation. In this paper we derive and analyze Bayesian confidence sets for quantifying uncertainty in the determination of willingness to pay for carbon dioxide abatement. We use two empirical case studies: household decisions of energy-efficient heating versus insulation, and purchase decisions of ultralow-emission vehicles. We first show that deriving credible sets using the posterior distribution of the willingness to pay is straightforward in the case of deterministic consumer heterogeneity. However, when using individual estimates, which is the case for the random parameters of the mixed logit model, it is complex to define the distribution of interest for the interval estimation problem. This latter problem is actually more involved than determining the moments of the heterogeneity distribution of the willingness to pay using frequentist econometrics. A solution that we propose is to derive and then summarize the distribution of point estimates of the individual willingness to pay under different loss functions. -- |
| Keywords: | Discrete Choice Models,Willingness to Pay,Credible Sets |
| JEL: | C25 D12 Q51 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:zewdip:13059&r=upt |
| By: | Yang-Ho Park |
| Abstract: | This paper reports on tail risk premiums in two tail risk hedging strategies: the S&P 500 puts and the VIX calls. As a new measure of tail risk, we suggest using a model-free, risk-neutral measure of the volatility of volatility implied by a cross section of the VIX options, which we call the VVIX index. The tail risk measured by the VVIX index has forecasting power for future tail risk hedge returns. Specifically, consistent with the literature on rare disasters, an increase in the VVIX index raises the current prices of tail risk hedges and thus lowers their subsequent returns over the next three to four weeks. Furthermore, we find that volatility of volatility risk and its associated risk premium both significantly contribute to the forecasting power of the VVIX index, and that the predictability largely results from the integrated volatility of volatility rather than volatility jumps. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2013-54&r=upt |