nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2013‒11‒02
eighteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Decreasing Downside Risk Aversion and Background Risk By David Crainich; Louis Eeckhoudt; Olivier Le Courtois
  2. Imperfect Attention and Menu Evaluation By Paola Manzini; Marco Mariotti
  3. Risk-averse and Risk-seeking Investor Preferences for Oil Spot and Futures By Lean, H.H.; McAleer, M.J.; Wong, W.-K.
  4. Confucianism and Preferences: Evidence from Lab Experiments in Taiwan and China By Liu, Elaine M.; Meng, Juanjuan; Wang, Joseph Tao-yi
  5. Consumption, Market Price of Risk, and Wealth Accumulation under Induced Uncertainty By Luo, Yulei; Young, Eric
  6. Portfolio Performance Measure and A New Generalized Utility-based N-moment Measure By Monica Billio; Gregory Jannin; Bertrand Maillet; Loriana Pelizzon
  7. Эффект Веблена, предельная полезность денег и денежная иллюзия By Malakhov, Sergey
  8. Use of Bayesian Markov Chain Monte Carlo Methods to Estimate EQ-5D Utility Scores from Eortic QLQ Data in Myeloma for Use in Cost effectiveness Analysis By Samer A Kharroubi; Richard Edlin; David Meads; Chantelle Browne; Julia Brown; Christopher McCabe
  9. Optimal Choice under Short Sell Limit with Sharpe Ratio as Criterion among Multiple Assets By Yiran Sheng; Ruokun Huang
  10. A Representation of Risk Measures By Massimiliano AMARANTE
  11. Nonparametric Welfare Analysis in Stochastic Models of Binary Choice By Debopam Bhattacharya
  12. Social Centipedes: the Impact of Group Identity on Preferences and Reasoning By Le Coq, Chloe; Tremewan, James; Wagner, Alexander K.
  13. Optimal Sequential Delegation By Kovác, Eugen; Krähmer, Daniel
  14. Mechanism Design by an Informed Principal: The Quasi-Linear Private-Values Case By Mylovanov, Tymofiy; Tröger, Thomas
  15. On Learning and Growth By Leonard J. Mirman; Kevin Reffett; Marc Santugini
  16. Mothers, Friends and Gender Identity By Olivetti, Claudia; Patacchini, Eleonora; Zenou, Yves
  17. Assignment errors and the valuation of EQ-5D health states-do responses mean what we think they mean? By Richard Edlin; Christopher McCabe; David Meads
  18. U.S. versus Sweden: The Effect of Alternative In-Work Tax Credit Policies on Labour Supply of Single Mothers By Aaberge, Rolf; Flood, Lennart

  1. By: David Crainich (CNRS-LEM and IESEG School of Management); Louis Eeckhoudt (IESEG School of Management (LEM-CNRS) and and CORE (Université Catholique de Louvain)); Olivier Le Courtois (EM Lyon Business School)
    Abstract: To analyze the impact of background risks, decreasing absolute risk aversion (DARA) must be combined with other restrictions on the shape of the utility function in order to make preferences risk vulnerable. In this note, we indicate that risk vulnerability can also be associated with the sole assumption of decreasing downside risk aversion (DDRA). That is, no matter how absolute risk aversion changes with wealth, DDDRA in the Arrow-Pratt sense and DDRA in the Ross sense are shown to be respectively necessary and sufficient for a background risk to raise the aversion to other independent risks.
    Keywords: Downside Risk Aversion, Background Risk, Risk Vulnerability
    JEL: D81
    Date: 2013–10
  2. By: Paola Manzini (University of St Andrews and IZA); Marco Mariotti (University of St Andrews)
    Abstract: We model the choice behaviour of an agent who suffers from imperfect attention but is otherwise von Neumann Morgenstern rational. We define inattention axiomatically through preference over menus and endowed alternatives: an agent is inattentive if it is better to be endowed with an alternative a than to be allowed to pick a from a menu in which a is is the best alternative. This property and vNM rationality on the domain of menus and alternatives imply that the agent notices each alternative with a given menu-dependent probability (attention parameter) and maximises a menu independent utility function over the alternatives he notices. Preference for flexibility restricts the model to menu independent attention parameters as in Manzini and Mariotti (2013). Our theory explains anomalies (e.g. the attraction effect) that other prominent stochastic choice theories cannot accommodate.
    Keywords: bounded rationality, stochastic choice
    JEL: D01
    Date: 2013–10–21
  3. By: Lean, H.H.; McAleer, M.J.; Wong, W.-K.
    Abstract: This paper examines risk-averse and risk-seeking investor preferences for oil spot and futures prices by using the mean-variance (MV) criterion and stochastic dominance (SD) approach. The MV findings cannot distinguish between the preferences of spot and futures markets. However, the SD tests show that spot dominates futures in the downside risk, while futures dominate spot in the upside profit. On the other hand, the SD findings suggest that spot dominates futures in downside risk, while futures dominate spot in upside profit. Risk-averse investors prefer investing in the spot index. Risk seekers are attracted to the futures index to maximize their expected utility but not expected wealth in the entire period, as well as for both the OPEC and Iraq War sub-periods. The SD findings show that there is no arbitrage opportunity between the spot and futures markets, and these markets are not rejected as being efficient.
    Keywords: stochastic dominance;risk averter;risk seeker;spot market;mean variance;futurres market
    Date: 2013–08–01
  4. By: Liu, Elaine M. (University of Houston); Meng, Juanjuan (Peking University); Wang, Joseph Tao-yi (National Taiwan University)
    Abstract: This paper investigates how Confucianism affects individual decision making in Taiwan and in China. We found that Chinese subjects in our experiments became less accepting of Confucian values, such that they became significantly more risk loving, less loss averse, and more impatient after being primed with Confucianism, whereas Taiwanese subjects became significantly less present-based and were inclined to be more trustworthy 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: 2013–10
  5. By: Luo, Yulei; Young, Eric
    Abstract: In this paper we examine implications of model uncertainty due to robustness (RB) for consumption-saving, market price of uncertainty, and aggregate wealth accumulation under limited information-processing capacity (rational inattention or RI) in an otherwise standard permanent income model. We first solve the robust permanent income models with inattentive consumers and show that RI by itself creats an additional demand for robustness that leads to higher ¡°induced uncertainty¡± facing consumers. Second, we explore how the induced uncertainty composed by (i) model uncertainty due to RB and (ii) state uncertainty due to RI, affects consumption-saving decisions and the market price of uncertainty. Particurly, we find that induced uncertainty can better explain the observed market price of uncertainty. Furthermore, we explore the observational equivalence between RB and risk-sensitivity (RS) in this filtering problem. Finally, we evaluate the importance of induced uncertainty and fundamental uncertainty in determining equilibrium aggregate wealth.
    Keywords: Robust Filtering, Rational Inattention, Observational Equivalence, Induced Uncertainty, Market Prices of Uncertainty, Wealth Accumulation
    JEL: D8 D83 E2 E21
    Date: 2013–10–10
  6. By: Monica Billio (Department of Economics, University Of Venice Cà Foscari); Gregory Jannin (Variances and University Paris I); Bertrand Maillet (University La Reunion and University of Orléans); Loriana Pelizzon (Department of Economics, University of Venice Ca’ Foscari)
    Abstract: Most of the performance measures proposed in the financial and academic literature are subject to be gamed in an active management framework (Goetzmann et al., 2007). One of the main reasons of this drawback is due to an incomplete characterization by these measures of studied return distributions. We introduce a new flexible Generalized Utility-based N-moment measure of performance (GUN, in short), characterizing the whole return distribution, and thus hardly gamable. More precisely, it takes into account the first four moments of the return distribution and the associated sensitivities of the studied agent, reflecting his preferences and risk profile. The new performance measure is also well adapted for analyzing performance of hedge funds and more peculiarly in presence of derivative instruments associated with non-Gaussian return distributions. Length: 34
    Keywords: C16, G11, G23, G24
    Date: 2013
  7. By: Malakhov, Sergey
    Abstract: The paper discovers microeconomic mechanism of Veblen effect as well as of Giffen case as results of the negative marginal utility of money. The marginal utility of consumption also becomes negative. The total consumption-leisure utility is increased due to the increase in leisure time. This overall effect results in the phenomenon of money illusion on the macroeconomic level. This general effect has deep historical and institutional grounds and, in order to minimize its disequilibrium economic consequences it needs more specific institutional regulation.
    Keywords: money flexibility, money illusion, Veblen effect, consumption-leisure choice
    JEL: D11 D83
    Date: 2013–09
  8. By: Samer A Kharroubi (Department of Mathematics, University of York, York); Richard Edlin (School of Population Health, University of Auckland); David Meads (Academic Unit of Health Economics, University of Leeds, Leeds); Chantelle Browne (Academic Unit of Health Economics, University of Leeds, Leeds); Julia Brown (Clinical Trials Research Unit, University of Leeds, Leeds); Christopher McCabe (Department of Emergency Medicine, School of Community Based Medicine, University of Alberta, Edmonton (Canada))
    Abstract: Background: Patient Reported Outcome Measures are an important component of the evidence for health technology appraisal. Their incorporation into cost effectiveness analyses (CEA) requires conversion of descriptive information into utilities. This can be done using bespoke utility algorithms. Otherwise, investigators will often estimate indirect utility models for the PROMS using off-the-shelf utility data such as the EQ-5D or SF-6D. Many different modeling strategies are reported in the literature; however, to date there has been limited utilization of Bayesian methods in this context. In this paper we use a large trial dataset containing the EORTC QLQ-C30 with MY20 and the EQ-5D to examine the relative advantage of the Bayesian methods in relation to dealing with missing data, relaxing the assumption of equal variances and characterizing the uncertainty in the model predictions. Methods: Data from a large myeloma trial were used to examine the relationship between scores in each of the 19 domains of the EORTC QLQ-C30/QLQ-MY20 and the EQ-5D utility. Data from 1839 patients was divided 75%/25% between derivation and validation sets. A conventional OLS model, assuming equal variance and a Bayesian model allowing unequal variance were estimated on complete cases. Two further models were estimated using conventional and Bayesian multiple imputation respectively, using the full dataset. Models were compared in terms of data fit, accuracy in model prediction and characterization of uncertainty in model predictions. Conclusions: Mean EQ-5D utility weights can be estimated from the EORTC QLQ-C30/QLQMY20 for use in CEA. Frequentist and Bayesian methods produced effectively identical models. However, the Bayesian models provide distributions describing the uncertainty surrounding the estimated utility values and are thus more suited informing analyses for probabilistic CEA.
    Keywords: Bayesian methods, EQ-5D, Multiple Myeloma, Quality of Life, mapping, Cost-utility analysis, regression modelling.
    JEL: I1
    Date: 2013
  9. By: Yiran Sheng; Ruokun Huang
    Abstract: This article is the term paper of the course Investments. We mainly focus on modeling long-term investment decisions of a typical utility-maximizing individual, with features of Chinese stock market in perspective. We adopt an OR based methodology with market information as input parameters to carry out the solution. Two main features of this article are: first, we take the no short-sell constraint in Chinese stock market into consideration and use an approach otherwise identical to Markowitz to work out the optimal portfolio choice; this method has critical and practical implication to Chinese investors. Second, we incorporate the benefits of multiple assets into one single well-defined utility function and use a MIQP procedure to derive the optimal allocation of funds upon each of them along the time-line.
    Date: 2013–10
  10. By: Massimiliano AMARANTE
    Abstract: We provide a representation theorem for risk measures satisfying (i) monotonicity; (ii) positive homogeneity; and (iii) translation invariance. As a simple corollary to our theorem, we obtain the usual representation of coherent risk measures (i.e., risk measures that are, in addition, sub-additive; see Artzner et al.
    Keywords: risk measures, capacity, Choquet integral
    JEL: G11 C65
    Date: 2013
  11. By: Debopam Bhattacharya
    Abstract: We consider empirical measurement of compensating/equivalent variation resulting from taxes and subsidies on goods which can be consumed only in binary form.� We incorporate unobserved heterogeneity in utility functions and establish nonparametric point-identification of the distribution of EV/CV and deadweight-loss from average structural demand functions.� Roy's identity is different in form from the continuous consumption case and related differential-equation based approaches are not useful for welfare-calculation owing to generic corner-solutions.� An application to children's school-attendance in India reveals that a 50% tuition-subsidy produces an average CV of about Rs 50 and a deadweight-loss of about Rs 18 per child per month.
    Keywords: Binary decision, taxes and subsidy, equivalent and compensating variation, unobserved heterogeneity, nonparametric identification, school-attendance, Indian National Sample Survey
    JEL: D12 D11 C14 C25
    Date: 2013–07–23
  12. By: Le Coq, Chloe (Stockholm Institute of Transition Economics); Tremewan, James (Department of Economics, University of Vienna (Austria)); Wagner, Alexander K. (Department of Economics, University of Cologne (Germany))
    Abstract: Using a group identity manipulation we examine the role of social preferences in an experimental one-shot centipede game. Contrary to what social preference theory would predict, we find that players continue longer when playing with outgroup members. Our explanation rests on two observations: (i) players should only stop if they are sufficiently confident that their partner will stop at the next node, given the exponentially-increasing payoffs in the game, and (ii) players are more likely to have this degree of certainty if they are matched with someone from the same group, whom they view as similar to themselves and thus predictable. We find strong statistical support for this argument. We conclude that group identity not only impacts a player’s utility function, as identified in earlier research, but also affects her reasoning about the partner’s behavior.
    Keywords: Group identity; centipede game; prospective reference theory
    JEL: C72 C91 C92 D83
    Date: 2013–09–30
  13. By: Kovác, Eugen; Krähmer, Daniel
    Abstract: The paper extends the optimal delegation framework pioneered by Holmström (1977, 1984) to a dynamic environment where, at the outset, the agent privately knows his ability to interpret decision relevant private information received later on. We show that any mechanism can be implemented by a sequential menu of delegation sets where the agent first picks a delegation set and then chooses an action within this set. For the uniform{quadratic case, we characterize when sequential delegation is strictly better than static delegation and derive the optimal delegation menu. We provide sufficient conditions so that our results extend beyond the uniform distribution.
    Keywords: optimal delegation; sequential screening; dynamic mechanism design; non-transferable utility
    JEL: D02 D20 D82 D86
    Date: 2013–04–11
  14. By: Mylovanov, Tymofiy; Tröger, Thomas
    Abstract: We show that, in environments with independent private values and transferable utility, a privately informed principal can implement a contract that is ex-ante optimal for her. As an application, we consider a bilateral exchange environment (Myerson and Satterthwaite, 1983) in which the principal is one of the traders. If the property rights over the good are dispersed among the traders, the principal will implement a contract in which she is almost surely better off than if there were no uncertainty about her information. The optimal contract is a combination of a participation fee, a buyout option for the principal, and a resale stage with posted prices and, hence, is a generalization of the posted price that would be optimal if the principal's valuation were commonly known. We also provide a condition under which the principal implements the same contract regardless of whether the agents know her information or not.
    Date: 2013
  15. By: Leonard J. Mirman; Kevin Reffett; Marc Santugini
    Abstract: We study the effect of learning on optimal growth. We first derive the Euler equation in a general learning environment without experimentation. We then consider the case of iso-elastic utility and linear production, for general distributions of the random shocks and beliefs (i.e., no conjugate priors) and for any horizon. We characterize the unique optimal policy function for this learning model. We show how learning alters the maximization problem of the social planner. We also compare the learning model with the deterministic and stochastic models. This work builds on the work on learning and growth in a Brock-Mirman environment initiated by Koulovatianos, Mirman, and Santugini (2009) (KMS) for the Mirman-Zilcha model (with log utility and Cobb-Douglas production). While the Mirman-Zilcha model provides some insights about the effect of learning on growth, it also hides many important features of learning that the model in this paper takes account of. In other words, compared to the Mirman-Zilcha model, we show that the case of iso-elastic utility and linear production yields a more profound effect of learning on dynamic programming and thus optimal behavior.
    Keywords: Brock-Mirman environment, Dynamic programming, Learning, Optimal growth
    JEL: D8 D9 E2
    Date: 2013
  16. By: Olivetti, Claudia (Boston University); Patacchini, Eleonora (Sapienza University of Rome); Zenou, Yves (Stockholm University)
    Abstract: This paper explores a novel mechanism of gender identity formation. Specifically, we explore how the work behavior of a teenager's own mother, as well as that of her friends' mothers, affect her work decisions in adulthood. The first mechanism is commonly included in economic models. The second, which in social psychology is also emphasized as an important factor in gender identity formation, has so far been overlooked. Accordingly, our key theoretical innovation is how the utility function is modeled. It is assumed that an adult woman's work decisions are influenced by her own mother's choices as well as her friends' mothers' choices when she was a teenager, and the interaction between the two. The empirical salience of this behavioral model is tested using a network model specification together with the longitudinal structure of the AddHealth data set. We find that both intergenerational channels positively affect a woman's work hours in adulthood, but the cross effect is negative, indicating the existence of cultural substitutability. That is, the mother's role model effect is larger the more distant she is (in terms of working hours) from the friends' mothers.
    Keywords: intergenerational transmission, gender identity, labor force participation, social networks
    JEL: J22 Z13
    Date: 2013–10
  17. By: Richard Edlin (Health Systems, School of Population Health, University of Auckland); Christopher McCabe (School of Community Medicine, University of Alberta, Edmonton, Canada); David Meads (Academic Unit of Health Economics, LIHS, University of Leeds)
    Abstract: Cost-utility analysis is used within the health technology assessment processes of many countries. For these analyses, patients typically indicate the health state that they are in based on a pre-defined descriptive classification. Each health state corresponds to a utility value; these values are obtained from members of the general public who are asked what they would be willing to give up to avoid spending time in that health state. If people struggle to do this, they might imagine (and so value) different states to those they are prompted with. Here, they assign a different meaning to the prompt than intended, which we designate as an ‘assignment error’. This paper formally defines these errors for the EQ-5D-3L and explores MVH dataset used to construct the UK EQ-5D-3L tariff. We modify the regressions used to form this tariff to include potential assignment errors and find that these errors are significant predictors in the regressions. For some states, there is evidence that over half the respondents answering valuation questions may make an assignment error. As these errors will affect some states more than others, they are a potential source of bias and hence distortion in resource allocation. The size of this distortion is explored in the UK context using the regressions identified by this paper, all of which suggest that less weight be given to curing moderate illness and more weight be given to curing more severe illness.
    Keywords: quality-adjusted life years, health related quality of life, assignment errors, estimation
    JEL: I1 I31
    Date: 2013
  18. By: Aaberge, Rolf (Statistics Norway); Flood, Lennart (University of Gothenburg)
    Abstract: An essential difference between the design of the Swedish and the US in-work tax credit systems relates to their functional forms. Where the US earned income tax credit (EITC) is phased out and favours low and medium earnings, the Swedish system is not phased out and offers 17 and 7 per cent tax credit for low and medium low incomes and a lump-sum tax deduction equal to approximately 2300 USD for medium and higher incomes. The purpose of this paper is to evaluate the efficiency and distributional effects of these two alternative tax credit designs. We pay particular attention to labour market exclusion; i.e. individuals within as well as outside the labour force are included in the analysis. To highlight the importance of the joint effects from the tax and the benefit systems it appears particular relevant to analyse the labour supply behaviour of single mothers. To this end, we estimate a structural random utility model of labour supply and welfare participation. The model accounts for heterogeneity in consumption-leisure preferences as well as for heterogeneity and constraints in job opportunities. The results of the evaluation show that the Swedish system without phase-out generates substantial larger labour supply responses than the US version of the tax credit. Due to increased labour supply and decline in welfare participation we find that the Swedish reform is self-financing for single mothers, whereas a 10 per cent deficit follows from the adapted EITC version used in this study. However, where income inequality rises modestly under the Swedish tax credit system, the US version with phase-out leads to a significant reduction in the income inequality.
    Keywords: labour supply, single mothers, in-work tax credit, social assistance, random utility model
    JEL: J22 I38
    Date: 2013–10

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