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on Utility Models and Prospect Theory |
| By: | Nicky Nicholls, Aylit Romm and Alexander Zimper |
| Abstract: | This paper experimentally tests whether violations of Savage's (1954) subjective expected utility theory decrease if the ambiguity of an uncertain decision situation is reduced through statistical learning. Because our data does not show such a decrease, existing models which formalize ambiguity within an Anscombe-Aumann (1963) framework - thereby reducing to expected utility theory in the absence of ambiguity - are violated. In contrast, axiomatic models of prospect theory can accommodate our experimental findings because they allow for violations of von Neumann and Morgenstern's (1947) independence axiom whenever uncertain decision situations transform into risky decision situations for which probabilities are known. |
| Keywords: | Prospect Theory, Choquet Expected Utility Theory, Multiple Priors, Expected Utility Theory, Sure Thing Principle, Independence Axiom |
| JEL: | C91 D81 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:rza:wpaper:386&r=upt |
| By: | Hammond, Peter J (Department of Economics, University of Warwick); Zank, Horst (University of Manchester) |
| Abstract: | For choice with deterministic consequences, the standard rationality hypothesis is ordinality — i.e., maximization of a weak preference ordering. For choice under risk (resp. uncertainty), preferences are assumed to be represented by the objectively (resp. subjectively) expected value of a von Neumann–Morgenstern utility function. For choice under risk, this implies a key independence axiom; under uncertainty, it implies some version of Savage's sure thing principle. This chapter investigates the extent to which ordinality, independence, and the sure thing principle can be derived from more fundamental axioms concerning behaviour in decision trees. Following Cubitt (1996), these principles include dynamic consistency, separability, and reduction of sequential choice, which can be derived in turn from one consequentialist hypothesis applied to continuation subtrees as well as entire decision trees. Examples of behaviour violating these principles are also reviewed, as are possible explanations of why such violations are often observed in experiments. JEL classification: expected utility ; consequentialism ; independence axiom ; consistent planning ; rationality ; dynamic consistency ; subjective probability ; sure thing principle JEL codes: D01 ; D03 ; D81 ; D91 ; C72 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:wrk:warwec:1033&r=upt |
| By: | David Dillenberger (Department of Economics, Univerity of Pennsylvania); Uzi Segal (Department of Economics, Boston College and Warwick Business School) |
| Abstract: | Experimental evidence suggests that individuals who face an asymmetric distribution over the likelihood of a specific event might actually prefer not to know the exact value of this probability. We address these findings by studying a decision maker who has recursive, non-expected utility preferences over two-stage lotteries. For a binary lottery that yields the better outcome with probability p, we identify noise around p with a compound lottery that induces a probability distribution over the exact value of the probability and has an average value p. We first propose and characterize a new notion of skewed distributions. We then use this result to provide conditions under which a decision maker who always rejects symmetric noise around p will always reject skewed to the left noise, but might accept skewed to the right noise. The model can be applied to the areas of investment under risk, medical decision making, and criminal law procedures, and can also be used to address the phenomenon of ambiguity seeking in the context of decision making under uncertainty. |
| Keywords: | Asymmetric noise, skewed distributions, recursive non-expected utility, ambiguity seeking, compound lotteries. |
| JEL: | D81 |
| Date: | 2013–11–25 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:13-066&r=upt |
| By: | Gollier, Christian; Hammitt, James; Treich, Nicolas |
| Abstract: | As in any research field, risk theory has its important questions, results, and paradoxes, as well as its seminal papers and key authors. Louis Eeckhoudt has been a key author in the field of risk theory. To celebrate his many contributions and continue the development of theories of decision making under risk, the Toulouse School of Economics hosted “Risk and choice: A conference in honor of Louis Eeckhoudt” July 12- 13, 2012. This paper presents some of Eeckhoudt’s main contributions to the literature, and provides some illustrations of the remarkable research saga in risk theory over the last 50 years since Pratt’s (1964) characterization of risk aversion under expected utility. |
| Keywords: | Risk aversion, prudence, risk, self-protection, insurance, portfolio choice, expected utility. |
| JEL: | D81 |
| Date: | 2013–07 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:27727&r=upt |
| By: | Alexander Ludwig and Alexander Zimper |
| Abstract: | Based on the axiomatic framework of Choquet decision theory, we develop a closed-form model of Bayesian learning with ambiguous beliefs about the mean of a normal distribution. In contrast to rational models of Bayesian learning the resulting Choquet Bayesian estimator results in a long-run bias that reflects the agent’s ambiguity attitudes. By calibrating the standard equilibrium conditions of the consumption based asset pricing model we illustrate that our approach contributes towards a resolution of the risk-free rate puzzle. For a plausible parameterization we obtain a risk-free rate in the range of 3.5 − 5%. This is 1 − 2.5% closer to the empirical risk-free rate than according calibrations of the rational expectations model. |
| Keywords: | Ambiguity, Non-additive probability measures, Bayesian learning, Truncated normal distribution, Risk-free rate puzzle |
| JEL: | C79 D83 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:rza:wpaper:390&r=upt |
| By: | König, Clemens |
| Abstract: | This paper proposes a novel explanation for the context dependency of individual choices in two-player games. Context dependency refers to the well-established phenomenon that a player, when choosing from a given opportunity set created by the other player’s strategy, chooses differently in different situations because of different alternatives to the other player’s strategy. The utility model used to explain this kind of context dependency incorporates a preference for net-loss reciprocation. Net-loss reciprocation means that a player’s willingness to impose a net loss (i.e., loss minus gain) on the other player increases in the net loss that he or she derives from the other player’s strategy. I show that net-loss reciprocation together with the method for calculating net losses developed in this paper explains the context dependencies in individual behaviour that have been documented in a number of experimental studies, whereas existing models of intention-based reciprocity fail to explain all the evidence. |
| Keywords: | Reciprocity; Fairness; Experimental economics; Game theory; Loss aversion |
| JEL: | C70 C91 D63 D64 |
| Date: | 2013–11–17 |
| URL: | http://d.repec.org/n?u=RePEc:lmu:muenec:17474&r=upt |
| By: | Andersson, Ola (Research Institute of Industrial Economics (IFN)); Holm, Håkan J. (Lund University); Tyran, Jean-Robert (University of Vienna); Wengström, Erik (Lund University) |
| Abstract: | We study risk taking on behalf of others in an experiment on a large random sample. The decision makers in our experiment are facing high-powered incentives to increase the risk on behalf of others through hedged compensation contracts or with tournament incentives. Compared to a baseline condition without such incentives, we find that the decision makers respond strongly to these incentives that result in an increased risk exposure of others. However, we find that the increase in risk taking is mitigated by altruistic preferences and pro-social personality traits. |
| Keywords: | Incentives; Competition; Hedging; Risk taking; Social preferences |
| JEL: | C72 C90 D30 D81 |
| Date: | 2013–11–19 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:iuiwop:0989&r=upt |
| By: | Chorus, Caspar |
| Abstract: | This paper presents, discusses and tests a generalized Random Regret Minimization (G-RRM) model. The G-RRM model is created by replacing a fixed constant in the attribute-specific regret functions of the RRM model, by a regret-weight variable. Depending on the value of the regret-weights, the G-RRM model generates predictions that equal those of, respectively, the canonical linear-in-parameters Random Utility Maximization (RUM) model, the conventional Random Regret Minimization (RRM) model, and hybrid RUM-RRM specifications. When the regret-weight variable is written as a binary logit function, the G-RRM model can be estimated on choice data using conventional software packages. As an empirical proof of concept, the G-RRM model is estimated on a stated route choice dataset, and its outcomes are compared with RUM and RRM counterparts. |
| Keywords: | Random Utility Maximization; Random Regret Minimization; Choice model; Unified approach; Generalized Random Regret Minimization |
| JEL: | C5 M30 R41 |
| Date: | 2013–11–21 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:51637&r=upt |
| By: | Marcello Basili |
| Abstract: | This paper advances an intuitive way to represent Keynes’s notion of long-term expectation. The epsilon-contamination approach is introduced and a rational and coherent decision rule is derived. The result is evidence that Ellsberg and Keynes share the notion of uncertainty and adopt the same class of decision rules. |
| Keywords: | Keynes, Ellsberg, expectation, consensus distribution, uncertainty, epsilon-contamination. |
| JEL: | B16 D81 |
| Date: | 2013–09 |
| URL: | http://d.repec.org/n?u=RePEc:usi:wpaper:685&r=upt |
| By: | Antoinette Baujard (GATE Lyon Saint-Etienne - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - École Normale Supérieure (ENS) - Lyon) |
| Abstract: | This paper presents the different utilitarian approaches to ethics. It stresses the influence of utilitarianism in economics in general and in welfare economics in particular. The key idea of the paper to explain the evolution from classical utilitarianism to preferences utilitarianism and towards post-welfarist approaches is the following. Utility is defi-ned normatively and positively. This generates some serious tensions. Utilitarianism needs to evolve to go beyond this ethical tension. Another idea defended in this paper is that the solutions developed by utilitarianism to solve the ethical issue eventually reinforces operational problems. This raises a legitimacy issue as whether the intervention of utilitarian economists in public decision are likely to be normatively transparent. |
| Keywords: | Utilitarianism; Welfarism; Hedonism; Preference, Utility |
| Date: | 2013–11–20 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-00906899&r=upt |
| By: | BLINOV, Sergey |
| Abstract: | The article describes “the theory of devaluation of values” developed by the author. In accordance with this theory, economic growth takes place using two inter-connected phenomena: a) reduction in time necessary for “the set of benefits (goods) currently consumed” to be produced, on the one hand (first form of values devaluation) and b) using the free time to produce additional benefits (goods), as a result of which a new set of benefits is created, a new “living standard” (second form of values devaluation), on the other hand. The theory allows the fallacy of identifying utility with wealth to be proved, for example, the article shows that “marginal utility” is equivalent to the “degree of poverty". The importance of time is stressed, as well as the interconnection between the free time in natural economy and savings in modern money economy. The theory allows one to take a new view of the economic history, the theory of economic growth, the theory of international trade. |
| Keywords: | value, productivity, time, marginal utility, wealth, economic growth |
| JEL: | D01 D60 E40 O10 |
| Date: | 2013–11–19 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:51534&r=upt |
| By: | Courbage, Christophe; Rey, Béatrice; Treich, Nicolas |
| Abstract: | This chapter surveys the economic literature on prevention and precaution. Prevention refers as either a self-protection activity – i.e. a reduction in the probability of a loss – or a self-insurance activity – i.e. a reduction of the loss –. Precaution is defined as a prudent and temporary activity when the risk is imperfectly known. We first present results on prevention, including the effect of risk preferences, wealth and background risks. Second, we discuss how the concept of precaution is strongly linked to the effect of arrival of information over time in sequential models as well as to situations in which there is ambiguity over probability distributions. |
| Date: | 2013–10 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:27733&r=upt |
| By: | Guy Meunier (ALISS - Alimentation et sciences sociales - Institut national de la recherche agronomique (INRA) : UR1303, Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X) |
| Abstract: | This article analyzes the eff ect of risk and risk aversion on the long-term equilibrium technology mix in an electricity market. It develops a model where fi rms can invest in baseload plants with a fi xed variable cost and peak plants with a random variable cost, and demand for electricity varies over time but is perfectly predictable. At equilibrium the electricity price is partly determined by the random variable cost and the returns from the two kinds of plants are negatively correlated. When the variable cost of the peak technology is high the return of peak plants is low but the return to baseload plants is high. Risk-averse fi rms reduce the capacity of the riskiest technology and develop the capacity of the other, compared to risk-neutral fi rms. In the particular case where a risk-neutral fi rm invests heavily in baseload technology and only sparely in peak capacity, a risk-averse fi rm would invest less in baseload, increase peak capacity, and increase total installed capacity. |
| Keywords: | Electricity market; Technology mix; Risk aversion |
| Date: | 2013–11–20 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-00906944&r=upt |
| By: | Julie A. Nelson |
| Abstract: | In their article "Strong Evidence for Gender Differences in Risk Taking", Gary Charness and Uri Gneezy (2012) review a number of experimental studies regarding investments in risky assets, and claim that these yield strong evidence that females are more risk averse than males. This study replicates and extends their article, demonstrating that its methods are highly problematic. While the methods used would be appropriate for categorical, individual-level differences, the data reviewed are not consistent with such a model. Instead, modest differences (at most) exist only at aggregate levels, such as group means. The evidence in favor of gender difference is thus considerably less strong than claimed. This analysis has important implications both for the design of behavioral and economic research and for policies related to discrimination and stereotyping. |
| Keywords: | risk aversion, gender, risk, stereotyping, effect size |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:mab:wpaper:19&r=upt |
| By: | Julie A. Nelson |
| Abstract: | Behavioral research has revealed how normal human cognitive processes can tend to lead us astray. But do these affect economic researchers, ourselves? This article explores the consequences of stereotyping and confirmation bias using a sample of published articles from the economics literature on gender and risk aversion. The results demonstrate that the supposedly “robust†claim that “women are more risk averse than men†is far less empirically supported than has been claimed. The questions of how these cognitive biases arise and why they have such power are discussed, and methodological practices that may help to attenuate these biases are outlined. |
| Keywords: | stereotyping, bias, confirmation bias, gender, risk aversion, effect size, index of similarity |
| JEL: | D83 D03 D81 J16 B41 C9 |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:mab:wpaper:20&r=upt |
| By: | Tack Yun (Seoul National University); Eunmi Ko (Seoul National University); Jinsook Kim (Seoul National University) |
| Abstract: | Our goal in this paper is two-fold. First, we develop a class of term structure models that allow for the role of bounded rationality by incorporating either information-processing constraint or fear for mis-specification into affine term structure models. We indentify a set of sufficient conditions to generate the observational equivalence between affine term-structure models with rational inattention and a fear for model misspecification. The presence of bounded rationality creates a new additional factor that is not spanned by conventional factors such as level, slope, and curvature factors. Second, our empirical results indicate that substantial amounts of information capacity constraint and robustness preference for model misspecification are needed to explain the observed behavior of yields. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed013:527&r=upt |
| By: | Catia Batista (Universidade Nova de Lisboa); Janis Umblijs (Ragnar Frisch Centre for Economic Research) |
| Abstract: | Do more risk loving migrants opt for self-employment? This is a question especially relevant for policy makers designing selective immigration policies in countries of destination. In order to provide a rigorous answer to it, we use a novel vignette-adjusted measure of risk preferences in the domain of work to investigate the link between risk aversion and entrepreneurship in migrant communities. Using a representative household survey of the migrant population in the Greater Dublin Area, we find a significant negative relationship between risk aversion and entrepreneurship. In addition, our results show that the use of vignettes improves the significance of the results, as they correct for differential item functioning (where respondents interpret the self-evaluation scale in different ways) between entrepreneurs and non-entrepreneurs, and corrects for variation in the use of self-evaluation scales between migrants from different countries of origin. |
| Keywords: | Migration, Risk Aversion, Entrepreneurship |
| JEL: | F22 J01 J15 J61 L26 |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:crm:wpaper:1325&r=upt |
| By: | Itai Arieli; Robert J. Aumann |
| Abstract: | The logic of backward induction (BI) in perfect information (PI) games has been intensely scrutinized for the past quarter century. A major development came in 2002, when P. Battigalli and M. Sinischalchi (BS) showed that an outcome of a PI game is consistent with common strong belief of utility maximization if and only if it is the BI outcome. Both BS's formulation, and their proof, are complex and deep. We show that the result continues to hold when utility maximization is replaced by a rationality condition that is even more compelling; more important, the formulation and proof become far more transparent, accessible, and self-contained. |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:huj:dispap:dp652&r=upt |
| By: | Lingjiong Zhu |
| Abstract: | The optimal strategies for a long-term static investor are studied. Given a portfolio of a stock and a bond, we derive the optimal allocation of the capitols to maximize the expected long-term growth rate of a utility function of the wealth. When the bond has constant interest rate, three models for the underlying stock price processes are studied: Heston model, 3/2 model and jump diffusion model. We also study the optimal strategies for a portfolio in which the stock price process follows a Black-Scholes model and the bond process has a Vasicek interest rate that is correlated to the stock price. |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1311.6179&r=upt |
| By: | Alan Duncan (Bankwest Curtin Economics Centre (BCEC), Curtin University); Mark Harris (School of Economics and Finance, Curtin University); Anthony Harris (Centre for Health Economics (CHE), Monash University); Eugenio Zucchelli (University of Lancaster, UK) |
| Abstract: | This paper proposes a discrete-choice behavioural model of labour supply to examine the role of ill-health on single parents’ employment. The model provides estimates of individual preferences over a given set of labour market states and allows these preferences to be influenced by a measure of mental health, a latent health index purged of reporting bias and various measures of health shocks. Exploiting longitudinal data from the HILDA Survey, we find that psychological well-being, ill-health and health shocks significantly influence single parents’ marginal disutility of work and marginal utility of income. Further, we apply behavioural microsimulation methods to estimate the likely labour supply responses among single parents in Australia from restricting eligibility to access disability support via the Australian Disability Support Pension (DSP) scheme. Our simulation exercise reveals that imposing tighter DSP eligibility rules has a moderate but positive effect on single mothers’ employment. |
| Keywords: | health, disability, wellbeing, health shocks, discrete choice, behavioural microsimulation, labour supply |
| JEL: | C10 C25 C51 I10 I19 J01 |
| Date: | 2013–07 |
| URL: | http://d.repec.org/n?u=RePEc:ozl:bcecwp:wp1307&r=upt |
| By: | Ingmar Schumacher |
| Abstract: | This model provides a mechanism explaining the surge in environmental culture across the globe. We discuss empirical evidence on the determinants of environmental culture and preferences. Based upon this empirical evidence, we develop an overlapping generations model with environmental quality and endogenous environmental culture. The model predicts that for low wealth levels, society is unable to free resources for environmental culture. In this case, society will only invest in environmental maintenance if environmental quality is suffciently low. Once society has reached a certain level of economic development, then it may optimally invest a part of its wealth in developing an environmental culture. Environmental culture has not only a positive impact on environmental quality through lower levels of consumption, but it improves the environment through maintenance expenditure for wealth-environment combinations at which, in a restricted model without environmental culture, no maintenance would be undertaken. Environmental culture leads to a society with a higher indirect utility at steady state in comparison to the restricted model. Our model leads us to the conclusion that, for societies trapped in a situation with low environmental quality, investments in culture may induce positive feedback loops, where more culture raises environmental quality which in turn raises environmental culture. We also discuss how environmental culture may lead to an Environmental Kuznets Curve. |
| Keywords: | environmental culture; overlapping generations model; environment; endogenous preferences. |
| JEL: | Z1 Q56 D90 |
| Date: | 2013–11–07 |
| URL: | http://d.repec.org/n?u=RePEc:eus:ce3swp:0413&r=upt |
| By: | Strulik, Holger |
| Abstract: | This paper provides the exact analytical solution for the standard model of endogenous growth when consumers have present-biased preferences and make time-inconsistent savings plans, which they revise continuously. It is shown that long-run growth is not necessarily lower under present-biased preferences. In fact, an equivalence result holds. If hyperbolical discounting provides the same present value of a constant infinite income stream as standard exponential discounting, then the equilibrium rate of economic growth is also the same under both discounting methods. In this sense present-bias and the entailed time-inconsistency of savings plans are harmless for economic growth. The result is robust to the introduction of non-homothetic utility and a variable elasticity of intertemporal substitution in consumption. -- |
| Keywords: | hyperbolic discounting,time-inconsistency,endogenous growth,adjustment dynamics |
| JEL: | D91 E21 O40 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cegedp:175&r=upt |
| By: | Cevikarslan, Salih (UNU-MERIT, and SBE, Maastricht University) |
| Abstract: | The aims of this paper are twofold. The first is to analyse the interaction between research and development (R&D) activities of firms and heterogeneous consumer preferences in structuring the evolution of an industry. The second is to explore the effects of patent life and patent breadth on market outcomes. To answer these research questions, an evolutionary, multi-agent based, sector-level cumulative innovation model is designed. The model addresses supply and demand sides of the market simultaneously with the co-evolution of heterogeneous consumer preferences, heterogeneous firm knowledge bases and technology levels at the micro level. In line with the evolutionary modelling tradition, we have a search algorithm-innovation and imitation of products by firms - a selection of algorithm-revealed preferences of the consumers - and a population of objects in which variation is expressed and on which selection operates: namely, firms (Windrum, 2004). Firms compete on quality and price of their products in an oligopolistic market whereas consumers, constrained by their computational limits, act to maximize their utility with their product choices in a boundedly rational way. There is continuous firm entry and exit depending on the competitive performance of the firms. |
| Keywords: | Patents, industrial dynamics, evolutionary economics, agent-based modelling |
| JEL: | B52 L11 O34 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:unm:unumer:2013020&r=upt |