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on Utility Models and Prospect Theory |
| By: | Marie-Cécile Fagart; Claude Fluet |
| Abstract: | We consider decision-makers facing a risky wealth prospect. The probability distribution depends on pecuniary effort, e.g., the amount invested in a venture or prevention expenditures to protect against accidental losses. We provide necessary local conditions and sufficient global conditions for greater risk aversion to induce more (or less) investment or to have no effect. We apply our results to incentives in the principal-agent framework when differently risk averse agents face the same monetary incentives. |
| Keywords: | Expected utility, risk aversion, comparative statics, mean utility preserving increase in risk, location independent risk |
| JEL: | D81 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:lvl:lacicr:1405&r=upt |
| By: | Eric Danan (THEMA - Université Cergy-Pontoise); Thibault Gajdos (GREQAM - Aix Marseille University); Jean-Marc Tallon (Centre d'Economie de la Sorbonne - Paris School of Economics) |
| Abstract: | We provide a generalization of Harsanyi (1955)'s aggregation theorem to the case of incomplete preferences at the individual and social level. Individuals and society have possibly incomplete expected utility preferences that are represented by sets of expected utility functions. Under Pareto indifference, social preferences are represented through a set of aggregation rules that are utilitarian in a generalized sense. Strengthening Pareto indifference to Pareto preference provides a refinement of the representation. |
| Keywords: | Incomplete preferences, aggregation, expected multi-utility, utilitarianism. |
| JEL: | D71 D81 |
| Date: | 2014–01 |
| URL: | http://d.repec.org/n?u=RePEc:mse:cesdoc:14002&r=upt |
| By: | R.A Dana; C. Le Van |
| Abstract: | This article reconsiders the theory of existence of efficient allocations and equilibria when consumption sets are unbounded below under the assumption that agents have incomplete preferences. It is motivated by an example in the theory of assets with short-selling where there is risk and ambiguity. Agents have Bewley’s incomplete preferences. As an inertia principle is assumed in markets, equilibria are individually rational. It is shown that a necessary and sufficient for existence of an individually rational efficient allocation or of an equilibrium is that the relative interiors of the risk adjusted sets of probabilities intersect. The more risk averse, the more ambiguity averse the agents, the more likely is an equilibrium to exist. The paper then turns to incomplete preferences with concave multi-utility representations. Several definitions of efficiency and of equilibrium with inertia are considered. Sufficient conditions and necessary and sufficient conditions are given for existence of efficient allocations and equilibria with inertia. |
| Keywords: | Uncertainty, risk, risk adjusted prior, no arbitrage, equilibrium with short-selling, incomplete preferences, equilibrium with inertia. |
| JEL: | C62 D50 D81 D84 G1 |
| Date: | 2014–01–06 |
| URL: | http://d.repec.org/n?u=RePEc:ipg:wpaper:2014-20&r=upt |
| By: | Astrid Gamba; Elena Manzoni |
| Abstract: | We study theoretically and experimentally decision making under uncertainty in a social environment. We introduce an interdependent preferences model that assumes that the decision maker evaluates monetary outcomes in relation both with his individual and his social reference point. In the experiment we reproduce a workplace environment whereby subjects interact in an effort task, earn (possibly) different wages from this task and then undertake a risky decision that may give them an extra bonus. Controlling for intrinsic risk attitudes, we find that both downward and upward social comparison strongly influence risk attitudes and that they both generate more risk loving behavior. Moreover, we find that a propension to envy counterposes such effect, by increasing risk aversion. |
| Keywords: | Social comparison, risk aversion, interdependent preferences, reference point |
| JEL: | C91 D03 D81 |
| Date: | 2014–01 |
| URL: | http://d.repec.org/n?u=RePEc:mib:wpaper:266&r=upt |
| By: | Aloqeili, M.; Carlier, Guillaume; Ekeland, Ivar |
| Abstract: | We consider H expected utility maximizers that have to share a risky aggregate multivariate endowment X∈RN and address the following two questions: does efficient risk-sharing imply restrictions on the form of individual consumptions as a function of X ? Can one identify the individual utility functions from the observation of the risk-sharing? We show that when H≥2NN−1 efficient risk sharings have to satisfy a system of nonlinear PDEs. Under an additional rank condition, we prove an identification theorem. |
| Keywords: | Multidimensional risk-sharing; Restrictions; Identification; |
| JEL: | C10 D61 D81 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:dau:papers:123456789/12413&r=upt |
| By: | Riedl A.M.; Wölbert E.M. (GSBE) |
| Abstract: | To accurately predict behavior economists need reliable measures of individual time preferences and attitudes toward risk and typically need to assume stability of these characteristics over time and across decision domains. We test the reliability of two choice tasks for eliciting discount rates, risk aversion, and probability weighting and assess the stability of these characteristics over timeand across situations. We find high reliability and that individual characteristics are remarkably stable over time. The estimated parameters correlate well with self-reported decisions in financial domains, but are largely uncorrelated with decisions in other important life domains involving intertemporal trade-offs and risk. |
| Keywords: | Methodological Issues: General; Design of Experiments: Laboratory, Individual; Behavioral Economics: Underlying Principles; Information, Knowledge, and Uncertainty: General; Intertemporal Choice and Growth: General; |
| JEL: | C18 C91 D03 D80 D90 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:unm:umagsb:2013041&r=upt |
| By: | Herings P.J.J.; Houba H (GSBE) |
| Abstract: | We analyze the Condorcet paradox within a strategic bargaining model with majority voting, exogenous recognition probabilities, and no discounting. Stationary subgame perfect equilibria (SSPE) exist whenever the geometric mean of the players' risk coefficients, ratios of utility differences between alternatives, is at most one. SSPEs ensure agreement within finite expected time. For generic parameter values, SSPEs are unique and exclude Condorcet cycles. In an SSPE, at least two players propose their best alternative and at most one player proposes his middle alternative with positive probability. Players never reject best alternatives, may reject middle alternatives with positive probability, and reject worst alternatives. Recognition probabilities represent bargaining power and drive expected delay. Irrespective of utilities, no delay occurs for suitable distributions of bargaining power, whereas expected delay goes to infinity in the limit where one player holds all bargaining power. Contrary to the case with unanimous approval, a player benefits from an increase in his risk aversion. |
| Keywords: | Stochastic and Dynamic Games; Evolutionary Games; Repeated Games; Bargaining Theory; Matching Theory; Political Processes: Rent-seeking, Lobbying, Elections, Legislatures, and Voting Behavior; |
| JEL: | C73 C78 D72 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:unm:umagsb:2013021&r=upt |
| By: | G. Carlier; R.-A. Dana |
| Abstract: | An exchange economy in which agents have convex incomplete preferences defined by families of concave utility functions is consid- ered. Sufficient conditions for the set of efficient allocations and equi- libria to coincide with the set of efficient allocations and equilibria that result when each agent has a utility in her family are provided. Welfare theorems in an incomplete preferences framework therefore hold under these conditions and efficient allocations and equilibria are characterized by first order conditions. |
| Keywords: | incomplete preferences, efficient allocations and equilibria. |
| Date: | 2014–01–06 |
| URL: | http://d.repec.org/n?u=RePEc:ipg:wpaper:2014-19&r=upt |
| By: | Michailova, Julija |
| Abstract: | We investigate the influence of overconfidence and risk aversion on individual financial decision making in the experimental asset markets of the Smith, Suchanek and Williams (1988) type, with no informational asymmetries. Subjects, based on their pre-experimental overconfidence scores, were assigned to the two types of markets: least overconfident subjects formed five “rational” markets and most overconfident subjects formed five “overconfident” markets. The asset market experiment was followed by post hoc risk aversion measurement. Our results revealed that in the suggested setting, performance and trading activity were overconfidence dependent only for female participants. Mistakes in price forecasting, that are negatively correlated with overconfidence, could partially account for the increase in trading activity and losses. In the decreased sample differences in individual outcomes were overconfidence and not risk aversion driven. |
| Keywords: | overconfidence; miscalibration; overprecision; risk aversion; financial decisions; economic experiments |
| JEL: | D81 G11 C90 C91 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:53114&r=upt |
| By: | Dranev Yury (National Research University Higher School of Economics); Fomkina Sofya (National Research University Higher School of Economics) |
| Abstract: | We introduce a new asset pricing model to account for risk asymmetrically in a very natural way. Assuming asymmetric investor behavior we develop a utility function similar to a quadratic utility but include a colog measure for capturing risk attitude. Asymmetry in investor preferences follows the asymmetric relationships between asset and market returns in equilibrium. Moreover the local version of the model depends on the characteristics of domestic markets, which is reflected in the different relationship between asset and market returns. We test the model in the Russian and South African markets and show that market premium in the Russian market is higher than in the South African market. |
| Keywords: | asset pricing models, risk measures, asymmetric investor’s preferences, market risk premium. |
| JEL: | G12 G15 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:hig:wpaper:26/fe/2013&r=upt |
| By: | Karle, Heiko; Kirchsteiger, Georg; Peitz, Martin |
| Abstract: | In this paper we analyze a consumer choice model with price uncertainty, loss aversion, and expectation-based reference points. The implications of this model are tested in an experiment in which participants have to make a consumption choice between two sandwiches. We make use of the fact that participants di er in their reported taste di erence between the two sandwiches and the degree of loss aversion which we measure separately. We find that more loss averse participants are more likely to opt for the cheaper sandwich provided that their reported taste di erence is below some threshold, confirming the model s predictions. -- |
| JEL: | C91 D01 D11 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:vfsc13:79943&r=upt |
| By: | Stoye, Jörg; Kitamura, Yuichi |
| Abstract: | This paper aims at formulating econometric tools for investigating stochastic rationality, using the Random Utility Models (RUM) to deal with unobserved heterogeneity nonparametrically. Theoretical implications of the RUM have been studied in the literature, and in particular this paper utilizes the axiomatic treatment by McFadden and Richter (McFadden and Richter, 1991, McFadden, 2005). A set of econometric methods to test stochastic rationality given a cross-sectional data is developed. This also provides means to conduct policy analysis with minimal assumptions. In terms of econometric methodology, it offers a procedure to deal with nonstandard features implied by inequality restrictions. This might be of interest on its own right, both theoretically and practically. -- |
| JEL: | C14 C33 D12 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:vfsc13:79753&r=upt |
| By: | Tausch F.; Cettolin E. (GSBE) |
| Abstract: | Risk sharing arrangements diminish individuals vulnerability to probabilistic events that negatively affect their financial situation. This is because risk sharing implies redistribution, as lucky individuals support the unlucky ones. We hypothesize that responsibility for risky choices decreases individuals willingness to share risk by dampening redistribution motives, and investigate this conjecture with a laboratory experiment. Responsibility is created by allowing participants to choose between two different risky lotteries before they decide how much risk they share with a randomly matched partner. Risk sharing is then compared to a treatment where risk exposure is randomly assigned. We find that average risk sharing does not depend on whether individuals can control their risk exposure. However, we observe that when individuals are responsible for their risk exposure, risk sharing decisions are systematically conditioned on the risk exposure of the sharing partner, whereas this is not the case when risk exposure is random. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:unm:umagsb:2013045&r=upt |
| By: | Pirschel, Inske; Ahrens, Steffen; Snower, Dennis |
| Abstract: | This paper provides an alternative theory of price adjustment resting on consumer loss aversion in the price dimension. In line with prospect theory the perceived losses from price increases are weighted stronger in the consumer s utility function than the perceived gains resulting from price decreases of equal magnitude. Prices are evaluated relative to a certain reference price which is endogenous, sluggish and depends to the consumer s recent rational price expectations. Two key modeling implications arise: First, demand responses are more elastic for price increases than for price decreases and thus firms face a downward-sloping demand curve that is kinked at the consumer s reference price. Second, changes in the consumer s recent rational price expectations and hence in the consumer s reference price can alter demand through what we call the reference-price-updating effect. We incorporate this into an otherwise standard dynamic neoclassical model of monopolistic competition and analyze price and quantity reactions to various demand shocks. We find that although firms may change their prices flexibly, depending on the size of the shock the prices adjust more or less pronounced than in the standard monopoly model and that prices can even be rigid. Additionally, we find that the price adjustment is asymmetric with respect to shock size and sign and the current state of the business cycle, i.e. pricing is state-dependent. -- |
| JEL: | D03 D21 E31 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:vfsc13:79793&r=upt |
| By: | Florian Ederer (Cowles Foundation & SOM, Yale University); Richard Holden (Australian School of Business, University of New South Wales); Margaret Meyer (Dept. of Economics, Nuffield College) |
| Abstract: | It is often suggested that incentive schemes under moral hazard can be gamed by an agent with superior knowledge of the environment, and that deliberate lack of transparency about the incentive scheme can reduce gaming. We formally investigate these arguments in a two-task moral hazard model in which the agent is privately informed about which task is less costly for him to work on. We examine two simple classes of incentive scheme that are "opaque" in that they make the agent uncertain ex ante about the values of the incentive coefficients in the linear payment rule. We show that, relative to deterministic menus of linear contracts, these opaque schemes induce more balanced efforts, but they also impose more risk on the agent per unit of aggregate effort induced. We identify settings in which optimally designed opaque schemes not only strictly dominate the best deterministic menu but also completely eliminate the efficiency losses from the agent's better knowledge of the environment. Opaque schemes are more likely to be preferred to transparent ones when i) efforts on the tasks are highly complementary for the principal; ii) the agent's privately known preference between the tasks is weak; iii) the agent's risk aversion is significant; and iv) the errors in measuring performance on the tasks have large correlation or small variance. |
| Keywords: | Incentives, Gaming, Contracts, Opacity |
| JEL: | D86 D21 L22 |
| Date: | 2014–01 |
| URL: | http://d.repec.org/n?u=RePEc:cwl:cwldpp:1935&r=upt |
| By: | Herweg, Fabian; Schmidt, Klaus |
| Abstract: | We propose a theory of ex post inefficient renegotiation that is based on loss aversion. When two parties write a long-term contract that has to be renegotiated after the realization of the state of the world, they take the initial contract as a reference point to which they compare gains and losses of the renegotiated transaction. We show that loss aversion makes the renegotiated outcome sticky and materially inefficient. The theory has important implications for the optimal design of long-term contracts. First, it explains why parties often abstain from writing a beneficial long-term contract or why some contracts specify transactions that are never ex post efficient. Second, it shows under what conditions parties should rely on the allocation of ownership rights to protect relationship-specific investments rather than writing a specific performance contract. Third, it shows that employment contracts can be strictly optimal even if parties are free to renegotiate. -- |
| JEL: | C78 D03 D86 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:vfsc13:79772&r=upt |
| By: | Ivan H. Ayala; Alfonso Palacio-Vera |
| Abstract: | The rational expectations hypothesis (REH) is the standard approach to expectations formation in macroeconomics. We discuss its compatibility with two strands of Karl Popper's philosophy: his theory of knowledge and learning, and his "rationality principle" (RP). First, we show that the REH is utterly incompatible with the former. Second, we argue that the REH can nevertheless be interpreted as a heuristic device that facilitates economic modeling and, consequently, it may be justified along the same lines as Popper's RP. We then argue that, our position as to the resolution of this paradox notwithstanding, Popper's philosophy provides a metatheoretical framework with which we can evaluate the REH. Within this framework, the REH can be viewed as a heuristic device or strategy that fulfils the same function as, for instance, the optimizing assumption. However, we believe that the REH imparts a serious methodological bias, since, by implying that macroeconomic instability is caused exclusively by "exogenous" shocks that randomly hit the economy, it precludes the analysis of any sources of inherent instability caused by the making of (nonrandom) errors by individuals, and hence it favors the creation of an institutional configuration that may be ill suited to address this type of instability. |
| Keywords: | Popper; Knowledge; Rational Expectations; Learning; Trial; Error Elimination |
| JEL: | A12 B41 B50 D84 |
| Date: | 2014–01 |
| URL: | http://d.repec.org/n?u=RePEc:lev:wrkpap:wp_786&r=upt |