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on Utility Models and Prospect Theory |
| By: | Ahrens, Steffen; Pirschel, Inske; Snower, Dennis J. |
| Abstract: | We present a new partial equilibrium theory of price adjustment, based on consumer loss aversion. In line with prospect theory, the consumers' perceived utility losses from price increases are weighted more heavily than the perceived utility gains from price decreases of equal magnitude. Price changes are evaluated relative to an endogenous reference price, which depends on the consumers' rational price expectations from the recent past. By implication, 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 consumers' reference price. Firms adjust their prices flexibly in response to variations in this demand curve, in the context of an otherwise standard dynamic neoclassical model of monopolistic competition. The resulting theory of price adjustment is starkly at variance with past theories. We find that - in line with the empirical evidence - prices are more sluggish upwards than downwards in response to temporary demand shocks, while they are more sluggish downwards than upwards in response to permanent demand shocks. -- |
| Keywords: | price sluggishness,loss aversion,state-dependent pricing |
| JEL: | D03 D21 E31 E50 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cauewp:201405&r=upt |
| By: | Tai-Sen HE (Division of Economics, School of Humanities and Social Sciences, Nanyang Technological University, Singapore, 637332.); Fuhai HONG (Division of Economics, School of Humanities and Social Sciences, Nanyang Technological University, Singapore, 637332.) |
| Abstract: | We examine whether prior exposure to environments with a varying degree of risk affects individuals’ risk-taking behavior. Using a laboratory experiment, we find that subjects exposed to a high risk environment exhibit higher levels of risk aversion than those who were exposed to a moderate or low risk environment. This effect is not driven by subjects’ realized outcomes from the risk. The finding has implications for theoretical models of decision-making under uncertainty, and can speak to a few current policy debates. |
| Keywords: | Risk; Risk Aversion; Laboratory Experiment |
| JEL: | D81 C91 |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:nan:wpaper:1403&r=upt |
| By: | Ryan O. Murphy; Robert H.W. ten Brincke |
| Abstract: | Individual risk preferences can be identified by using decision models with tuned parameters that maximally fit a set of risky choices made by a decision maker. A goal of this model fitting procedure is to isolate parameters that correspond to stable risk preferences. These preferences can be modeled as an individual difference, indicating a particular decision maker's tastes and willingness to tolerate risk. Using hierarchical statistical methods we show significant improvements in the reliability of individual risk preference parameters over other common estimation methods. This hierarchal procedure uses population level information (in addition to an individual's choices) to break ties (or near-ties) in the fit quality for sets of possible risk preference parameters. By breaking these statistical ``ties'' in a sensible way, researchers can avoid overfitting choice data and thus better measure individual differences in people's risk preferences. |
| Keywords: | Prospect theory, Risk preference, Decision making under risk, Hierarchical parameter estimation, Maximum likelihood |
| URL: | http://d.repec.org/n?u=RePEc:stz:wpaper:eth-rc-14-005&r=upt |
| By: | Kauffeldt, Florian; Wiesenfarth, Boris |
| Abstract: | We analyze a Hotelling location-then-price duopoly game under demand uncertainty with uniformly distributed consumers in a standard quadratic costs scenario. The novelty of our approach consists of assuming that firms' beliefs are represented by non-extreme-outcome-additive (neo-additive) capacities. We derive firms' subgame-perfect product design decisions under ambiguity. Furthermore, we investigate the influence of ambiguity and ambiguity attitude on equilibrium product differentiation and contrast our results with an environment of risky firms. We find that the impact of the degree of confidence or ambiguity is particularly significant when it comes to delivering accurate explanations for a wide range of phenomena related to observed product design behavior. |
| Keywords: | Hotelling; Confidence; Optimism; Pessimism; Degree of Ambiguity; Choquet Expected Utility; Neo-additive Capacities; Product Differentiation |
| Date: | 2014–04–17 |
| URL: | http://d.repec.org/n?u=RePEc:awi:wpaper:0562&r=upt |
| By: | Bahaji, Hamza |
| Abstract: | This research provides an alternative framework for the analysis of employee stock option exercise patterns. It develops a binomial model where the exercise decision obeys to a policy that maximizes the expected utility to a representative employee exhibiting preferences as described by the Cumulative Prospect Theory (CPT). Using a large database on exercise transactions in 12 US public corporations, I examined the performance of the model in predicting actual exercise patterns. Interestingly, the probability weighting coefficients yielded by the model calibration are consistent with those from the experimental literature. Further, the results suggest that the model outperforms the Expected Utility Theory-based model in predicting actual exercise decisions in the sample. These findings convey the main contribution of this paper: the strong ability of the CPT framework to explain employees exercise behavior. It therefore provides rationale for using this framework in order to get more relevant fair value estimates of stock options. |
| Keywords: | Stock options; Exercise behavior; Cumulative Prospect Theory; Fair value; Option valuation; |
| JEL: | G13 G30 J33 M41 |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:dau:papers:123456789/13098&r=upt |
| By: | Donatella Baiardi; Matteo Manera; Mario Menegatti |
| Abstract: | This paper empirically estimates a micro-founded model which studies the macroeconomic impact of environmental and financial risks on consumption choices in the Mediterranean Region. The analysis is carried out using time series aggregate data for fourteen Mediterranean countries over the period 1965-2008. Our results indicate that both risks and their interaction significantly influence consumption dynamics. Our estimates of the indexes of relative risk aversion and relative prudence, as well as the relative preference for the quality of environment suggest marked cross-country heterogeneity. |
| Keywords: | Consumption, environmental risk, financial risk, prudence, relative risk aversion, relative preference for the quality of environment |
| JEL: | Q50 D81 E21 |
| Date: | 2014–04 |
| URL: | http://d.repec.org/n?u=RePEc:mib:wpaper:271&r=upt |
| By: | Emin Gahramanov; Xueli Tang |
| Abstract: | Despite ample empirical evidence on the prevalence of high discount rates among people, applied, quantitative-theoretical macro studies with exponential discounting often assume low positive, or even negative discount rate values. Relying on recent advances from the numerical optimal control branch of mathematics, we solve a neoclassical, continuous time model of endogenous consumption/saving and labor supply, and show that even if an agent has a moderately high discount rate, his labour supply and consumption behavior will be highly counterfactual. We provide a remedy to such counterfactual findings by augmenting a standard utility function based on recent evidences from the leisure sciences, while maintaining a rational choice approach of neoclassical economics. |
| Keywords: | Bounded control; Numerical Optimal Control; Life-cycle Consumption and Labor-Leisure |
| JEL: | D91 C02 C61 J22 J26 |
| Date: | 2014–03–31 |
| URL: | http://d.repec.org/n?u=RePEc:dkn:econwp:eco_2014_2&r=upt |
| By: | Rong Hai (Department of Economics, University of Chicago); Andrew Postlewaite (Department of Economics, University of Pennsylvania); Dirk Krueger (Department of Economics, University of Pennsylvania) |
| Abstract: | We propose a new category of consumption goods, memorable goods, that generate a flow of utility after consumption. We analyze an otherwise standard consumption model that distinguishes memorable goods from other nondurable goods. Consumers optimally choose lumpy consumption of memorable goods. We then empirically document significant differences between levels and volatilities of memorable and other nondurable good expenditures. In two applications we find that the welfare cost of consumption fluctuations driven by income shocks are significantly overstated if memorable goods are not accounted for and that estimates of excess sensitivity of consumption might be entirely due to memorable goods. |
| Keywords: | Memorable Goods, Consumption Volatility, Welfare Cost |
| JEL: | D91 E21 |
| Date: | 2013–08–23 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:14-012&r=upt |