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on Utility Models and Prospect Theory |
| By: | Sujoy Mukerji; Peter Klibanoff; Kyoungwon Seo |
| Abstract: | We axiomatize preferences that can be represented by a monotonic aggregation of subjective expected utilities generated by a utility function and some set of i.i.d. probability measures over a product state space, S1. For such preferences, we define relevant measures, show that they are treated as if they were the only marginals possibly governing the state space and connect them with the measures appearing in the aforementioned representation. These results allow us to interpret relevant measures as reflecting part of perceived ambiguity, meaning subjective uncertainty about probabilities over states. Under mild conditions, we show that increases or decreases in ambiguity aversion cannot affect the relevant measures. This property, necessary for the conclusion that these measures reflect only perceived ambiguity, distinguishes the set of relevant measures from the leading alternative in the literature. We apply our findings to a number of well-known models of ambiguity-sensitive preferences. For each model, we identify the set of relevant measures and the implications of comparative ambiguity aversion. |
| Keywords: | Symmetry, beliefs, ambiguity, ambiguity aversion, sets of probabilities |
| JEL: | D01 D80 D81 D83 |
| Date: | 2014–06–10 |
| URL: | http://d.repec.org/n?u=RePEc:oxf:wpaper:711&r=upt |
| By: | Roman V. Belavkin (Middlesex University London) |
| Abstract: | The von Neumann and Morgenstern theory postulates that rational choice under uncertainty is equivalent to maximization of expected utility (EU). This view is mathematically appealing and natural because of the affine structure of the space of probability measures. Behavioural economists and psychologists, on the other hand, have demonstrated that humans consistently violate the EU postulate by switching from risk-averse to risk-taking behaviour. This paradox has led to the development of descriptive theories of decisions, such as the celebrated prospect theory, which uses an S-shaped value function with concave and convex branches explaining the observed asymmetry. Although successful in modelling human behaviour, these theories appear to contradict the natural set of axioms behind the EU postulate. Here we show that the observed asymmetry in behaviour can be explained if, apart from utilities of the out comes, rational agents also value information communicated by random events. We review the main ideas of the classical value of information theory and its generalizations. Then we prove that the value of information is an S-shaped function, and that its asymmetry does not depend on how the concept of information is defined, but follows only from linearity of the expected utility. Thus, unlike many descriptive and `non-expected' utility theories that abandon the linearity (i.e. the `independence' axiom), we formulate a rigorous argument that the von Neumann and Morgenstern rational agents should be both risk-averse and risk-taking if they are not indifferen to information. |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:beb:wpseet:201403&r=upt |
| By: | David Kelsey (Department of Economics, University of Exeter); Sara le Roux (Department of Economics, Oxford Brookes University) |
| Abstract: | We report an experimental test of the influence of ambiguity on behaviour in a coordination game. We study the behaviour of subjects in the presence of ambiguity and attempt to determine whether they prefer to choose an ambiguity safe option. We fi?nd that this strategy, which is not played in either Nash equilibrium or iterated dominance equilibrium, is indeed chosen quite frequently. This provides evidence that ambiguity aversion infl?uences behaviour in games. While the behaviour of the Row Player is consistent with randomising between her strategies, the Column Player shows a marked preference for avoiding ambiguity and choosing his ambiguity-safe strategy. |
| Keywords: | Ambiguity; Choquet expected utility; coordination game; Ellsberg urn, experimental economics. |
| JEL: | C72 C91 D03 D81 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:exe:wpaper:1410&r=upt |
| By: | Christian Robert (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I (UCBL) : EA2429); Pierre-Emmanuel Thérond (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I (UCBL) : EA2429) |
| Abstract: | We consider the class of concave distortion risk measures to study how choice is influenced by the decision-maker's attitude to risk and provide comparative static results. We also assume ambiguity about the probability distribution of the risk and consider a framework à la Klibanoff, Marinacci and Mukerji (2005) to study the value of information that resolves ambiguity. We show that this value increases with greater ambiguity, with greater ambiguity aversion, and in some cases with greater risk aversion. Finally we examine whether a more risk-averse and a more ambiguity-averse individual will invest in more effort to shift his initial risk distribution to a better target distribution. |
| Keywords: | Ambiguity ; dual theory ; risk measures ;distorsion ; optimal effort |
| Date: | 2014–05 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-00813199&r=upt |
| By: | Adler, Matthew; Treich, Nicolas |
| Abstract: | Most economic problems combining risk and equity have been studied under utilitarianism. As an alternative, we study consumption decisions under risk assuming a prioritarian social welfare function. Under a standard assumption about the utility function (i.e., decreasing absolute risk aversion), there is always more current consumption under ex ante prioritarianism than under utilitarianism. Thus, a concern for equity (in the ex ante prioritarian sense) means less concern for the risky future. In contrast, under standard utility and social welfare functions, there is less current consumption under ex post prioritarianism than under utilitarianism. |
| Keywords: | Precautionary savings, utilitarianism, prioritarianism, discounting, climate change. |
| JEL: | D81 E21 I31 |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:28283&r=upt |
| By: | Antoine Billot (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - École des Hautes Études en Sciences Sociales (EHESS) - École des Ponts ParisTech (ENPC) - École normale supérieure [ENS] - Paris - Institut national de la recherche agronomique (INRA), LEMMA - Laboratoire d'économie mathématique et de microéconomie appliquée - Université Paris II - Panthéon-Assas : EA4442 - Sorbonne Universités); Vassili Vergopoulos (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne) |
| Abstract: | While models of ambiguity are reputed to generate a basic tension between dynamic consistency and the Ellsberg choices, this paper identifies a third implicit ingredient of this tension, namely the parsimony rule, which enforces each state of nature to encode a well-defined unique observation. This paper then develops nonparsimonious interpretations of the state space to make the Ellsberg choices compatible with both expected utility and dynamic consistency. The state space may contain nonobservable states: a state is allowed to encode more than one observation, a pattern called state ambiguity. The presence of such ambiguous states motivates an explicit distinction between the decision-maker and the theory-maker, the latter designing the state space and eliciting the former's preferences. |
| Keywords: | Ambiguity ; State of nature ; Epistemics ; Dynamic consistency |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:hal:psewpa:halshs-01006698&r=upt |
| By: | Dziewulski, Pawel |
| Abstract: | Consider an experiment in which subjects are asked to choose between pairs consisting of a monetary payment and a time-delay at which the payment is delivered. Given a finite set of observations, under what conditions the choices of an individual agent can be rationalised by a discounted utility function? We develop an axiomatic characterisation of time-preference with various forms of discounting, including weakly present-biased, quasi-hyperbolic, and exponential, and determine the testable restrictions for each specification. Moreover, we discuss identification issues which may arise in this class of experiments. |
| Keywords: | revealed preference, testable restrictions, rationalisation, time{-}preference, discounted utility |
| JEL: | C14 C60 C61 D11 D12 |
| Date: | 2014–06–11 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:56596&r=upt |
| By: | Zuo Quan Xu |
| Abstract: | One index satisfies the duality axiom if one agent, who is uniformly more risk-averse than another, accepts a gamble, the latter accepts any less risky gamble under the index. Aumann and Serrano (2008) show that only one index defined for so-called gambles satisfies the duality and positive homogeneity axioms. We call it a duality index. This paper extends the definition of duality index to all outcomes including all gambles, and considers a portfolio selection problem in a complete market, in which the agent's target is to minimize the index of the utility of the relative investment outcome. By linking this problem to a series of Merton's optimum consumption-like problems, the optimal solution is explicitly derived. It is shown that if the prior benchmark level is too high (which can be verified), then the investment risk will be beyond any agent's risk tolerance. If the benchmark level is reasonable, then the optimal solution will be the same as that of one of the Merton's series problems, but with a particular value of absolute risk aversion, which is given by an explicit algebraic equation as a part of the optimal solution. According to our result, it is riskier to achieve the same surplus profit in a stable market than in a less-stable market, which is consistent with the common financial intuition. |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1406.4222&r=upt |
| By: | Olivier Bonroy (GAEL - Economie Appliquée de Grenoble - Institut national de la recherche agronomique (INRA) : UR1215 - Université Pierre-Mendès-France - Grenoble II); Stéphane Lemarié (GAEL - Economie Appliquée de Grenoble - Institut national de la recherche agronomique (INRA) : UR1215 - Université Pierre-Mendès-France - Grenoble II); Jean-Philippe Tropeano (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris) |
| Abstract: | The existing literature on credence goods and expert services has overlooked the importance of risk aversion. In this paper we extend a standard expert model of credence goods with verifiable service quality by considering risk-averse consumers. Our results show that the presence of risk aversion reduces the expert's incentive to invest in diagnosis and may thus lead to consumers' mistreatment. |
| Keywords: | Credence goods; Expert services; Risk aversion |
| Date: | 2013–09 |
| URL: | http://d.repec.org/n?u=RePEc:hal:pseose:hal-00976890&r=upt |
| By: | Jérôme Hergueux (IEP Paris - Sciences Po Paris - Institut d'études politiques de Paris - Institut d'Études Politiques [IEP] - Paris - PRES Sorbonne Paris Cité - Fondation Nationale des Sciences Politiques [FNSP]); Nicolas Jacquemet (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, BETA - Bureau d'économie théorique et appliquée - CNRS : UMR7522 - Université de Strasbourg - Université Nancy II) |
| Abstract: | Internet is a very attractive technology for the implementation of experiments, both in order to obtain larger and more diverse samples and as a field of economic research in its own right. This paper reports on an experiment performed both online and in the laboratory, designed to strengthen the internal validity of decisions elicited over the Internet. We use the same subject pool, the same monetary stakes and the same decision interface, and control the assignment of subjects between the Internet and a traditional university laboratory. We apply the comparison to the elicitation of social preferences in a Public Good game, a dictator game, an ultimatum bargaining game and a trust game, coupled with an elicitation of risk aversion. This comparison concludes in favor of the reliability of behaviors elicited through the Internet. We moreover find a strong overall parallelism in the preferences elicited in the two settings. The paper also reports some quantitative differences in the point estimates, which always go in the direction of more other-regarding decisions from online subjects. This observation challenges either the predictions of social distance theory or the generally assumed increased social distance in internet interactions. |
| Keywords: | Social experiment ; Field experiment ; Internet Methodology ; Randomized assignment |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:hal:pseose:halshs-00984211&r=upt |
| By: | Wilman Gomez |
| Abstract: | Abstract: In this chapter, the Smets-Wouters (2003) New Kenesian model is reformulated by introducing the loss aversion utility function developed in chapter two. The purpose of this is to understand how asymmetric real business cycles are linked to asymmetric behavior of agents in a price and wage rigidities set up. The simulations of the model reveal not only that the loss aversion in consumption and leisure is a good mechanism channel for explaining business cycle asymmetries, but also is a good mechanism channel for explaining asymmetric adjustment of prices and wages. Therefore the existence of asymmetries in Phillips Curve. Moreover, loss aversion makes downward rigidities in prices and wages stronger and also reproduces a more severe and persistent fall of the employment. All in all, this model generates asymmetrical real business cycles, asymmetric price and wage adjustment as well as hysteresis. |
| Date: | 2014–06–02 |
| URL: | http://d.repec.org/n?u=RePEc:col:000092:011756&r=upt |
| By: | Marielle Brunette (INRA - INRA Laboratoire d'Economie Forestière - INRA); Jérôme Foncel (Université Lille 3 - Université Lille 3 - université Lille 3); Eric Nazindigouba Kéré (CERDI - Centre d'études et de recherches sur le developpement international - CNRS : UMR6587 - Université d'Auvergne - Clermont-Ferrand I) |
| Abstract: | This paper deals with the forest owner's attitude towards risk and the harvesting decision in several ways. First, we propose to characterize and quantify the forest owner's attitude towards risk. Second, we analyze the determinants of the forest owner's risk attitude. Finally, we determine the impact of the forest owner's risk attitude on the harvesting decision. The French forest owner's risk attitude is tackled by implementing a questionnaire, including a context-free measure borrowed from experimental economics. The determinants of the forest owner's risk attitude and harvesting decision are estimated through a recursive bivariate ordered probit model. We show that French forest owners are characterized by a relative risk aversion coefficient close to 1. In addition, we found that the forest owner's risk aversion is influenced positively and significantly by gender (female), age, and willingness to protect the environment, while the percentage of forest income in the total patrimony of the forest owner has a negative effect. Finally, we obtain that the forest owner's risk aversion positively and significantly impacts the harvesting decision. |
| Keywords: | Forest owner's risk attitude; Risk aversion; Harvesting decision. |
| Date: | 2014–06–12 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-01005200&r=upt |
| By: | Roberto Casarin (Department of Economics, University of Venice Cà Foscari); Monica Billio (Department of Economics, University of Venice, Cà Foscari); Anthony Osuntuyi (Department of Mathematics, Obafemi Awolowo University) |
| Abstract: | A new Bayesian multi-chain Markov Switching GARCH model for dynamic hedging in energy futures markets is developed by constructing a system of simultaneous equations for the return dynamics on the hedged portfolio and futures. More specifically, both the mean and variance of the hedged portfolio are assumed to be governed by two unobserved discrete state processes, while the futures dynamics is driven by a univariate hidden state process. The noise in both processes are characterized by a MS-GARCH model. This formulation has two main practical and conceptual advantages. First, the different states of the discrete processes can be identified as different volatility regimes. Secondly, the parameters can be easily interpreted as different hedging components. Our formulation also provides an avenue to analyze the contribution of the volatility dynamics and state probabilities to the optimal hedge ratio at each point in time. Moreover, the combination of the expected utility framework with regime-switching models allows the definition of a robust minimum variance hedging strategy to also account for parameter uncertainty. Evidence of changes in the optimal hedging strategies before and after the financial crisis is found when the proposed robust hedging strategy is applied to crude oil spot and futures markets. |
| Keywords: | Energy futures; GARCH; Hedge ratio; Markov-switching. |
| JEL: | C1 C11 C15 C32 F31 G15 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:ven:wpaper:2014:07&r=upt |
| By: | Takashi Kato; Jun Sekine; Hiromitsu Yamamoto |
| Abstract: | A one-factor asset pricing model with an Ornstein--Uhlenbeck process as its state variable is studied under partial information: the mean-reverting level and the mean-reverting speed parameters are modeled as hidden/unobservable stochastic variables. No-arbitrage pricing formulas for derivative securities written on a liquid asset and exponential utility indifference pricing formulas for derivative securities written on an illiquid asset are presented. Moreover, a conditionally linear filtering result is introduced to compute the pricing/hedging formulas and the Bayesian estimators of the hidden variables. |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1406.4275&r=upt |
| By: | Gollier, Christian |
| Abstract: | Weitzman (1998, 2001) proposed a simple “gamma discounting” method to characterize the term structure of discount rates today from the sole distribution of future spot interest rates. This rule which justifies using a smaller discount rate for longer maturities is now used for long-term policy evaluations in the UK, France, Norway, and potentially in the US. But we show that there is no social preference within the discounted expected utility framework that generically supports this pricing model and its underlying criterion, the expected net present value rule. Considering a standard Lucas tree economy, we characterize the term structure from the joint distribution of future spot interest rates and future consumption levels. When future growth rates are serially correlated, efficient discount rates today are decreasing with maturity, and the gamma discounting rule yields discount rates that are larger than the efficient ones. |
| Keywords: | decreasing discount rates, term structure, uncertain growth, Weitzman-Gollier puzzle. |
| JEL: | E43 G11 G12 Q54 |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:ide:wpaper:28260&r=upt |
| By: | Jan Kabatek (Tilburg University [Tilburg] - Netspar); Arthur Van Soest (Tilburg University [Tilburg] - Netspar); Elena Stancanelli (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris) |
| Abstract: | Earlier studies suggest that income taxation may affect not only labour supply but also domestic work. Here we investigate the impact of income taxation on partners' labour supply and housework, using data for France that taxes incomes of married couples jointly. We estimate a household utility model in which the marginal utilities of leisure and housework of both partners are modelled as random coefficients, depending on observed and unobserved characteristics. We conclude that both partners' market and housework hours are responsive to changes in the tax system. A policy simulation suggests that replacing joint taxation of married spouses' incomes with separate taxation would increase the husband's housework hours by 1.3% and reduce his labour supply by 0.8%. The wife's market hours would increase by 3.7%, and her housework hours would fall by 2.0%. |
| Keywords: | Time use; Taxation; Discrete choice models |
| Date: | 2014–04 |
| URL: | http://d.repec.org/n?u=RePEc:hal:pseose:hal-00966801&r=upt |