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on Utility Models and Prospect Theory |
| By: | Krahnen, Jan Pieter; Ockenfels, Peter; Wilde, Christian |
| Abstract: | This paper provides a systematic analysis of individual attitudes towards ambiguity, based on laboratory experiments. The design of the analysis allows to capture individual behavior across various levels of ambiguity, ranging from low to high. Attitudes towards risk and attitudes towards ambiguity are disentangled, providing pure measures of ambiguity aversion. Ambiguity aversion is captured in several ways, i.e. as a discount factor net of a risk premium, and as an estimated parameter in a generalized utility function. We find that ambiguity aversion varies across individuals, and with the level of ambiguity, being most prominent for intermediate levels. Around one third of subjects show no aversion, one third show maximum aversion, and one third show intermediate levels of ambiguity aversion, while there is almost no ambiguity seeking. While most theoretical work on ambiguity builds on maxmin expected utility, our results provide evidence that MEU does not adequately capture individual attitudes towards ambiguity for the majority of individuals. Instead, our results support models that allow for intermediate levels of ambiguity aversion. Moreover, we find risk aversion to be statistically unrelated to ambiguity aversion on average. Taken together, the results support the view that ambiguity is an important and distinct argument in decision making under uncertainty. -- |
| Keywords: | ambiguity,valuation discount,experimental economics |
| JEL: | D81 G02 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:safewp:55&r=upt |
| By: | Othón M. Moreno |
| Abstract: | The focus of this paper is to analyze the effect that ambiguity will have on the buyer's reservation price and the value of the option to purchase the durable good with an embedded option to resell it. The agent is assumed to be risk neutral and ambiguity averse. The problem is formulated as an optimal stopping problem with multiple priors in continuous time with infinite horizon. Uncertainty comes from prices, which is summarized in a state variable that follows a Brownian motion. Preferences have a multiple-prior utility representation where the set of priors consist of a family of Brownian motions with unknown drift and common variance. We show that the direction of the change in the buyer's reservation price depends on the parametrization of the model and that the value of the embedded option is decreasing in the perceived level of ambiguity. |
| Keywords: | Ambiguity, optimal stopping, embedded option, durable goods |
| JEL: | C61 D81 D91 |
| Date: | 2014–01 |
| URL: | http://d.repec.org/n?u=RePEc:bdm:wpaper:2014-02&r=upt |
| By: | Marielle Brunette (Laboratoire d'Economie Forestière, INRA - AgroParisTech); Stéphane Couture (INRA, UR 875 Applied Mathematics and Computer Science laboratory) |
| Abstract: | In this paper, we propose to analyse the choice of risk management activity made by a non-industrial private forest owner who derives utility from consumption and from the sentimental value of the forest that bears a risk of disaster. We consider a bivariate utility function depending on consumption and sentimental value of forest. In this context, we analyse insurance and/or self-insurance decisions. We show that, under fair premium, full insurance is optimal only if the cross derivative of the utility function equals zero. Under-insurance and over-insurance may also be optimal depending on the sign of this cross derivative. We also show that, under a positive loading factor, optimal partial insurance is validated only if the cross derivative is positive; otherwise full insurance may be optimal even with a loading insurance. We also observe that risk aversion increases the level of insurance demand and selfinsurance activity, extending this standard result obtained with an univariate utility function to a bivariate utility function. Moreover, when the forest owner can simultaneously insure and invest in self-insurance activity, full insurance is never optimal if the cross derivative is positive. Finally, we prove that insurance and selfinsurance may be substitutes, and if preferences are separable and exhibit decreasing absolute risk aversion, then insurance and self-insurance are always considered as substitutes. |
| Keywords: | Forest management, insurance, self-insurance, bivariate utility, risk. |
| JEL: | D81 Q26 Q23 |
| Date: | 2014–01 |
| URL: | http://d.repec.org/n?u=RePEc:lef:wpaper:2014-01&r=upt |
| By: | McClellon, M. |
| Abstract: | This paper introduces and axiomatizes a new class of representations for incomplete preferences called confidence models. Confidence models describe decision makers who behave as if they have probabilistic uncertainty over their true preferences, and are only willing to express a binary preference if it is sufficiently likely to hold. Confidence models are flexible enough to model behavior on a variety of domains, and they are general enough to nest the popular multi-utility models of incomplete preferences. Most importantly, they provide a natural way to connect incomplete preferences with stochastic choice. This connection is characterized by a simple condition that serves to identify the behavioral content of incomplete preferences. |
| Date: | 2014–01 |
| URL: | http://d.repec.org/n?u=RePEc:qsh:wpaper:144976&r=upt |
| By: | Baillon, Aurélien; Halevy, Yoram; Li, Chen |
| Abstract: | We demonstrate how the standard usage of the random incentive system in ambiguity experiments is not incentive compatible if the decision maker is ambiguity averse. We propose a slight modification of the procedure in which the randomization takes place before decisions are made and the state is realized and prove that if subjects evaluate the experimental environment in that way (first - risk, second - uncertainty), incentive compatibility may be restored. |
| Keywords: | Uncertianty, Design of Experiments |
| JEL: | D81 C9 |
| Date: | 2014–06–15 |
| URL: | http://d.repec.org/n?u=RePEc:ubc:pmicro:yoram_halevy-2014-26&r=upt |
| By: | Igor Mouraviev (Center for Mathematical Economics, Bielefeld University); Frank Riedel (Center for Mathematical Economics, Bielefeld University); Linda Sass (Center for Mathematical Economics, Bielefeld University) |
| Abstract: | The paper generalizes Kuhn's Theorem to extensive form games in which players condition their play on the realization of ambiguous randomization devices and use a maxmin decision rule to evaluate the consequences of their decisions. It proves that ambiguous behavioral and ambiguous mixed strategies are payoff- and outcome equivalent only if the latter strategies satisfy a rectangularity condition. The paper also discusses dynamic consistency. In particular, it shows that not only the profile of ambiguous strategies must be appropriately chosen but also the extensive form must satisfy further restrictions beyond those implied by perfect recall in order to ensure that each player respects her ex ante contingent choice with the evolution of play. |
| Keywords: | Kuhn's Theorem, Strategic Ambiguity, Maxmin Utility, Ellsberg Games |
| JEL: | C72 D81 |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:bie:wpaper:510&r=upt |
| By: | Nicholas Longford |
| Abstract: | A method of small-area estimation with a utility function is developed. The utility characterises a policy planned to be implemented in each area, based on the area's estimate of a key quantity. It is shown by simulations that the commonly applied composite and empirical Bayes estimators are inefficient for a wide range of asymmetric utility functions. Adaptations for limited budget to implement the policy are explored. An argument is presented for a closer integration of estimation and (regional) policy making because no single small- area estimator is suitable for a wide range of purposes. |
| Keywords: | Composition; empirical Bayes; expected loss; borrowing strength; exploiting similarity; small-area estimation; utility function. |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:upf:upfgen:1427&r=upt |
| By: | Kraft, Holger; Seiferling, Thomas; Seifried, Frank Thomas |
| Abstract: | We study consumption-portfolio and asset pricing frameworks with recursive preferences and unspanned risk. We show that in both cases, portfolio choice and asset pricing, the value function of the investor/representative agent can be characterized by a specific semilinear partial differential equation. To date, the solution to this equation has mostly been approximated by Campbell-Shiller techniques, without addressing general issues of existence and uniqueness. We develop a novel approach that rigorously constructs the solution by a fixed point argument. We prove that under regularity conditions a solution exists and establish a fast and accurate numerical method to solve consumption-portfolio and asset pricing problems with recursive preferences and unspanned risk. Our setting is not restricted to affine asset price dynamics. Numerical examples illustrate our approach. -- |
| Keywords: | consumption-portfolio choice,asset pricing,stochastic differential utility,incomplete markets,fixed point approach,FBSDE |
| JEL: | G11 G12 D52 D91 C61 C68 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:safewp:52&r=upt |
| By: | Martin Le Doux Mbele Bidima; Mikl\'os R\'asonyi |
| Abstract: | Consider a discrete-time infinite horizon financial market model in which the logarithm of the stock price is a time discretization of a stochastic differential equation. Under conditions different from those given in a previous paper of ours, we prove the existence of investment opportunities producing an exponentially growing profit with probability tending to $1$ geometrically fast. This is achieved using ergodic results on Markov chains and tools of large deviations theory. Furthermore, we discuss asymptotic arbitrage in the expected utility sense and its relationship to the first part of the paper. |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1406.5312&r=upt |
| By: | Rosato, Antonio |
| Abstract: | Empirical evidence from sequential auctions shows that prices of identical goods tend to decline between rounds. In this paper, I show how expectations-based reference-dependent preferences and loss aversion can rationalize this phenomenon. I analyze two-round sealed-bid auctions with symmetric bidders having independent private values and unit demand. Equilibrium bids in the second round are history-dependent and subject to a "discouragement effect": the higher the winning bid in the first auction is, the less aggressive the behavior of the remaining bidders in the second auction. When choosing his strategy in the first round, however, a bidder conditions his bid on being pivotal and hence expects not to be discouraged. Equilibrium behavior, therefore, leads the winner of the first round to overestimate the bid of his highest opponent and hence the next-round price so that equilibrium prices decline. Moreover, sequential and simultaneous auctions are not bidder-payoff equivalent nor revenue equivalent. |
| Keywords: | Reference-Dependent Preferences; Loss Aversion; Sequential Auctions; Afternoon Effect. |
| JEL: | D03 D44 D81 D82 |
| Date: | 2014–06–21 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:56824&r=upt |
| By: | An Chen; Carla Mereu; Robert Stelzer |
| Abstract: | This paper considers a utility maximization and optimal asset allocation problem in the presence of a stochastic endowment that cannot be fully hedged through trading in the financial market. We rely on the dynamic programming approach to solve the optimization problem. The properties of the value function, particularly the homogeneity, are used to reduce the HJB equation by one dimension. Furthermore, the optimal strategy is derived, and its asymptotic behavior is discussed. |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1406.6245&r=upt |
| By: | Thorne, F.; Loughran, D.; Fox, S.; Mullins, E.; Wallace, M. |
| Abstract: | The introduction of genetically modified (GM) crops to Europe has been a significant source of tension among EU member states. While the political landscape is much divided there is also much unknown at the consumer level. The question of whether European consumers want GM foods made available to them or not has yet to be answered definitively. Hence, this research is considered timely; the objective is to examine willingness to pay (either a positive or negative amount) for GM Late Blight resistant (GMLBR) potatoes in Ireland. The methods used in this study serve as a new departure in the experimental auctions literature, whereby willingness to purchase bids for a new technology can have a positive and negative value in a single experiment. The results show that the majority of consumers’ that participated in the experiment derived a greater utility from the conventional potato product compared to the GM potato product when priced at equivalent values. 3 out of 4 participants required the GM product to be priced at a discount in order for the utility to be derived from the GM product to be the same as the utility derived from the conventional product. However, the findings from this research would indicate that if the entry price point for the GMLBR potato product was correctly positioned then a market for the product could exist. Further investigation of the factors that influenced the participants’ willingness to purchase the GMLBR potato indicated that education level, presence of children in the household and frequency of potato purchases significantly affected the purchase decision. |
| Keywords: | Crop Production/Industries, International Relations/Trade, Political Economy, Research and Development/Tech Change/Emerging Technologies, |
| Date: | 2014–04 |
| URL: | http://d.repec.org/n?u=RePEc:ags:aesc14:169746&r=upt |
| By: | Hannu Salonen (Department of Economics, University of Turku) |
| Abstract: | We study non-cooperative link formation games in which players have to decide how much to invest in relationships with other players. The relationship between equilibrium strategies and network centrality measures are investigated in games where there is a common valuation of players as friends. If the utility from relationships with other players is bilinear, then indegree, eigenvector centrality, and the Katz-Bonacich centrality measure put the players in opposite order than the common valuation. If the utility from relationships is strictly concave, then these measures order the players in the same way as the common valuation. |
| Keywords: | link formation games, centrality measures, complete network |
| JEL: | C72 D43 |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:tkk:dpaper:dp92&r=upt |
| By: | Costel Andonie (City University of Hong Kong); Christoph Kuzmics (Center for Mathematical Economics, Bielefeld University); Brian W. Rogers (Washington University in St. Louis) |
| Abstract: | How should we make value judgments about wealth inequality? Harsanyi (1953) proposes to take an individual who evaluates her well-being by expected utility and ask her to evaluate the wealth possibilities ex-ante (i.e. before she finds her place in society, i.e., under the "veil of ignorance" of Rawls (1971)) assuming that she will be allocated any one of the possible wealth levels with equal probability. We propose a different notion of how wealth levels are allocated, based on a competition or contest. We find that inequality can be captured through the equilibrium properties of such a game. We connect the inequality measures so derived to existing measures of inequality, and demonstrate the conditions under which they satisfy the received key axioms of inequality measures (anonymity, homogeneity and the Pigou-Dalton transfer principle). Our approach also provides a natural way to discuss the tradeoff between greater total wealth and greater inequality. |
| Keywords: | utilitarianism, inequality, contests |
| JEL: | C72 C73 D63 D72 |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:bie:wpaper:512&r=upt |
| By: | Harold L. Cole (Department of Economics, University of Pennsylvania and NBER); Soojin Kim (Krannert School of Management, Department of Economics, Purdue University); Dirk Krueger (Department of Economics, University of Pennsylvania, CEPR, CFS, NBER and Netspar) |
| Abstract: | This paper constructs a dynamic model of health insurance to evaluate the short- and long-run effects of policies that prevent firms from conditioning wages on health conditions of their workers, and that prevent health insurance companies from charging individuals with adverse health conditions higher insurance premia. Our study is motivated by recent US legislation that has tightened regulations on wage discrimination against workers with poorer health status (such as Americans with Disability Act of 1990, ADA, and its amendment in 2008, the ADAAA) and that prohibits health insurance companies from charging different premiums for workers of different health status starting in 2014 (Patient Protection and Affordable Care Act, PPACA). In the model, a trade-off arises between the static gains from better insurance against poor health induced by these policies and their adverse dynamic incentive effects on household efforts to lead a healthy life. Using household panel data from the PSID we estimate and calibrate the model and then use it to evaluate the static and dynamic consequences of no-wage discrimination and no-prior conditions laws for the evolution of the cross-sectional health and consumption distribution of a cohort of households, as well as ex-ante lifetime utility of a typical member of this cohort. In our quantitative analysis we find that although the competitive equilibrium features too little consumption insurance and a combination of both policies is effective in providing such insurance period by period, it is suboptimal to introduce both policies jointly since such a policy innovation severely undermines the incentives to lead healthier lives and thus induces a more rapid deterioration of the cohort health distribution over time. This effect more than offsets the static gains from better consumption insurance so that expected discounted lifetime utility is lower under both policies, relative to implementing wage nondiscrimination legislation alone. This is true despite the fact that both policy options are strongly welfare improving relative to the competitive equilibrium. |
| Keywords: | Health Risks, Social Insurance, Health Effort Choices |
| JEL: | E61 H31 I18 |
| Date: | 2014–04–24 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:14-023&r=upt |