nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2014‒08‒20
eleven papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Is the Flat Tax Optimal under Income Risk? By Dominique Henriet; Patrick Pintus; Alain Trannoy
  2. Affective Utilities: A Rational Theory of Optimistic Bias in Asset Markets By Anat Bracha; Donald J. Brown
  3. Not-So-Strong Evidence for Gender Differences in Risk Taking By Julie A. Nelson
  4. Keep Up With the Winners: Experimental Evidence on Risk Taking, Asset Integration, and Peer Effects By Marcel Fafchamps; Bereket Kebede; Daniel John Zizzo
  5. Probabilistic opinion pooling generalized Part one: General agendas By Dietrich, Franz; List, Christian
  6. Psychological Incentives, Financial Incentives, and Risk Attitudes in Tournaments: An Artefactual Field Experiment By C. Bram Cadsby; Jim Engle-Warnick; Tony Fang; Fei Song
  7. Occupational Sorting of School Graduates: The Role of Economic Preferences By Fouarge, Didier; Kriechel, Ben; Dohmen, Thomas
  8. Indifference Bands for Route Switching By Xuan Di; Henry X. Liu; Shanjiang Zhu; David Levinson
  9. Confronting the Representative Consumer with Household-Size Heterogeneity By Christos Koulovatianos; Carsten Schröder; Ulrich Schmidt
  10. The Elasticity of Intergenerational Substitution, Parental Altruism, and Fertility Choice By Cordoba, Juan Carlos; Ripoll, Marla
  11. Fair Accumulation under Risky Lifetime By Grégory Ponthière

  1. By: Dominique Henriet (École Centrale Marseille (Aix-Marseille School of Economics), CNRS & EHES); Patrick Pintus (Aix-Marseille Universit´e (Aix-Marseille School of Economics), CNRS & EHESS); Alain Trannoy (Aix-Marseille Universite (Aix-Marseille School of Economics) CNRS EHESS)
    Abstract: We derive testable conditions ensuring that the income tax is optimal when agents are ex-ante identical but face idiosyncratic income risk. The optimal tax depends positively on both absolute risk aversion and risk variance and negatively on labor supply elasticity and absolute prudence. The comparison with the formula of the optimal non-linear income tax provides the restrictions on both the preferences and the income distribution conditional on effort ensuring that the optimal tax is indeed linear. In general it requires that the ratio of absolute prudence to absolute risk aversion be no less than two; if the income density has a linear likelihood ratio, it requires a (generalized) logarithmic consumption utility. Under HARA utility and linear or logarithmic likelihood ratios, explicit solutions for the optimal non-linear income tax are derived.
    Keywords: Optimal Income Taxation, Income Risk, Linear and Nonlinear Income Tax.
    JEL: H21 H24
    Date: 2014–05–30
  2. By: Anat Bracha (Federal Reserve Bank of Boston); Donald J. Brown (Dept. of Economics, Yale University)
    Abstract: The equilibrium prices in asset markets, as stated by Keynes (1930): "...will be fixed at the point at which the sales of the bears and the purchases of the bulls are balanced." We propose a descriptive theory of finance explicating Keynes' claim that the prices of assets today equilibrate the optimism and pessimism of bulls and bears regarding the payoffs of assets tomorrow. This equilibration of optimistic and pessimistic beliefs of investors is a consequence of investors maximizing affective utilities subject to budget constraints defined by market prices and investor's income. The set of affective utilities is a new class of non-expected utility functions representing the attitudes of investors for optimism or pessimism, defined as the composition of the investor's attitudes for risk and her attitudes for ambiguity. Bulls and bears are defined respectively as optimistic and pessimistic investors.
    Keywords: Risk, Ambiguity, Irrational Exuberance
    JEL: D81 G02 G11
    Date: 2013–06
  3. By: Julie A. Nelson
    Keywords: cognitive schema, fear, gender, risk aversion, stereotypes
    Date: 2013–09
  4. By: Marcel Fafchamps (University of Oxford); Bereket Kebede (University of East Anglia); Daniel John Zizzo (University of East Anglia)
    Abstract: The paper reports the result of an experimental game on asset integration and risk taking. We find evidence that winnings in earlier rounds affect risk taking in subsequent rounds, but no evidence that real life wealth outside the experiment affects risk taking. We and some evidence of imitation of the risk taking behavior of others that is distinct from learning. Controlling for past winnings, participants who receive a low endowment in a round engage in more risk taking. We also test a keeping-up-with-the-Joneses hypothesis and find some evidence that subjects seek to keep up with winners. Taken together, the evidence is consistent with risk taking tracking a reference point that is affected by social comparisons.
    Date: 2014
  5. By: Dietrich, Franz; List, Christian
    Abstract: How can different individuals' probability assignments to some events be aggregated into a collective probability assignment? Classic results on this problem assume that the set of relevant events -- the agenda -- is a σ-algebra and is thus closed under disjunction (union) and conjunction (intersection). We drop this demanding assumption and explore probabilistic opinion pooling on general agendas. One might be interested in the probability of rain and that of an interest-rate increase, but not in the probability of rain or an interest-rate increase. We characterize linear pooling and neutral pooling for general agendas, with classic results as special cases for agendas that are σ-algebras. As an illustrative application, we also consider probabilistic preference aggregation. Finally, we unify our results with existing results on binary judgment aggregation and Arrovian preference aggregation. Our unified theorems show why the same kinds of axioms (independence and consensus preservation) have radically different implications for different aggregation problems: linearity for probability aggregation and dictatorship for binary judgment or preference aggregation.
    Keywords: Probabilistic opinion pooling, judgment aggregation, subjective probability, probabilistic preferences, vague/fuzzy preferences, agenda characterizations, a unified perspective on aggregation
    JEL: D70 D71 D8 D80
    Date: 2013–05
  6. By: C. Bram Cadsby (Department of Economics and Finance, University of Guelph); Jim Engle-Warnick (McGill University); Tony Fang (Monash University); Fei Song (Ryerson University)
    Abstract: Tournaments are widely used to assign bonuses and determine promotions. Tournament-based compensation is motivating because of the link between relative performance and financial rewards. However, performing relatively well (poorly) may also yield psychological benefits (pain). This may also stimulate effort. Through a real-effort artefactual field experiment with factory workers in China, we examine how both psychological and financial incentives, together with attitudes toward risk, may influence motivation and performance. For comparison purposes, Chinese undergraduate students also participated in a comparable laboratory experiment. We provided performance-ranking information both privately and publicly, with and without rank based financial incentives. Our results show that performance-ranking information had a significant motivational effect on average performance for students, but not for workers. Adding financial incentives based on rank provided little evidence of further improvements. Much of the difference between workers and students can be explained by differences in attitudes toward risk. Indeed, for both groups the size of both financial and psychological incentive effects is inversely related to individual levels of risk aversion, and is positive and significant both for workers and for students who are sufficiently risk-tolerant. Lastly, performance did not deteriorate when incentives were removed, suggesting that they worked through the encouragement of learning.
    Keywords: incentives, social comparison, performance feedback, peer pressure, tournament, risk aversion, artefactual field experiment
    JEL: C91
    Date: 2014
  7. By: Fouarge, Didier (ROA, Maastricht University); Kriechel, Ben (Economix Research & Consulting); Dohmen, Thomas (University of Bonn)
    Abstract: We relate risk attitudes and patience of young graduates from high-school, college and university, measured around the time that they start their labor market career in a large representative survey, to the riskiness and timing of earnings in the occupations they choose to work in. We find a systematic positive and significant relation between willingness to take risks and measures of occupational earnings risks and employment risk that we derive from a large administrative data set. Patient individuals are significantly more likely to choose for occupations with a steep earnings profile. Individuals whose economic preferences are not well aligned with the riskiness and timing of earnings in their initial occupation are more likely to change to an occupation that better matches their economic preferences.
    Keywords: risk preferences, earnings risk, sorting, occupational choice
    JEL: J24 J31 D01
    Date: 2014–07
  8. By: Xuan Di; Henry X. Liu; Shanjiang Zhu; David Levinson (Nexus (Networks, Economics, and Urban Systems) Research Group, Department of Civil Engineering, University of Minnesota)
    Abstract: The replacement I-35W bridge in Minneapolis saw less traffic than the original bridge though it provided substantial travel time saving for many travelers. This observation cannot be explained by the classical route choice assumption that travelers always take the shortest path. Accordingly, a boundedly rational route switching model is proposed assuming that travelers will not switch to the new bridge unless travel time saving goes beyond a threshold or “indifference bandâ€. To validate the boundedly rational route switching assumption, route choices of 78 subjects from a GPS travel behavior study were analyzed before and after the addition of the new I-35W bridge. Indifference bands are estimated for both commuters who were previously bridge users and those who never had the experience of using the old bridge. This study offers the first empirical estimation of bounded rationality parameters from GPS data and provides guidelines for traffic assignment.
    Keywords: Route Choice, Travel Demand Modeling, Bounded Rationality, Indifference Band, GPS Study, Travel Behavior, Networks
    JEL: R40
    Date: 2014
  9. By: Christos Koulovatianos (CREA, Université de Luxembourg); Carsten Schröder (DIW, Free University of Berlin,); Ulrich Schmidt (IFW, University of Kiel)
    Abstract: Most simulated micro-founded macro models use solely consumer-demand aggregates in order to estimate deep economy-wide preference parameters, which are useful for policy eva- luation. The underlying demand-aggregation properties that this approach requires, should be easy to empirically disprove: since household-consumption choices differ for households with more members, aggregation can be rejected if appropriate data violate an affine equa- tion regarding how much individuals benefit from within-household sharing of goods. We develop a survey method that tests the validity of this equation, without utility-estimation restrictions via models. Surprisingly, in six countries, this equation is not rejected, lending support to using consumer-demand aggregates.
    Keywords: Linear Aggregation, Dynamic Representative Consumer, Household-Size Economies, Equivalent Income, Survey Method
    JEL: C42 E21 D12 E01 D11 D91 D31 I32
    Date: 2014
  10. By: Cordoba, Juan Carlos; Ripoll, Marla
    Abstract: Dynastic models common in macroeconomics use a single parameter to control the willingness of individuals to substitute consumption both intertemporally, or across periods, and intergenerationally, or across parents and their children. This paper defines the concept of Elasticity of Intergenerational Substitution (EGS), and extends a standard dynastic model in order to disentangle the EGS from the EIS, or Elasticity of Intertemporal Substitution. A calibrated version of the model lends strong support to the notion that the EGS is significantly large than 1, and probably around 2.5. In contrast, estimates of the EIS suggests that it is lower than 1. What disciplines the identification is the need to match empirically plausible fertility rates for the U.S.
    Keywords: Altruism; non-separable utility; intertemporal substitution; intergenerational substitution; value of a child
    JEL: D10 D64 D91 J13
    Date: 2014–08–01
  11. By: Grégory Ponthière (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), EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: Individuals save for their old days, but not all of them enjoy the old age. This paper characterizes the optimal capital accumulation in a two-period OLG model where lifetime is risky and varies across individuals. We compare two long-run social optima: (1) the average utilitarian optimum, where steady-state average welfare is maximized; (2) the egalitarian optimum, where the welfare of the worst-o¤ at the steady-state is maximized. It is shown that, under plausible conditions, the egalitarian optimum involves a higher capital and a lower fertility than the utilitarian optimum. Those inequalities hold also in a second-best framework where survival conditions are exogenously linked to the capital level.
    Keywords: Egalitarianism ; Differentiated Mortality ; Optimal Capital Accumulation ; Golden Rule ; Fertility
    Date: 2012–10

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