nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2014‒11‒28
eleven papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Risk, Uncertainty and Entrepreneurship: Evidence from a Lab-in-the-Field Experiment By Koudstaal, Martin; Sloof, Randolph; van Praag, Mirjam C.
  2. Utility from Bequeathing Savings or Utility from Accumulating in the Ramsey Growth Model By Khelifi, Atef
  3. An application of wage bargaining to price negotiation with discount factors varying in time By Ahmet Ozkardas; Agnieszka Rusinowska
  4. University Choice: The Role of Expected Earnings, Non-pecuniary Outcomes and Financial Constraints By Delavande, Adeline; Zafar, Basit
  5. Safe Assets By Robert J. Barro; Andrew Mollerus
  6. Measuring risk preferences in rural Ethiopia: Risk tolerance and exogenous income proxies By Vieider, Ferdinand M.; Beyene, Abebe; Bluffstone, Randall; Dissanayake, Sahan; Gebreegziabher, Zenebe; Martinsson, Peter; Mekonnen, Alemu
  7. Evaluating the Effectiveness of Flood Mitigation Policies in the U.S. By Fan, Qin; Davlasheridze, Meri
  8. Over-aging: Are present human populations too old? By Stelter, Robert
  9. Inequality aversion in long-term contracts By Cato, Susumu; Ebina, Takeshi
  10. Entry into Entrepreneurship, Endogenous Adaption of Risk Attitudes and Entrepreneurial Survival By Matthias Brachert; Walter Hyll; Mirko Titze
  11. Precautionary Saving of Chinese and U.S. Households By Horag Choi; Steven Lugauer; Nelson C. Mark

  1. By: Koudstaal, Martin (University of Amsterdam); Sloof, Randolph (University of Amsterdam); van Praag, Mirjam C. (Copenhagen Business School)
    Abstract: Theory predicts that entrepreneurs have distinct attitudes towards risk and uncertainty, but empirical evidence is mixed. To better understand the unique behavioral characteristics of entrepreneurs and the causes of these mixed results, we perform a large 'lab-in-the-field' experiment comparing entrepreneurs to managers – a suitable comparison group – and employees (n = 2288). The results indicate that entrepreneurs perceive themselves as less risk averse than managers and employees, in line with common wisdom. However, when using experimental incentivized measures, the differences are subtler. Entrepreneurs are only found to be unique in their lower degree of loss aversion, and not in their risk or ambiguity aversion. This combination of results might be explained by our finding that perceived risk attitude is not only correlated to risk aversion but also to loss aversion. Overall, we therefore suggest using a broader definition of risk that captures this unique feature of entrepreneurs; their willingness to risk losses.
    Keywords: entrepreneurs, managers, risk aversion, loss aversion, ambiguity aversion, lab-in-the-field experiment
    JEL: L26 C93 D03 M13
    Date: 2014–10
  2. By: Khelifi, Atef
    Abstract: Despite ‘joy of giving models’ have been extensively examined in the literature, the Ramsey growth model has never been explored under the assumption of a direct preference for bequeathing savings that are reinvested. This assumption implies a Utility function depending on both consumption and savings, which may also be motivated as one that captures a direct preference for thriftiness or wealth accumulation arguably involved. The resulting growth model generalizes those accounting for the capitalist spirit as Zou (1994), and shows that the restrictive standard one is perhaps not the actual optimized version of the Solow model. (JEL O41, E21, D91)
    Keywords: Bequest;Capitalist Spirit;Ramsey Growth model;Savings;Joy-of-giving;Optimal control theory
    JEL: D0 D91 E0 E00 E21 O41
    Date: 2014–11–15
  3. By: Ahmet Ozkardas (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne); Agnieszka Rusinowska (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: We consider a non-cooperative price bargaining model between a monopolistic producer and a monopsonic consumer. The innovative element that our model brings to the existing literature on price negotiation concerns the parties' preferences which are not expressed by constant discount rates, but by sequences of discount factors varying in time. We assume that the sequence of discount rates of a party can be arbitrary, with the only restriction that the infinite series that determines the utility for the given party must be convergent. Under certain parameters, the price negociation model coincides with wage bargaining with the exogenous always strike decision. We determine the unique subgame perfect equilibrium in this model for no-delay strategies independent of the former history of the game. Then we relax the no-delay assumption and determine the highest equilibrium payoff of the seller and the lowest equilibrium payoff of the buyer for the general case. We show that the no-delay equilibrium strategy profiles support these extreme payoffs.
    Keywords: Price bargaining; alternating offers; varying discount rates; subgame perfect equilibrium
    Date: 2013–10
  4. By: Delavande, Adeline; Zafar, Basit
    Abstract: We investigate the determinants of students’ university choice, with a focus on expected monetary returns, non-pecuniary factors enjoyed at school, and financial constraints, in the Pakistani context. To mitigate the identification problem concerning the separation of preferences, expectations and markets constraints, we combine rich data on individual-specific subjective expectations about labor market and non-pecuniary outcomes, with direct measures of financial constraints and students’ stated school choice both with and without financial constraints. Estimates from a life-cycle model show that future earnings play a small (but statistically significant) role. However, non-pecuniary outcomes, such as school’s ideology, are major determinants. Data on students’ choices without financial constraints allow for the outof- sample validation of the model, which shows a strikingly good fit. Our results show that 37% of students are financially constrained in the university choice, and that implementing policies relaxing financial constraints would increase students’ average lifetime subjective expected utility by 21%. From a methodological point, we find that ignoring non-pecuniary factors, uncertainty related to employment and drop-out, or direct measures of financial constraints, yields biased estimates – thereby underscoring the importance of having data on these aspects for understanding university choice in any context.
    Date: 2014–10–30
  5. By: Robert J. Barro; Andrew Mollerus
    Abstract: A safe asset's real value is insulated from shocks, including declines in GDP from rare macroeconomic disasters. However, in a Lucas-tree world, the aggregate risk is given by the process for GDP and cannot be altered by the creation of safe assets. Therefore, in the equilibrium of a representative-agent version of this economy, the quantity of safe assets will effectively be nil. With heterogeneity in coefficients of relative risk aversion, safe assets may take the form of private bond issues from low-risk-aversion to high-risk-aversion agents. The model assumes Epstein-Zin/Weil preferences and log utility (intertemporal elasticity of substitution equal to one) and achieves stationarity by having agents die off and be replaced. We derive the steady-state quantity of safe assets and the shares of each agent in equity ownership and overall assets. In a baseline case, the risk-free rate is 1.0% per year, the unlevered equity premium is 4.2%, and the quantity of safe assets ranges up to 10% of economy-wide assets (comprising the capitalized value of the full GDP). A disaster shock leads to an extended period in which the share of wealth held by the low-risk-averse agent and the risk-free rate are low but rising and the ratio of safe to total assets is high but falling. In the baseline model, Ricardian Equivalence holds in that added government bonds have no effect on the risk-free rate and the net quantity of safe assets. The implied crowding-out coefficient for private bonds with respect to public bonds is around -0.5, a value found in some existing empirical studies.
    JEL: G1 E0 E2
    Date: 2014–10
  6. By: Vieider, Ferdinand M.; Beyene, Abebe; Bluffstone, Randall; Dissanayake, Sahan; Gebreegziabher, Zenebe; Martinsson, Peter; Mekonnen, Alemu
    Abstract: Risk aversion has generally been found to decrease in income or wealth. This may lead one to expect that poor countries will be more risk averse than rich countries. Recent comparative findings with students, however, suggest the opposite, giving rise to a riskincome paradox. We test this paradox by measuring the risk preferences of over 500 household heads spread over the highlands of Ethiopia. We do so using certainty equivalents, which have rarely been used in developing countries, but permit us to relate the findings to a host of evidence from the West. We find high degrees of risk tolerance, in agreement with the student comparisons finding higher risk tolerance in poorer countries. We also find risk tolerance to increase in income proxies, thus completing the paradox. We thereby use income proxies that can be considered as exogenous, allowing us to conclude that at least part of the causality must run from income to risk tolerance. We furthermore provide extensive methodological discussions on measuring and estimating risk preferences in development settings.
    Keywords: risk preferences,development,experimental methodology
    JEL: C93 D03 D80 O12
    Date: 2014
  7. By: Fan, Qin; Davlasheridze, Meri
    Abstract: We employ a two-stage random utility model (RUM) to estimate people’ marginal willingness to pay (WTP) for enhancing community-level floodplain management activities reflected in the National flood insurance program (NFIP)’s Community Rating System (CRS) program. CRS is a voluntary program, which provides the participating communities with discounts on flood insurance premium in exchange for strengthened flood protection activities. Results show that people with different demographics react differently to flood risk and generally value flood protection activities. We find that among the CRS program activities, people place the highest value on activities concerning repetitive flood loss reduction, with the second highest being public information disclosure about flood risk. In addition, results suggest that people significantly value structural mitigation projects such as flood- and debris- control dams. Importantly, our results suggest that water body as an amenity measure is perceived positively in people’s location choices, nonetheless flood risk information disclosure diminishes the amenity value.
    Keywords: Flood Insurance, Community Rating System, Tiebout Sorting, Locational Equilibrium, Environmental Economics and Policy, Risk and Uncertainty, Q51, Q54 and Q58,
    Date: 2014
  8. By: Stelter, Robert
    Abstract: This paper investigates the problem of an \optimum population" concerning age structures in a 3-period OLG-model with endogenous fertility and longevity. The first-best solution for a number-dampened total social welfare function, including Millian and Benthamite utilitarianism as two extreme cases, identifies the optimal age structure, generally failed in the laissez-faire economy. Individuals over-invest in health expenditures and choose a non-optimal number of offspring. A calibration exercise for 80 countries emphasizes that mean ages in the optimal solution with the highest feasible individual utility exceed the observed in all countries, especially due to a very low first-best number of children. Introducing a preference for the population stock in the social welfare function increases fertility, but reduces individual utility, in the first-best solution. Optimal mean age shrinks and an over-aging of the laissez-faire economy becomes more likely. To decentralize first-best solutions health expenditures are taxed, whereas children are either taxed or subsided.
    Keywords: endogenous fertility,adult mortality,optimal age structure,over-aging,optimal taxation
    JEL: H20 I10 J18
    Date: 2014
  9. By: Cato, Susumu; Ebina, Takeshi
    Abstract: This paper examines a two-period moral hazard model with an inequality-averse agent. We show how the agent's past performance will help the principal to relax incentive compatibility constraints and how the existence of an inequality aversion of the agent affects a level of wage in each period in a long-term contract. In particular, we focus on the performance in period 1 on the level of wage in period 2. We show that the agent's wage in period 2 depends on performance in periods 1 and 2. This implies that the long-term relationship creates the opportunity for intertemporal risk and inequality sharing.
    Keywords: Moral hazard, Inequality aversion, Behavioral contract theory, Distribution
    JEL: D63 D86 J31 L23
    Date: 2014–11–14
  10. By: Matthias Brachert; Walter Hyll; Mirko Titze
    Abstract: Empirical studies use the assumption of stability in individual risk attitudes when searching for a relationship between attitude to risk and the decision to become and survive as an entrepreneur. We show that risk attitudes do not remain stable but face endogenous adaption when starting a new business. This adaption is associated with entrepreneurial survival. The results show that entrepreneurs with low risk tolerance before entering self-employment and increased risk tolerance when self-employed have a higher probability of survival than similar entrepreneurs experiencing a decrease in the willingness to take risks. We find the opposite results for entrepreneurs who express a higher willingness to take risks before becoming self-employed: in this case, a decrease in tolerance of risk is correlated with an increasing survival probability.
    Keywords: Endogenous attitudes, Risk attitudes, Entrepreneurial survival, SOEP
    JEL: D03 D81 M13
    Date: 2014
  11. By: Horag Choi; Steven Lugauer; Nelson C. Mark
    Abstract: We employ a model of precautionary saving to study why household saving rates are so high in China and so low in the US. The use of recursive preferences gives a convenient decomposition of saving into precautionary and non precautionary components. This decomposition indicates that over 80 percent of China's saving rate and nearly all of the US saving arises from the precautionary motive. The difference in the income growth rate between China and the US is vastly more important for explaining saving rate differences than differences in income risk. We estimate the preference parameters and find that Chinese and US households are more similar in their attitude toward risk than in their intertemporal substitutability of consumption.
    JEL: E21 F4
    Date: 2014–09

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