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on Utility Models and Prospect Theory |
| By: | 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: | This paper elaborates an axiomatic treatment of the Subjective Expected Utility (SEU) model that dispenses with the assumption of an exogenous state space. Within a state-free description of uncertainty and alternatives, axioms for preferences are formulated and shown to characterize the existence of a subjective state space, a subjective probability and a utility function. In the representation, the individual appears to behave as if he used the state space to describe uncertainty and maximized SEU to make decisions. Moreover, the state space, probability and utility are unique in some appropriate sense. |
| Keywords: | Expected utility; subjective state space; causality; consequentialism |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-01021388&r=upt |
| By: | Malakhov, Sergey |
| Abstract: | When income growth under price dispersion reduces the time of search and raises prices of purchases, the increase in purchase price can be presented as the increase in the willingness to pay for insurance or the willingness to pay for consumer credit. The optimal consumer decision represents the trade-off between the propensity to search for beneficial insurance or consumer credit, and marginal savings on insurance policy or consumer credit. Under price dispersion the indirect utility function takes the form of cubic parabola, where the risk aversion behavior ends at the saddle point of the comprehensive insurance or the complete consumer credit. The comparative static analysis of the saddle point of the utility function discovers the ambiguity of the departure from risk-neutrality. This ambiguity can produce the ordinary risk seeking behavior as well as mathematical catastrophes of Veblen-effect’s imprudence and over prudence of family altruism. The comeback to risk aversion is also ambiguous and it results either in increasing or in decreasing relative risk aversion. The paper argues that the decreasing relative risk aversion comes to the optimum quantity of money. |
| Keywords: | consumer search, risk, insurance, credit, optimum quantity of money, Veblen effect, family altruism, mathematical catastrophe |
| JEL: | D11 D81 |
| Date: | 2014–10–28 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:59720&r=upt |
| By: | Dertwinkel-Kalt, Markus; Köhler, Katrin |
| Abstract: | Whereas exchange asymmetries for goods are well known, we provide a first incentivized test of exchange asymmetries for bads (i.e., items yielding a negative utility). On the one hand, prospect theory predicts an endowment effect for goods and bads, on the other hand, attention-based theories such as salience theory predict an endowment effect for goods, but a reverse endowment effect (i.e., a particular high willingness to switch) for bads. Since both strands of research often make the same predictions concerning biased decision making, the investigation of exchange asymmetries for bads is a key element to distinguish between their validity. In our experiment, we find a strong endowment effect for bads, so that our results speak in favor of prospect theory. |
| Keywords: | Loss Aversion,Salience Theory,Prospect Theory,Endowment Effect |
| JEL: | D03 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:dicedp:161&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: | Harsanyi's axiomatic justification of utilitarianism is extended to a framework with subjective and heterogenous priors. Contrary to the existing literature on aggregation of preferences under uncertainty, society is here allowed to formulate probability judgements, not on the actual state of the world as individuals do, but rather on the opinion they each have on the actual state. An extended Pareto condition is then proposed that characterizes the social utility function as a convex combination of individual ones and the social prior as the independent product of individual ones. |
| Keywords: | Utilitarianism; prior heterogeneity; Pareto condition |
| Date: | 2014–06 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-01021399&r=upt |
| By: | Groneck, Max; Ludwig, Alexander; Zimper, Alexander |
| Abstract: | On average, "young" people underestimate whereas "old" people overestimate their chances to survive into the future. We adopt a Bayesian learning model of ambiguous survival beliefs which replicates these patterns. The model is embedded within a non-expected utility model of life-cycle consumption and saving. Our analysis shows that agents with ambiguous survival beliefs (i) save less than originally planned, (ii) exhibit undersaving at younger ages, and (iii) hold larger amounts of assets in old age than their rational expectations counterparts who correctly assess their survival probabilities. Our ambiguity-driven model therefore simultaneously accounts for three important empirical findings on household saving behavior. |
| Keywords: | Cumulative prospect theory,Choquet expected utility,Dynamic inconsistency,Life-cycle hypothesis,Saving puzzles |
| JEL: | D91 D83 E21 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:safewp:73&r=upt |
| By: | Brinkmann, Felix; Korn, Olaf |
| Abstract: | Option-implied moments, like implied volatility, contain useful information about an underlying asset's return distribution, but are derived under the risk-neutral probability measure. This paper shows how to convert risk-neutral moments into the corresponding physical ones. The main theoretical result expresses moments under the physical probability measure in terms of observed option prices and the preferences of a representative investor. Based on this result, we investigate several empirical questions. We show that a model of a representative investor with CRRA utility can explain the variance risk premium for the S&P500 index but fails to capture variance and skewness risk premiums simultaneously. Moreover, we present methods to estimate forward-looking market risk premiums and investors' disappointment aversion implied in market prices. |
| Keywords: | option-implied moments,risk adjustment,variance risk premium,market risk premium,disappointment aversion |
| JEL: | G13 G17 C51 C53 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cfrwps:1407&r=upt |
| By: | Davide Pettenuzzo (Brandeis University); Francesco Ravazzolo (Norges Bank, and BI Norwegian Business School) |
| Abstract: | We propose a novel Bayesian model combination approach where the combination weights depend on the past forecasting performance of the individual models entering the combina- tion through a utility-based objective function. We use this approach in the context of stock return predictability and optimal portfolio decisions, and investigate its forecasting perfor- mance relative to a host of existing combination schemes. We find that our method produces markedly more accurate predictions than the existing model combinations, both in terms of statistical and economic measures of out-of-sample predictability. We also investigate the incremental role of our model combination method in the presence of model instabilities, by considering predictive regressions that feature time-varying regression coefficients and volatil- ity. We find that the gains from using our model combination method increase significantly when we allow for instabilities in the individual models entering the combination. |
| Keywords: | Bayesian econometrics; Time-varying parameters; Model combinations; Port- folio choice. |
| JEL: | C11 C22 G11 G12 |
| Date: | 2014–10 |
| URL: | http://d.repec.org/n?u=RePEc:brd:wpaper:80&r=upt |
| By: | Philipp Möhlmeier (BiGSEM - Bielefeld University - Center for Mathematical Economics); 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); Emily Tanimura (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne) |
| Abstract: | We develop a modification of the connections model by Jackson and Wolinsky (1996) that takes into account negative externalities arising from the connectivity of direct and indirect neighbors, thus combining aspects of the connections model and the co-author model. We consider a general functional form for agents' utility that incorporates both the effects of distance and of neighbors' degree. Consequently, we introduce a framework that can be seen as a degree-distance-based connections model with both negative and positive externalities. Our analysis shows how the introduction of negative externalities modifies certain results about stability and efficiency compared to the original connections model. In particular, we see the emergence of new stable structures, such as a star with links between peripheral nodes. We also identify structures, for example, certain disconnected networks, that are efficient in our model but which could not be efficient in the original connections model. While our results are proved for the general utility function, some of them are illustrated by using a specific functional form of the degree-distance-based utility. |
| Keywords: | Connections model; degree; distance; negative externalities; positive externalities; pairwise stability; efficiency |
| Date: | 2013–04 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-00825266&r=upt |
| By: | Bertrand Wigniolle (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: | This paper shows that it is possible to extend the scope of the existence of rational bubbles when uncertainty is introduced associated with rank-dependent expected utility. This RDU assumption can be viewed as a transformation of probabilities depending on the pessimism/optimism of the agent. The results show that pessimism favors the existence of deterministic bubbles, when optimism may promote the existence of stochastic bubbles. Moreover, under pessimism, the RDU assumption may generate multiple bubbly equilibria. The RDU assumption also leads to new conditions ensuring the (absence of) Paretooptimality of the competitive equilibrium without bubbles. These conditions still govern the existence of bubbles. |
| Keywords: | Rational bubbles; RDU preferences |
| Date: | 2014–04 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-00974144&r=upt |
| By: | Tamás Csermely (Department of Economics, Vienna University of Economics and Business); Alexander Rabas (Department of Economics, University of Vienna) |
| Abstract: | The question of how to measure and classify people’s risk preferences is of substantial importance in the field of Economics. Inspired by the multitude of ways used to elicit risk preferences, we conduct a holistic investigation of the most prevalent method, the multiple price list (MPL) and its derivations. In accordance with previous literature, we find that revealed preferences differ under various and even the same versions of the MPL. Thus, an arbitrary selection of a particular risk assessment method can lead to biased results especially if researchers investigate its connection to other phenomena. In order to resolve this issue, we determine the most stable version of the MPL by using multiple measures of within-method consistency, and the version with the highest forecast accuracy by using behavior in two economically relevant games as benchmarks. A derivation of the well-known method by Holt and Laury (2002), where the highest payoff is varied instead of probabilities, emerges as the best MPL method in both dimensions. |
| Keywords: | Risk, MPL, Experiment, Revealed Preferences |
| JEL: | C91 D81 |
| Date: | 2014–10 |
| URL: | http://d.repec.org/n?u=RePEc:wiw:wiwwuw:wuwp185&r=upt |
| By: | Christopher J. Tyson (Queen Mary University of London) |
| Abstract: | Using the techniques of revealed preference analysis, we study a two-stage model of choice behavior. In the first stage, the decision maker maximizes a menu-dependent binary relation encoding preferences that are imperfectly perceived. In the second, a menu-independent binary relation is maximized over the subset of alternatives that survive the first stage. This structure can support various interpretations, including those of salience effects, positive action, and surface characteristics. We characterize the model behaviorally both in ordinal form and in terms of the corresponding numerical representations. |
| Keywords: | Bounded rationality, Choice function, Revealed preference, Salience |
| JEL: | D01 D03 |
| Date: | 2014–09 |
| URL: | http://d.repec.org/n?u=RePEc:qmw:qmwecw:wp725&r=upt |
| By: | Narjes, Manuel; Lippert, Christian |
| Abstract: | This article is an attempt to estimate the economic value of policies aimed at conserving native bees (and their pollination services) in Northern Thailand, by means of a discrete choice experiment. The preferences of 198 longan (Dimocarpus longan) farmers for three conservation strategies in particular, namely “bee-friendly pest management”, “improving native bee habitats within agro-forest ecosystems” and “fostering the husbandry of native bee species”, were analyzed. Thereby, the part-worth utilities of these strategies and of their potential effects on the population of native bees were estimated with conditional logit and random parameter logit models. Furthermore, the contribution of a “cost” attribute to the explanation of the utility associated with the choice alternatives allowed the calculation of willingness to pay estimates for the individual conservation strategies and for changes in the population of native bees. As a result, a positive contribution of the proposed conservation measures to the utility derived from the choice alternatives containing them could be established. Similarly, positive changes in the population of native bees also increased the chances of related conservation policy profiles being chosen. It can be concluded that the population of longan farmers is generally willing to pay for the conservation of native bees in their region, although explaining their preference heterogeneity for the proposed conservation measures will require further analyses. |
| Keywords: | Native Bee Conservation, Crop Pollination, Northern Thailand, Discrete Choice Experiment, Conditional Logit, Random Parameter Logit., Agricultural and Food Policy, Crop Production/Industries, Environmental Economics and Policy, Risk and Uncertainty, |
| Date: | 2014–09 |
| URL: | http://d.repec.org/n?u=RePEc:ags:gewi14:187427&r=upt |
| By: | Wenner, Lukas |
| Abstract: | I show theoretically that applying the model of Köszegi and Rabin (2006) to a simple purchasing decision where consumers are ex-ante uncertain about the price realisation, gives - when changing the underlying distribution of expected prices - rise to counterintuitive predictions in contrast with a 'good deal model" where consumers are predicted to be disappointed (rejoice) when the realised price is perceived as being worse (better) than the other possible realisation. While the underlying ideas of both models are similar with respect to expectation-based reference points, the different results come from the concept of Personal Equilibrium in Köszegi and Rabin (2006). The experimental results show some support for the simpler good deal model for a number of different real consumption goods though the support is weaker for goods that either have a salient market price or no market price outside of the experiment. |
| Keywords: | Reference Points,Loss Aversion,Price Expectations,Experimental Consumer Choice |
| JEL: | D03 C91 D84 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:wzbeoc:spii2014306&r=upt |
| By: | Decancq, Koen (University of Antwerp); Neumann, Dirk (Université catholique de Louvain) |
| Abstract: | We discuss and compare five measures of individual well-being, namely income, an objective composite well-being index, a measure of subjective well-being, equivalent income, and a well-being measure based on the von Neumann-Morgenstern utilities of the individuals. After examining the information requirements of these measures, we illustrate their implementation using data from the German Socio-Economic Panel (SOEP) for 2010. We find sizeable differences in the characteristics of the individuals identified as worst off according to the different well-being measures. Less than 1% of the individuals belong to the bottom decile according to all five measures. Moreover, the measures lead to considerably different well-being rankings of the individuals. These findings highlight the importance of the choice of well-being measure for policy making. |
| Keywords: | von Neumann-Morgenstern utility function, equivalent income, life satisfaction, composite well-being index, income, worst off, Germany |
| JEL: | D31 D63 I30 |
| Date: | 2014–10 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp8589&r=upt |
| By: | Robert Kollmann |
| Abstract: | Standard macro models cannot explain why real exchange rates are volatile anddisconnected from macro aggregates. Recent research argues that models with persistentgrowth rate shocks and recursive preferences can solve that puzzle. I show that this resultis highly sensitive to the structure of financial markets. When just a bond is tradedinternationally, then long-run risk generates insufficient exchange rate volatility. A longrunrisk model with recursive-preferences can generate realistic exchange rate volatility,if all agents efficiently share their consumption risk by trading in complete financialmarkets; however, this entails massive international wealth transfers, and excessiveswings in net foreign asset positions. By contrast, a long-run risk, recursive-preferencesmodel in which only a fraction of households trades in complete markets, while theremaining households lead hand-to-mouth lives, can generate realistic exchange rate andexternal balance volatility. |
| Keywords: | exchange rate; long-run risk; recursive preferences; complete financial markets; financial frictions; international risk sharing |
| JEL: | F31 F36 F41 F43 |
| Date: | 2014–11 |
| URL: | http://d.repec.org/n?u=RePEc:eca:wpaper:2013/177116&r=upt |
| By: | Müller, Stephan |
| Abstract: | This paper applies the indirect evolutionary approach to study the evolution of inequality aversion in a simplified game of life. The game comprises a dilemma, a problem of coordination, and a problem of distribution as a general framework for the evolution of preferences. In singlegame environments, there emerges a global advantage for inequality-averse individuals in the dilemma and a global disadvantage for inequality-averse players who are favoured by the problem of distribution. The simplified game of life puts these strong predictions into perspective. In particular, selfish and inequality-averse individuals may coexist in the subpopulation, favoured in the problem of distribution. |
| Keywords: | inequality aversion,evolution,preferences |
| JEL: | C72 C73 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cegedp:219&r=upt |
| By: | Aloosh, Arash |
| Abstract: | In a long-run risk model with stochastic volatility and frictionless markets, I express expected forex returns as a function of consumption growth variances and stock variance risk premiums (VRPs)—the difference between the risk-neutral and statistical expectations of market return variation. This provides a motivation for using the forward-looking information available in stock market volatility indices to predict forex returns. Empirically, I find that stock VRPs predict forex returns at a one-month horizon, both in-sample and out-of-sample. Moreover, compared to two major currency carry predictors, global VRP has more predictive power for currency carry trade returns, bilateral forex returns, and excess equity return differentials. |
| Keywords: | Global Variance Risk Premium; Excess Foreign Exchange (Forex) Return; Frictionless Markets; Predictability. |
| JEL: | F31 F37 G15 |
| Date: | 2014–11–19 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:59931&r=upt |
| By: | Michal Ksawery Popiel (Queen's University) |
| Abstract: | Social networks are an important component in understanding the decision to consume addictive substances. They capture the role of limited access, peer influence, and social acceptance and tolerance. However, despite the empirical evidence of their role, they have been absent from theoretical models. This paper proposes a mechanism through which agents can influence each other in their decision to consume an addictive good. An agent's decision is sensitive to her state of addiction as well as to the composition of her neighbourhood. The model is consistent with the empirical evidence that peer influence can work in both ways: influencing an individual to use and helping them to quit. The structure of the network has important implications on the outcome of agents' decisions as well as the effectiveness of policies aimed at limiting use of addictive substances through deterrence. I provide a network-based explanation of why usage rates can vary across otherwise similar agents and show how in some situations encouraging network ties can lead to lower use while in others it can have the opposite effect. Furthermore, I explore the effect of networks on diffusion of addiction and, using simulations, find that addiction spreads faster in an environment where there are few strong links than in one with many weak links. |
| Keywords: | addiction, dual-self, networks, random utility |
| JEL: | C70 D01 I18 |
| Date: | 2014–11 |
| URL: | http://d.repec.org/n?u=RePEc:qed:wpaper:1332&r=upt |