nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2015‒01‒14
nineteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. A Dual Approach to Ambiguity Aversion By Antoine Bommier
  2. Asset Demand and Ambiguity Aversion By Chiaki Hara; Toshiki Honda
  3. On The Social Efficiency In Monopolistic Competitioin Models By Igor G. Pospelov; Stanislav A. Radionov
  4. Soft Paternalism and Nudging - Critique of the Behavioral Foundations By Pasche, Markus
  5. Optimal investment under behavioural criteria in incomplete diffusion market models By Mikl\'os R\'asonyi; Jos\'e Gregorio Rodr\'{i}guez-Villarreal
  6. Dimensional Analysis of Production and Utility Functions in Economics By Kim, Minseong
  7. Portfolio Choice under Parameter Uncertainty: Bayesian Analysis and Robust Optimization Comparison By António Alberto Santos; Ana Margarida Monteiro; Rui Pascoal
  8. Putting One's Money Where One's Mouth is: Increasing Saliency in the Field. By Daniel A. Brent; Lata Gangadharan; Anke Leroux; Paul A. Raschky
  9. Essays in behavioral economics : Applied game theory and experiments By Mermer, A.G.
  10. Digit ratio and risk taking: Evidence from a large, multi-ethnic sample By Pablo Brañas-Garza; Matteo M. Galizzi; Jeroen Nieboer
  11. Toward and Understanding of Reference-Dependent Labor Supply: Theory and Evidence from a Field Experiment By Alec Brandon; John List; Steffen Andersen; Uri Gneezy
  12. Tail Risk Constraints and Maximum Entropy By Donald Geman; H\'elyette Geman; Nassim Nicholas Taleb
  13. Advertisement versus Motivation in Competitive Search Equilibrium By Katsuya Takii
  14. Does the Choice of Well-Being Measure Matter Empirically?: An Illustration with German Data By Koen Decancq; Dirk Neumann
  15. Intrahousehold Decision Making and Fertility By Doepke, Matthias; Kindermann, Fabian
  16. An Empirical Model of the Medical Match By Nikhil Agarwal
  17. Distancia Psicológica By Moreno-Okuno, Alejandro; Aguilera Navarrete, Natividad
  18. Increasing Block Tariffs in the Water Sector: An Interpreation in Terms of Social Preferences By Georg Meran; Christian von Hirschhausen
  19. The impact of care farms and green care on health-related quality of life: a systematic review guiding cost-effectiveness analysis By Nyantara Wickramasekera; Sandy Tubeuf; Thomas Veale; Judy Wright; Helen Elsey; Jenni Murray

  1. By: Antoine Bommier (ETH Zurich, Switzerland)
    Abstract: In this paper, the assumption of monotonicity of Anscombe and Aumann (1963) is replaced by a weaker assumption of monotonicity with respect to first order stochastic dominance. I derive a representation result where ambiguous distributions of objective beliefs are first aggregated into “equivalent unambiguous beliefs” and then risk preferences are used to compute the utility of these equivalent unambiguous beliefs. Such an approach makes it possible to disentangle ambiguity aversion, related to the treatment of information, and risk aversion, related to the evaluation of the equivalent unambiguous beliefs. An application shows the tractability of the framework and its intuitive appeal.
    Keywords: ambiguity aversion; first-order stochastic dominance; separability; comonotonic sure-thing principle; rank-dependent utility; saving behavior.
    JEL: D81
    Date: 2014–12
  2. By: Chiaki Hara (Institute of Economic Research, Kyoto University); Toshiki Honda (Graduate School of International Corporate Strategy, Hitotsubashi University)
    Abstract: We study the optimal portfolio choice problem of an investor who is averse to both risk and ambiguity. Using the class of utility functions proposed by Klibano, Marinacci, and Mukerji (2005), we establish a generalized mutual fund theorem, which shows that there are a xed number of mutual funds that cater for all investors, regardless of their ambiguity aversion. We prove that the optimal portfolio is decomposed into two, one remaining and the other vanishing as the degree of ambiguity aversion goes to innity. We also introduce factor models with ambiguity and compare our results with the Bayesian portfolio approach.
    Keywords: Ambiguity aversion, optimal portfolio, 1=N portfolio, mutual fund theorem, factor model, Bayesian portfolio choice problem
    Date: 2014–12
  3. By: Igor G. Pospelov (National Research University Higher School of Economics); Stanislav A. Radionov (National Research University Higher School of Economics)
    Abstract: We consider standard monopolistic competition models with aggregate consumer's preferences dened by two well-known classes of utility functions | the Kimball utility function and the variable elasticity of substitution utility function. It is known that market equilibruim is ecient only for the special case when utility function has a constant elasticity of substitution, but we nd that in both cases a special tax on rms' output may be introduced such that market equilibrium becomes ecient
    Keywords: monopolistic competition, eciency.
    JEL: D43 D61
    Date: 2014
  4. By: Pasche, Markus
    Abstract: This brief note rises doubts on the argument that nudging will help people to behave more rational in terms of their own preferences. This justification of soft paternalism overlooks some methodological problems of expected utility theory which are one of the roots of behavioral economics.
    Keywords: soft paternalism; nudging; behavioral economics, utility theory, rationality
    JEL: B4 D03 D04
    Date: 2014–12–20
  5. By: Mikl\'os R\'asonyi; Jos\'e Gregorio Rodr\'{i}guez-Villarreal
    Abstract: The most commonly accepted model for investors' preferences is expected utility theory. More recently, other theories have emerged and pose new challenges to mathematics. The present paper treats preferences of cumulative prospect theory (CPT), where an "S-shaped" utility function is considered (i.e. convex up to a certain point and concave from there on). Also, distorted probability measures are applied for calculating the utility of a given position with respect to a (possibly random) benchmark $G$. Such problems have heretofore been solved essentially for complete continuous-time market models only. In the present paper we make a step forward and consider incomplete models of a diffusion type where the return of the investment in consideration depends on some economic factors. Our main result asserts, under mild assumptions, the existence of an optimal strategy when the driving noise of the economic factors is independent of that of the investment and the rate of return is non-negative. We are also able to accommodate models of a specific type where the factor may have non-zero correlation with the investment.
    Date: 2015–01
  6. By: Kim, Minseong
    Abstract: This paper explores dimensional analysis of production and utility functions in economics. As raised by Barnett, dimensional analysis is important in consistency checks of economics functions. However, unlike Barnett's dismissal of CES and Cobb-Douglas production functions, we will demonstrate that under constant return-to-scale and other assumptions, production function can indeed be justified dimensionally. And then we consider utility functions.
    Keywords: dimensional analysis; production function; utility function; consistency in economics
    JEL: B41 C00 C02 E10 E13
    Date: 2015–01–06
  7. By: António Alberto Santos (Faculty of Economics, University of Coimbra and GEMF, Portugal); Ana Margarida Monteiro (Faculty of Economics, University of Coimbra and GEMF, Portugal); Rui Pascoal (Faculty of Economics, University of Coimbra, Portugal)
    Abstract: Parameter uncertainty has been a recurrent subject treated in the financial literature. The normative portfolio selection approach considers two main kinds of decision rules: expected expected utility maximization and mean-variance criterion. Assuming that the mean-variance criterion is a good approximation to the expected utility maximization paradigm, a major factor of concern is parameter uncertainty which, when it is not taken into account, can lead to meaningless portfolios. A statistical approach, based on a Bayesian analysis, can be applied to parameter uncertainty. This can be compared with a robust optimization approach where it is assumed that the value of the unknown parameters can change within a given region. Comparisons over these two approaches are performed in this paper. We consider two measures to quantify the effects of the estimation risk, one of the measures is new and extends an existing one. The results allows us to distinguish the approaches and select the one that implies lower mean losses.
    Keywords: portfolio choice, Bayesian statistics, robust optimization, conic programming, semidefinite programming, loss distribution.
    JEL: C11 C13 C44 C58 C63 C87 G11 G32
    Date: 2014–12
  8. By: Daniel A. Brent; Lata Gangadharan; Anke Leroux; Paul A. Raschky
    Abstract: We present a novel approach to address differences between stated and paid choices by incentivizing stated choices in a randomized field experiment. The treatment increases consequentiality in the field by making each decision financially relevant. Our results show that the treatment effect is small in aggregate. However, we find that the treatment increases estimates of the marginal utility of income, especially among low-income households. The treatment also affects estimates of preferences for specific attributes by reducing willingness to pay for attributes with indirect benefits. Respondents with greater self-reported environmental preferences are more susceptible to the treatment in attribute space.
    Keywords: Field experiment, non-market goods, stated preference, hypothetical bias
    JEL: Q51 C93
    Date: 2014–09
  9. By: Mermer, A.G. (Tilburg University, School of Economics and Management)
    Abstract: Behavioral Economics aims at understanding the decision of economic agents who are not necessarily monetary utility maximizers and accounts for the fact that agents may have other concerns next to economic gain. This thesis contributes to the literature by studying the behavior of economic agents who are not necessarily monetary utility maximizers in situations with strategic interaction. The second chapter solves a game-theoretic model of contests assuming that agents have reference-dependent preferences. The results help to explain behavior observed in recent experiments that is hard to reconcile with the assumption of standard preferences. The optimal price mechanism is derived which differs markedly from the one derived under the assumption of standard preferences. The third and fourth chapters use laboratory experimentation which allows for careful scrutinizing of behavioral assumptions made in economic models. The third chapter experimentally investigates agents’ cooperative behavior in indefinitely-repeated dilemma games with different strategic environments. It is reported that subjects play collusive choices significantly more often when actions exhibit strategic substitutability than when actions exhibit strategic complementarity. In Chapter 4 we experimentally study information acquisition in a social dilemma game. It is reported that in a twice-repeated trust game trustors choose to be informed about the type of the trustee in a setting where, theoretically, having such information is detrimental for cooperation and material payoffs.
    Date: 2014
  10. By: Pablo Brañas-Garza (Middlesex University London, Business School); Matteo M. Galizzi (London School of Economics and Political Science, Behavioural Research Lab); Jeroen Nieboer (London School of Economics and Political Science, Behavioural Research Lab)
    Abstract: Using a large (n=543) multi-ethnic sample of laboratory subjects, we systematically investigate the link between the digit ratio (the ratio of the length of the index finger to the length of the ring finger, also called 2D:4D ratio) and two measures of individual risk taking: (i) risk preferences over lotteries with real monetary incentives and (ii) self-reported risk attitude. Previous studies have found that the digit ratio, a proxy for pre-natal testosterone exposure, correlates with risk taking in some subject samples, but not others. In our sample, we find, first, that the right-hand digit ratio is significantly associated with risk preferences: subjects with lower right-hand ratios tend to choose more risky lotteries. Second, the right-hand digit ratio is not associated with self-reported risk attitudes. Third, there is no statistically significant association between the left-hand digit ratio and either measure of individual risk taking.
    Keywords: Testosterone, 2D:4D ratio, risk preferences, risk attitudes
    JEL: C91 C92 D44 D81 D87
    Date: 2014
  11. By: Alec Brandon; John List; Steffen Andersen; Uri Gneezy
    Abstract: Perhaps the most powerful form of framing arises through reference dependence, wherein choices are made recognizing the starting point or a goal. In labor economics, for example, a form of reference dependence, income targeting, has been argued to represent a serious challenge to traditional economic models. We design a field experiment linked tightly to three popular economic models of labor supply-two behavioral variants and one simple neoclassical model--to deepen our understanding of the positive implications of our major theories. Consistent with neoclassical theory and reference--dependent preferences with endogenous reference points, workers (vendors in open air markets) supply more hours when presented with an expected transitory increase in hourly wages. In contrast with the prediction of behavioral models, however, when vendors earn an unexpected windfall early in the day, their labor supply does not respond. A key feature of our market in terms of parsing the theories is that vendors do not post prices rather they haggle with customers. In this way, our data also speak to the possibility of reference-dependent preferences over other dimensions. Our investigation again yields results that are in line with neoclassical theory, as bargaining patterns are unaffected by the unexpected windfall.
    Date: 2014
  12. By: Donald Geman; H\'elyette Geman; Nassim Nicholas Taleb
    Abstract: In the world of modern financial theory, portfolio construction has traditionally operated under at least one of two central assumptions: the constraints are derived from a utility function and/or the multivariate probability distribution of the underlying asset returns is fully known. In practice, both the performance criteria and the informational structure are markedly different: risk-taking agents are mandated to build portfolios by primarily constraining the tails of the portfolio return to satisfy VaR, stress testing, or expected shortfall (CVaR) conditions, and are largely ignorant about the remaining properties of the probability distributions. As an alternative, we derive the shape of portfolio distributions which have maximum entropy subject to real-world left-tail constraints and other expectations. Two consequences are (i) the left-tail constraints are sufficiently powerful to overide other considerations in the conventional theory, rendering individual portfolio components of limited relevance; and (ii) the "barbell" payoff (maximal certainty/low risk on one side, maximum uncertainty on the other) emerges naturally from this construction.
    Date: 2014–12
  13. By: Katsuya Takii (Osaka School of International Public Policy (OSIPP), Osaka University)
    Abstract: We analyze equilibrium wage contracts in a competitive search model where a firm motivates workers to invest in a match-specific skill. If skill is not critical for production, the contract is first best. If critical, the contract coincides with an efficiency wage contract and cannot attain even second best. Unlike standard efficiency wage models, the wage plays a dual role, advertisement and motivation, which induces a novel source of inefficiency: the competition to attract workers forces a wage to be chosen that increases the ex ante utility of workers at the expense of ex post utility.
    Keywords: Search Theory, Incentive, Advertisement, Specific Skill
    JEL: E24 J64 M50
    Date: 2014–12
  14. By: Koen Decancq; Dirk Neumann
    Abstract: We discuss and compare fiÂ…ve 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 fiÂ…nd sizeable differences in the characteristics of the individuals identiÂ…ed as worst of according to the different well-being measures. Less than 1% of the individuals belong to the bottom decile according to all Â…five measures. Moreover, the measures lead to considerably different well-being rankings of the individuals. These Â…findings highlight the importance of the choice of well-being measure for policy making.
    Keywords: Income, composite well-being index, life satisfaction, equivalent income, von Neumann-Morgenstern utility function, worst off, Germany
    JEL: D31 D63 I30
    Date: 2014
  15. By: Doepke, Matthias (Northwestern University); Kindermann, Fabian (University of Bonn)
    Abstract: The economic theory of fertility choice builds predominantly on the unitary model of the household, in which there is a single household utility function and potential intra-household disagreement is abstracted from. Empirical evidence suggests, however, that many (potential) mothers and fathers disagree on whether to have children, on how many children to have, and on when to have them. In this paper, we review existing work that brings models of intrahousehold conflict and bargaining to bear on fertility choice, and we point out promising future directions for this line of research.
    Keywords: fertility, bargaining, child care, limited commitment
    JEL: D13 J12 J13
    Date: 2014–12
  16. By: Nikhil Agarwal
    Abstract: This paper develops a framework for estimating preferences in two-sided matching markets with non-transferable utility using only data on observed matches. Unlike single-agent choices, matches depend on the preferences of other agents in the market. I use pairwise stability together with a vertical preference restriction on one side of the market to identify preference parameters for both sides of the market. Recovering the distribution of preferences is only possible in an environment with many-to-one matching. These methods allow me to investigate two issues concerning the centralized market for medical residents. First, I examine the antitrust allegation that the clearinghouse restrains competition, resulting in salaries below the marginal product of labor. Counterfactual simulations of a competitive wage equilibrium show that residents’ willingness to pay for desirable programs results in estimated salary markdowns ranging from $23,000 to $43,000 below the marginal product of labor, with larger markdowns at more desirable programs. Therefore, a limited number of positions at high quality programs, not the design of the match, is the likely cause of low salaries. Second, I analyze wage and supply policies aimed at increasing the number of residents training in rural areas while accounting for general equilibrium effects from the matching market. I find that financial incentives increase the quality, but not the number of rural residents. Quantity regulations increase the number of rural trainees, but the impact on resident quality depends on the design of the intervention.
    JEL: C51 C78 J41 J44 L44
    Date: 2014–12
  17. By: Moreno-Okuno, Alejandro; Aguilera Navarrete, Natividad
    Abstract: The utility function with traditional exponential discount cannot explain individuals´ problems of inter-temporal inconsistence and self-control. Several economists have explained these problems with what is known as “present-bias”. The present-bias means that a good becomes more tempting when it is in the present than when it is in the future. Nevertheless, how tempting a good is depends on other factors as well. For example, a good becomes more tempting the closer it is in spatial distance from an individual. The psychological theory of “psychological distance” assumes that individuals give more importance to those goods that are closer to us (we give more importance to the present because it is closer in temporal distance). In this article we generalize the concept of present bias to include other dimensions of psychological distance. We propose a model in which individuals give more importance not only to those goods that are closer in temporal distance, but to those which are closer, for example in spatial distance. This allows individuals to control their present-bias by moving away their temptations in any psychological distance different than the temporal distance.
    Keywords: Quasi-Hyperbolic Discount, Present-Bias, Psychological Distance
    JEL: D11 D60 D80 D91
    Date: 2014–02–24
  18. By: Georg Meran; Christian von Hirschhausen
    Abstract: Many developing countries around the world apply progressive water tariffs, often structured in the form of discretely increasing block tariffs (IBTs). These tariffs have been criticized in the welfare economic literature due to their perceived inefficiency: many of the prices charged under IBTs do not correspond to marginal costs and thus violate the principle of allocative efficiency. In this paper we explore an alternative interpretation of the widespread use of IBTs, in terms of social preferences and fairness considerations. For this, we rely on an extension of the Fehr and Schmidt (1999) utility function, including inequality aversion, to which we add another parameter representing a preference for redistribution, which reflects a societal preference to correct for income difference perceived as unfair. In addition, the paper also includes household size in the analysis, finding that as poor households are on average larger (in per capita terms), a simple IBT tariff disregarding household size may not be "fair" at all. We conclude on a methodological note on the importance of addressing allocative and distributional issues simultaneously.
    Keywords: water, tariffication, prices, fairness, distribution, institutions
    JEL: L51 L95 H21 D40
    Date: 2014
  19. By: Nyantara Wickramasekera (Leeds Institute of Health Sciences, University of Leeds); Sandy Tubeuf (Leeds Institute of Health Sciences, University of Leeds); Thomas Veale (Leeds Institute of Health Sciences, University of Leeds); Judy Wright (Leeds Institute of Health Sciences, University of Leeds); Helen Elsey (Leeds Institute of Health Sciences, University of Leeds); Jenni Murray (Leeds Institute of Health Sciences, University of Leeds)
    Abstract: Background: Care farms are increasingly commissioned by public sector and health sector organizations to provide support to vulnerable people. It is a complex intervention that provides farming activities for therapeutic purposes. The evidence base assessing the effectiveness of care farms is relatively recent and to date no systematic review has been conducted to assess the impact of care farms using health-related-quality-of-life measures. Aim: This systematic review aims to identify any existing literature evaluating the impact of care farms and green care interventions in adult populations, with a specific focus on health-relatedquality- of-life measures that could be used for a cost-effectiveness or cost-utility analysis. Methods: 19 general health and social science databases were searched systematically in November 2013. Care farm and green care interventions, for adults measuring HRQOL outcome were included and assessed for methodological quality using the Cochrane’s six item risk of bias checklist. Results: Five studies with four hundred and eighty-four participants were included in this review. Two studies favoured the interventions, whereas three studies did not find strong evidence that the intervention had an effect on participants’ health-related-quality-of-life at post-intervention follow-up. These results indicated that care farms and green care may benefit certain populations such as breast and lung cancer patients, the elderly, and people with affective disorders. Conclusions: Given the small number of available studies and their methodological limitations we cannot make unequivocal conclusions about the impact of care farms on health-relatedquality- of-life. With this caveat, some evidence suggests that care farms and green care interventions can improve quality of life for some participants. However, this review highlights the need to conduct more high quality trials with larger sample sizes and longer term follow-up.
    Keywords: health-related quality-of-life, care farms, green care, cost-effectiveness, cost-utility
    JEL: I31 I38
    Date: 2014

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