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on Utility Models and Prospect Theory |
| By: | David Dillenberger (Department of Economics, University of Pennsylvania ); Andrew Postlewaite (Department of Economics, University of Pennsylvania ); Kareen Rozen (Department of Economics, Yale University ) |
| Abstract: | Maximizing subjective expected utility is the classic model of decision making under uncertainty. Savage (1954) provides axioms on preference over acts that are equivalent to the existence of a subjective expected utility representation, and further establishes that such a representation is essentially unique. We show that there is a continuum of other \expected utility" representations in which the probability distributions over states used to evaluate acts depend on the set of possible outcomes of the act and suggest that these alternate representations can capture pessimism or optimism. We then extend the DM's preferences to be defined over both subjective acts and objective lotteries, allowing for source-dependent preferences. Our result permits modeling ambiguity aversion in Ellsberg's two-urn experiment using a single utility function and pessimistic probability assessments over prizes for lotteries and acts, while maintaining the axioms of Savage and von Neumann-Morganstern on the appropriate domains. |
| Keywords: | Subjective expected utility, optimism, pessimism, stake-dependent probability |
| JEL: | D80 D81 |
| Date: | 2013–11–01 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:15-009&r=upt |
| By: | Akay, Alpaslan (Department of Economics, School of Business, Economics and Law, Göteborg University ); Bargain, Olivier (AixMarseille University ); Jara, H. Xavier (University of Essex ) |
| Abstract: | Subjective wellbeing (SWB) is increasingly used as a way to measure individual wellbeing. Interpreted as "experienced utility", it has been compared to "decision utility" using specific experiments (Kahneman et al., 1997) or stated preferences(Benjamin et al. 2012). We suggest here an original largescale comparison between ordinal preferences elicited from SWB data and those inferred from actual choices(revealed preferences). Precisely, we focus on incomeleisure preferences, closely associated to redistributive policies. We compare indifference curves consistent with incomeleisure subjective satisfaction with those derived from actual labor supply choices, on the same panel of British households. Results show striking similarities between these measures on average, reflecting that overall, people’s decision are not inconsistent with SWB maximization. Yet, the shape of individual preferences differ across approaches when looking at specific subpopulations. We investigate these differences and test for potential explanatory channels, particularly the roles of constraints and of individual "errors" related to aspirations, expectations or focusing illusion. We draw implications of our results for welfare analysis and policy evaluation.<p> |
| Keywords: | decision utility; experienced utility; labor supply; subjective well being |
| JEL: | C90 D63 |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:gunwpe:0611&r=upt |
| By: | Audrey Hu (University of Amsterdam,Tinbergen Institute ); Steven A. Matthews (Department of Economics, University of Pennsylvania ); Liang Zou (University of Amsterdam ) |
| Abstract: | We establish conditions under which an English auction for an indivisible risky asset has an efficient ex post equilibrium when the bidders are heterogeneous in both their exposures to, and their attitudes toward, the ensuing risk the asset will generate for the winning bidder. Each bidder's privately known type is unidimensional, but may affect both his risk attitude and the expected value of the asset's return to the winner. An ex post equilibrium in which the winning bidder has the largest willingness to pay for the asset exists if two conditions hold: each bidder's marginal utility of income is log-supermodular, and the vector-valued function mapping the type vector into the bidders' expected values for the asset satisfies a weighted average crossing condition. However, this equilibrium need not be efficient. We show that it is efficient if each bidder's expected value for the asset is nonincreasing in the types of the other bidders, or if the bidders exhibit nonincreasing absolute risk aversion or if the asset is riskless. |
| Keywords: | English auction, ensuing risk, heterogeneous risk preferences, interdependent values, ex post equilibrium, ex post efficiency |
| JEL: | D44 D82 |
| Date: | 2015–02–25 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:15-010&r=upt |
| By: | Christian Kellner ; David Reinstein ; Gerhard Riener ; Michael Sanders |
| Abstract: | When and how should a fundraiser ask for a donation from an individual facing an uncertain bonus income? A standard model of expected utility over outcomes predicts that the individual’s before choice – her ex-ante commitment conditional on her income – will be the same as her choice after the income has been revealed. Deciding “if you win, how much will you donate?” involves a commitment (i) over a donation for a state of the world that may not be realized and (ii) over uncertain income. Models involving reference-dependent utility, tangibility, and self-signaling predict more giving before, while theories of affect predict more giving after. In our online field experiment at a UK university, as well as in our laboratory experiments in Germany, charitable giving was significantly larger in the Before treatment than in the After treatment for male subjects, with a significant gender differential. Lab treatments isolated distinct mechanisms: for men, donations were higher in all treatments where the donation’s collection was uncertain, whether or not the income was known. This supports a (self)-signaling explanation: commitments realized with a lower probability must involve larger amounts to have the same signaling power. Our results are directly relevant to fundraising and volunteer-recruitment strategies,and offer further evidence that we need to exercise caution in applying expected-utility theory in the presence of social preferences. |
| Date: | 2015–02–18 |
| URL: | http://d.repec.org/n?u=RePEc:esx:essedp:762&r=upt |
| By: | Keith M. Ericson ; John Myles White ; David Laibson ; Jonathan D. Cohen |
| Abstract: | Heuristic models have been proposed for many domains of choice. We compare heuristic models of intertemporal choice, which can account for many of the known intertemporal choice anomalies, to discounting models. We conduct an out-of-sample, cross-validated comparison of intertemporal choice models. Heuristic models outperform traditional utility discounting models, including models of exponential and hyperbolic discounting. The best performing models predict choices by using a weighted average of absolute differences and relative (percentage) differences of the attributes of the goods in a choice set. We conclude that heuristic models explain time-money tradeoff choices in experiments better than utility discounting models. |
| JEL: | D03 D9 |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:20948&r=upt |
| By: | Fosgerau, Mogens ; de Palma, André |
| Abstract: | We formulate a family of direct utility functions for the consumption of a differentiated good. This is used to generate a family of demand systems with flexible substitution patterns. Demand models for market shares can be estimated by regression enabling the use of instrumental variables. Models for microdata can be estimated with maximum likelihood. Our direct utility functions are based on a generalization of the Shannon entropy. They include dual representations of all additive random utility discrete choice models and more. |
| Keywords: | market shares; product differentiation; duality; discrete choice; entropy |
| JEL: | C25 D01 L1 |
| Date: | 2015–02–02 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:62106&r=upt |
| By: | Ariel Neufeld ; Marcel Nutz |
| Abstract: | We study a robust portfolio optimization problem under model uncertainty for an investor with logarithmic or power utility. The uncertainty is specified by a set of possible L\'evy triplets; that is, possible instantaneous drift, volatility and jump characteristics of the price process. We show that an optimal investment strategy exists and compute it in semi-closed form. Moreover, we provide a saddle point analysis describing a worst-case model. |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1502.05920&r=upt |
| By: | Müller, Stephan ; Rau, Holger A. |
| Abstract: | We experimentally analyze the relation of risk preferences and subjects aversion to advantageous inequality as measured by the guilt parameter of the Fehr and Schmidt (1999) model. Our findings reveal a significant negative correlation between subjects risk attitudes and their altruistic behavior. Risk tolerant subjects tend to be selfish, whereas risk-averse people show high levels of altruism. |
| Keywords: | altruism,experiment,risk preferences |
| JEL: | C91 D64 D81 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cegedp:231&r=upt |
| By: | Sara Biagini ; Mustafa Pinar |
| Abstract: | We derive a closed form portfolio optimization rule for an investor who is diffident about mean return and volatility estimates, and has a CRRA utility. The novelty is that confidence is here represented using ellipsoidal uncertainty sets for the drift, given a volatility realization. This specification affords a simple and concise analysis, as the optimal portfolio allocation policy is shaped by a rescaled market Sharpe ratio, computed under the worst case volatility. The result is based on a max-min Hamilton-Jacobi-Bellman-Isaacs PDE, which extends the classical Merton problem and reverts to it for an ambiguity-neutral investor. |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1502.02847&r=upt |
| By: | Enrica Carbone ; Xueqi Dong ; John Hey |
| Abstract: | This paper represents an intersection between two lines of research. The first is portfolio choice theory, which underlies much of finance; the second is the elicitation of preferences under uncertainty. The theory of the behaviour of financial markets builds heavily on portfolio choice theory; until recently this has assumed that preferences are of a particularly simple kind. In contrast research on preferences has revealed that people have more sophisticated preferences. This paper tries to bring the two fields together by investigating, in a portfolio choice context, the preferences that are revealed by decisions. In the second of these two fields, researchers are increasingly using allocation problems to elicit the preferences of subjects, believing that such problems are more informative, and perhaps more natural, than other elicitation methods. At the same time portfolio choice theory is itself concerned with an allocation problem. Usually in experimental finance the allocation problems are over Arrow securities each of which pays off only in one state of the world. Instead we study the more realistic case, familiar from finance, in which all assets pay off in all states of the world. To make our study more realistic we frame the problem as one under ambiguity, where the probabilities of the states are not known to the decision-maker. This enables us to compare the performance of some recent theories of behaviour under ambiguity as well as traditional ones (such as Mean-Variance) from the theory of finance. We also identify a ‘rule of thumb’ that decision-makers may be using in this rather complex scenario. This research may help us to understand more fully actual portfolio choice decisions. |
| Keywords: | ambiguity, portfolio choice, preferences under ambiguity, securities. |
| JEL: | C9 D81 G02 G11 |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:yor:yorken:15/03&r=upt |
| By: | Cl\'ement M\'enass\'e ; Peter Tankov |
| Abstract: | Financial markets based on L\'evy processes are typically incomplete and option prices depend on risk preferences of individual agents. In this context, the notion of utility indifference price has gained popularity in the academic circles. Although theoretically very appealing, this pricing method remains difficult to apply in practice, due to the high computational cost of solving the nonlinear partial integro-differential equation associated to the indifference price. In this work, we develop closed form approximations to exponential utility indifference prices in exponential L\'evy models. To this end, we first establish a new non-asymptotic approximation of the indifference price which extends earlier results on small risk aversion asymptotics of this quantity. Next, we use this formula to derive a closed-form approximation of the indifference price by treating the L\'evy model as a perturbation of the Black-Scholes model. This extends the methodology introduced in a recent paper for smooth linear functionals of L\'evy processes (A. \v{C}ern\'y, S. Denkl and J. Kallsen, arXiv:1309.7833) to nonlinear and non-smooth functionals. Our closed formula represents the indifference price as the linear combination of the Black-Scholes price and correction terms which depend on the variance, skewness and kurtosis of the underlying L\'evy process, and the derivatives of the Black-Scholes price. As a by-product, we obtain a simple explicit formula for the spread between the buyer's and the seller's indifference price. This formula allows to quantify, in a model-independent fashion, how sensitive a given product is to jump risk in the limit of small jump size. |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1502.03359&r=upt |
| By: | Erhan Bayraktar ; Zhou Zhou |
| Abstract: | We consider a financial model where stocks are available for dynamic trading, and European and American options are available for static trading (semi-static trading strategies). We assume that the American options are infinitely divisible, and can only be bought but not sold. We first get the fundamental theorem of asset pricing (FTAP) using semi-static trading strategies. Using the FTAP result, we further get the dualities for the hedging prices of European and American options. Based on the hedging dualities, we also get the duality for the utility maximization involving semi-static trading strategies. |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1502.06681&r=upt |
| By: | Michele Longo ; Alessandra Mainini |
| Abstract: | We maximize the expected utility from terminal wealth for an HARA investor when the market price of risk is an unobservable random variable. We compute the optimal portfolio explicitly and explore the effects of learning by comparing it with the corresponding myopic policy. In particular, we show that, for a market price of risk constant in sign, the ratio between the portfolio under partial observation and its myopic counterpart increases with respect to risk tolerance. As a consequence, the absolute value of the partial observation case is larger (smaller) than the myopic one if the investor is more (less) risk tolerant than the logarithmic investor. Moreover, our explicit computations enable to study in details the so called hedging demand induced by learning about market price of risk. |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1502.02968&r=upt |
| By: | Leonard J. Mirman ; Egas M. Salgueiro ; Marc Santugini |
| Abstract: | We address the issue of risk aversion in a competitive equilibrium when some buyers engage in learning and information is conveyed through the price system. Specifically, since the learning process yields uncertainty, we study the effect of risk aversion on the equilibrium outcomes of the model, including the amount of information released by the market. We show that risk aversion has an effect on the market outcomes but not on the flow of information. In particular, an increase in risk aversion lowers the competitive price and quantity. However, an increase in risk aversion does not change the amount of information embedded in the equilibrium price. |
| Keywords: | Learning, Risk aversion, Uncertainty |
| JEL: | D21 D42 D82 D83 D84 L12 L15 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:lvl:lacicr:1502&r=upt |
| By: | Eisenbach, Thomas M. (Federal Reserve Bank of New York ); Schmalz, Martin C. (Federal Reserve Bank of New York ) |
| Abstract: | We provide a preference-based rationale for endogenous overconfidence. Horizon-dependent risk aversion, combined with a possibility to forget, can generate overconfidence and excessive risk taking in equilibrium. An “anxiety prone” agent, who is more risk-averse to imminent than to distant risks, has an incentive to distort her future self’s beliefs toward underestimating risk. Such self-deception can be achieved even if the future self is aware of the attempted distortion. We relate our results to the literature on empirically observed overconfidence and excessive risk taking in several domains of financial and other types of decision making.” |
| Keywords: | overconfidence; dynamic consistency; biases; deception; risk taking |
| JEL: | A12 D81 D83 D84 |
| Date: | 2015–02–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:711&r=upt |
| By: | Stephen Ansolabehere (Government Department, Harvard University ); M. Socorro Puy (Department of Economic Theory, Universidad de Málaga ) |
| Abstract: | We present a framework to analyze the relative importance of issues for the electorate. We distinguish two concepts -- issue salience and issue divisiveness -- and present those in the context of the multidimensional spatial model. Issue salience, which is widely studied in empirical and theoretical models, is the weight of one issue over another in a typical voter's utility function. Issue divisiveness is the differentiation between the issues, which depends on the positions or alignments of competing parties and candidates on each issue. We show that empirical research commonly conflates salience and divisiveness, as the regression coefficient in a multiple regression of vote choice on issues reflects both, the weight or salience of each issue and the distinctiveness of the two parties on each issue. We analyze the example of regional elections in the Basque province of Spain to demonstrate the mechanics and value of the approach developed. The politics of this region provide a good instance where debate over the importance of ideology and nationalism conflates salience and divisiveness. |
| Keywords: | Issue-Silence; Issue-Divisiveness; Positional Issues; Basque Elections |
| Date: | 2015–01 |
| URL: | http://d.repec.org/n?u=RePEc:mal:wpaper:2015-1&r=upt |
| By: | Valentin Haddad (Princeton University ); Marianne Andries (Toulouse School of Economics ) |
| Abstract: | We propose a theory of inattention solely based on preferences, absent any cognitive limitations, or external costs of acquiring information. Under disappointment aversion, information decisions and risk attitude are intertwined, and agents are intrinsically information averse. We illustrate this link between attitude towards risk and information in a standard portfolio problem. We show agents never choose to receive information continuously in a diffusive environment: they optimally acquire information at infrequent intervals only. In contrast to existing theories, we show the optimal frequency of information acquisition can decrease when risk increases, consistent with empirical evidence. We show information aversion tends to lower significantly the benefits of diversification, leads to a joint evaluation of project gains and their information process, as well as creates scope for the creation of information providers. These results suggest our approach can explain many observed features of decision under uncertainty. |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed014:1091&r=upt |
| By: | Sylvain Béal (CRESE, Université de Franche-Comté ); André Casajus (Economics and Information Systems, HHL Leipzig Graduate School of Management and LSI Leipziger Spieltheoretisches Institut, Leipzig, Germany ); Frank Huettner (Economics and Information Systems, HHL Leipzig Graduate School of Management and LSI Leipziger Spieltheoretisches Institut, Leipzig, Germany ) |
| Abstract: | We study values for transferable utility games enriched by a communication graph (CO-games) where the graph does not necessarily a¤ect the productivity but can in?uence the way the players distribute the worth generated by the grand coalition. Thus, we can envisage values that are efficient instead of values that are component efficient. For CO-games with connected graphs, efficiency and component efficiency coincide. In particular, the Myerson value (Myerson, 1977) is efficient for such games. Moreover, fairness is characteristic of the Myerson value. We identify the value that is efficient for all CO-games, coincides with the Myerson value for CO-games with connected graphs, and satisfies fairness. |
| Keywords: | communication graph, fairness, efficiency, efficient extension, Shapley value, Myerson value |
| JEL: | C71 D60 |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:crb:wpaper:2015-01&r=upt |
| By: | Breitmoser, Yves |
| Abstract: | People overestimate the probability that others share their values or preferences. I introduce type projection equilibrium (TPE) to capture such projection in Bayesian games. TPE allows each player to believe his opponents share his type with intermediate probability \rho. After establishing existence, I address my main question: How does projection affect behavior in games? I analyze auctions and distribution games. In auctions, projection implies an increased sense of competition, which induces overbidding in all (first-price) auctions. In addition, it biases the perceived value distribution, which induces cursed bidding in common value auctions. Thus, projection induces a hitherto neglected bias in bidding. It is novel in that it explains behavior across conditions and it is independently founded in psychology. I test projection equilibrium in multiple ways on existing data and find that it substantially improves on alternative concepts, both in isolation and in addition to them. The findings are cross-validated by testing projection of social preferences in distribution games. |
| Keywords: | auctions, overbidding, winner's curse, projection, risk aversion, cursed equilibrium, level-k, social preferences |
| JEL: | C72 C91 D44 |
| Date: | 2015–02–10 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:62052&r=upt |
| By: | Jia Chen ; Degui Li ; Oliver Linton ; Zudi Lu |
| Abstract: | Dynamic portfolio choice has been a central and essential objective for institutional investors in active asset management. In this paper, we study the dynamic portfolio choice with multiple conditioning variables, where the number of the conditioning variables can be either fixed or diverging to infinity at certain polynomial rate of the sample size. We propose a novel data-driven method to estimate the optimal portfolio choice, motivated by the model averaging marginal regression approach suggested by Li, Linton and Lu (2015). More specifically, in order to avoid the curse of dimensionality associated with multivariate nonparametric regression problem and to make it practically implementable, we first estimate the marginal optimal portfolio choice by maximising the conditional utility function for each univariate conditioning variable, and then construct the joint dynamic optimal portfolio through the weighted average of the marginal optimal portfolio across all the conditioning variables. Under some regularity conditions, we establish the large sample properties for the developed portfolio choice procedure. Both simulation studies and empirical application well demonstrate the performance of the proposed methodology. |
| Keywords: | Conditioning variables, kernel smoothing, model averaging, portfolio choice, utility function |
| JEL: | C13 C14 C32 |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:yor:yorken:15/01&r=upt |
| By: | Klinedinst, Mark |
| Abstract: | The project to create an experimental “clean coal” plant in Mississippi is funded by electric utility customers in the poorest state in the United States. The incentives for the project come from the industry capturing the Public Service Commission of Mississippi. The controversial incentives stipulate that the Southern Company can earn a return on money spent to create electrical infrastructure, even if the experimental plant never produces any electricity. The Southern Company’s Kemper County Mississippi “Radcliffe” Plant, originally estimated to cost about $1.2 billion, is approaching $6 billion dollars, is still not operational, and may never be a profitable facility. Despite this, over 180,000 of America’s poorest citizens are expected to foot the bill. Although this is one of the most intense examples of corporate welfare, the “Radcliffe” Plant is hardly the only current case in the utility industry. The “Public Service Commission” of Mississippi facilitated this large transfer of income from ratepayers to investors in this monopoly. |
| Keywords: | utility, public service commission, coal, rate, electric |
| JEL: | A1 L5 Q38 Q4 |
| Date: | 2014–11–14 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:62214&r=upt |
| By: | Okay Gunes (Centre d'Economie de la Sorbonne ); Armagan Tuna Aktuna-Gunes (Centre d'Economie de la Sorbonne - Paris School of Economics ) |
| Abstract: | In this article, the satisfactory consumption and labor supply elasticities of demand are measured through a model of time allocation that includes eight time assignment equations by using the full time use (the temporal values of the monetary expenditure plus time spent) concept obtained by matching the Classic Family Budget survey with the Time Use survey for Turkey. The cross-sectional data covers the period of 2003-2006 in Turkey. The elasticity results show a clear picture of the relationship between satisfactory consumption and working with commodity demands for Turkey. As a contribution to the literature, we explore the reasons behind the demand for satisfactory consumption through working decisions by measuring well-being inequality for each consumption group. In order to increase the robustness of our result, overall well-being inequality is measured by introducing the axiom of superposed utility of preferences. As expected, overall well-being inequality delcines to 0.26, which is 119 percentage points lower than the average rate of well-being inequality (0.57) in Turkey. |
| Keywords: | Time use, life satisfaction, well-being inequality, superposed utilities. |
| JEL: | C51 D03 J22 I31 |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:mse:cesdoc:15019&r=upt |
| By: | Wellschmied, Felix (Universidad Carlos III de Madrid ) |
| Abstract: | This paper quantitatively determines the asset limit in income support programs which minimizes consumption volatility in a lifecycle model with incomplete markets and idiosyncratic earnings risk. An asset limit allows allocating transfers to those households with the highest utility gains from extra consumption. Moreover, it serves as substitute for history and age dependent taxation. However, a low limit provides incentives for high school dropouts to accumulate almost no wealth. Consequently, they miss self-insurance and suffer from high consumption volatility. For an unborn, these effects are optimally traded-off with an asset limit of $145000. |
| Keywords: | means-tested programs, public insurance, incomplete markets |
| JEL: | D91 I38 J26 |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp8838&r=upt |
| By: | Suzuki, T. (Tilburg University, School of Economics and Management ) |
| Abstract: | When individuals generate benefits from their cooperation, allocation<br/>problems may occur regarding how much of the benefit from the<br/>cooperation each individual should take. In many economic situations,<br/>defining the contribution of each individual in a fair way is essential. This<br/>thesis is on cooperative game theory, a mathematical tool that models<br/>and analyses cooperative situations between individuals. Throughout<br/>the monograph, allocation rules that are based on the contributions of<br/>individuals are studied.<br/><br/>The first two parts of this thesis are on the class of transferable utility<br/>games, in which benefits from cooperation can be freely transferred<br/>between agents. In the first part, allocation rules when the cooperation<br/>between agents is restricted by a communication structure are studied.<br/>A chapter of this part gives a new characterization of a known allocation<br/>rule. In the next chapter, allocation rules are investigated for the class of<br/>games in which the underlying communication structure is represented<br/>by a circle. The second part of this thesis introduces a new type of<br/>restriction on cooperation between players, called quasi-building system,<br/>which covers many known structures. The third part of this thesis deals<br/>with situations in which benefits from cooperation are not transferable<br/>between individuals. This part focuses on when an allocation rule based<br/>on contributions of individuals leads to an economically satisfying result. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:tiu:tiutis:9bd876f2-c055-4d01-95f0-cfc969c49cda&r=upt |
| By: | Rodolfo Campos ; Iliana Reggio |
| Abstract: | We study the optimal provision of unemployment insurance (UI) in a framework that distinguishes between consumption and expenditure. We derive a "sufficient statistics" formula for optimal UI that is expressed terms of observable variables and can therefore be used in applied work. Recent research has shown that unemployed households pay less per unit of consumption than employed households. This finding has two counteracting effects on the optimal level of UI. On the one hand, consumption smoothing benefits identified from expenditure data overestimate the true marginal benefits of UI. On the other hand, UI benefits become more valuable because they buy more consumption when unemployed. In an optimal design, which effect dominates depends on the curvature of the utility function. We show that for relative risk aversion larger than one the first effect dominates, leading to lower levels of optimal UI. |
| Keywords: | consumption , expenditure , consumption-smoothing , social insurance , unemployment insurance |
| JEL: | D11 J64 J65 J68 |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:cte:werepe:we1502&r=upt |