nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2015‒03‒05
eleven papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Estimating Individual Ambiguity Aversion: A Simple Approach By Uri Gneezy; Alex Imas; John List
  2. Long-Term Care Utility and Late in Life Saving By John Ameriks; Joseph S. Briggs; Andrew Caplin; Matthew D. Shapiro; Christopher Tonetti
  3. Optimally Investing to Reach a Bequest Goal By Erhan Bayraktar; Virginia R. Young
  4. An Evolutionary Risk Basis for the Differential Treatment of Gains and Losses By Nagar, Venky; Rajan, Madhav V.; Ray, Korok
  5. Revisiting the Tradeoff between Risk and Incentives: The Shocking Effect of Random Shocks By Brice Corgnet; Roberto Hernán-González
  6. What we don’t know doesn’t hurt us: rational inattention and the permanent income hypothesis in general equilibrium By Nie, Jun; Luo, Yulei; Wang, Gaowang; Young, Eric R.
  7. Optimal Taxation with Incomplete Markets By Thomas Sargent; Mikhail Golosov; David Evans; anmol bhandari
  8. Pork-Barrel Spending under Cournot Legislators and the Quantity Equation By Soldatos, Gerasimos T.
  9. The Variance Risk Premium and Fundamental Uncertainty By Conrad, Christian; Loch, Karin
  10. Process and Order in Classical and Marginalist Economics By Nuno Ornelas Martins
  11. College Diversity and Investment Incentives By Thomas Gall; Patrick Legros; Andrew Newman

  1. By: Uri Gneezy; Alex Imas; John List
    Abstract: We introduce a simple, easy to implement instrument for jointly eliciting risk and ambiguity attitudes. Using this instrument, we structurally estimate a two-parameter model of preferences. Our findings indicate that ambiguity aversion is significantly overstated when risk neutrality is assumed. This highlights the interplay between risk and ambiguity attitudes as well as the importance of joint estimation. In addition, over our stakes levels we find no difference in the estimated parameters when incentives are real or hypothetical, raising the possibility that a simple hypothetical question can provide insights into an individuals preferences over ambiguity in such economic environments.
    JEL: C9 C91 C92 C93 D81
    Date: 2015–02
  2. By: John Ameriks; Joseph S. Briggs; Andrew Caplin; Matthew D. Shapiro; Christopher Tonetti
    Abstract: Older wealthholders spend down assets slowly. To study this pattern, the paper introduces health dependent utility into a model in which different preferences for bequests, expenditures when in need of long-term care (LTC), and ordinary consumption combine with health and longevity uncertainty to determine saving behavior. To help separately identify motives, it develops Strategic Survey Questions (SSQs) that elicit stated preferences. The model is estimated using new SSQ and wealth data from the Vanguard Research Initiative. Estimates of the health-state utility function imply that motives associated with LTC are significantly more important than bequest motives in determining late in life saving.
    JEL: D91 E21 H31 I10 J14
    Date: 2015–02
  3. By: Erhan Bayraktar; Virginia R. Young
    Abstract: We determine the optimal strategy for investing in a Black-Scholes market in order to maximize the probability that wealth at death meets a bequest goal $b$. We, thereby, make more objective the goal of maximizing expected utility of death, first considered in a continuous-time framework by Merton (1969). Specifically, instead of requiring the individual to choose a utility function, we only require the individual to choose a bequest goal $b$. We learn that, for wealth lying between $0$ and $b$, the optimal investment strategy is {\it independent} of $b$, a surprising result. Therefore, if the individual were to revise her bequest goal, her investment strategy would not change if her wealth is less than the new goal.
    Date: 2015–03
  4. By: Nagar, Venky (University of MI); Rajan, Madhav V. (Stanford University); Ray, Korok (George Washington University)
    Abstract: This study endogenously generates the asymmetric verification concept of conservatism, using evolutionary biology as a foundation. A producer produces (or hunts) a consumable with a stochastic production technology, and possibly faces a stealer thereafter, who seeks to expropriate the consumable. The producer, for fear of being perceived as weak, will never share her output with the stealer, but will launch an all-out fight. This all-or nothing gamble demonstrates the producer's convex utility in losses. On the other hand, the optimal choice in production (or hunting) indicates a concave preference in gains. These endogenously derived asymmetric risk-profiles towards gains and losses, when applied to choice theory, generate a demand for higher verifiability standards for probable gains than losses. The model then shows how this preference is modulated by various social and informational configurations of individuals. Our findings explain observed conservatism patterns in a variety of institutional settings.
    Date: 2014–05
  5. By: Brice Corgnet (Chapman University); Roberto Hernán-González (University of Nottingham)
    Abstract: Despite its central role in the theory of incentives, empirical evidence of a tradeoff between risk and incentives remains scarce. We reexamine this empirical puzzle in a controlled laboratory environment so as to isolate possible confounding factors encountered in the field. In line with the principal-agent model, we find that principals increase fixed pay while lowering performance pay when the relationship between effort and output is noisier. Unexpectedly, agents produce substantially more in the noisy environment than in the baseline despite lesser pay for performance. We show that this result can be accounted for by introducing agents’ loss aversion in the principal-agent model. Our findings call for an extension of standard agency models and for a reassessment of apparently inefficient management practices.
    Keywords: Principal-agent models, incentive theory, loss aversion, laboratory experiments
    JEL: C92 D23 D86 M54
    Date: 2015
  6. By: Nie, Jun (Federal Reserve Bank of Kansas City); Luo, Yulei; Wang, Gaowang; Young, Eric R.
    Abstract: This paper derives the general equilibrium effects of rational inattention (or RI; Sims 2003,2010) in a model of incomplete income insurance (Huggett 1993, Wang 2003). We show that,under the assumption of CARA utility with Gaussian shocks, the permanent income hypothesis (PIH) arises in steady state equilibrium due to a balancing of precautionary savings and impatience. We then explore how RI affects the equilibrium joint dynamics of consumption, income and wealth, and find that elastic attention can make the model fit the data better. We finally show that the welfare costs of incomplete information are even smaller due to general equilibrium adjustments in interest rates.
    Keywords: Rational inattention; Permanent income hypothesis; General equilibrium; Consumption and income volatility.
    JEL: C61 D83 E21
    Date: 2014–11–01
  7. By: Thomas Sargent (New York University); Mikhail Golosov (Princeton University); David Evans (New York University); anmol bhandari (New York University)
    Abstract: This paper characterizes tax and debt dynamics in Ramsey plans for incomplete markets economies that generalize an Aiyagari et al. (2002) economy by allowing a single asset traded by the government to be risky. Long run debt and tax dynamics can be attracted not only to the first-best continuation allocations discovered by Aiyagari et al. for quasi-linear preferences, but instead to a continuation allocation associated with a level of (marginal-utility-scaled) government debt that would prevail in a Lucas-Stokey economy that starts from a particular initial level of government debt. The paper formulates, analyzes, and numerically solves Bellman equations for two value functions for a Ramsey planner, one for t ≥ 1, the other for t = 0.
    Date: 2014
  8. By: Soldatos, Gerasimos T.
    Abstract: This note makes the following two points based on Cournot utility functions of the legislators and on the government budget constraint viewed from the perspective of the equation of exchange. Without logrolling, i.e. with different perceptions of the budget constraint, there can be such a legislature preference structure that can turn a pork-barrel project into welfare-enhancing public expenditure depending on economic circumstances. With logrolling, i.e. with agreement at least regarding the size of the budget, the “pork” may be taken out of the project regardless the economic conjuncture. These results are independent of the utility function used, while the use of the quantity equation serves only as the simplest macroeconomic framework in which the two general points herein may be made.
    Keywords: Pork-barrel spending, budget deficit, quantity equation, Cournot legislators, logrolling
    JEL: D72 E31 H61
    Date: 2014
  9. By: Conrad, Christian; Loch, Karin
    Abstract: We propose a new measure of the expected variance risk premium that is based on a forecast of the conditional variance from a GARCH-MIDAS model. We find that the new measure has strong predictive ability for future U.S. aggregate stock market returns and rationalize this result by showing that the new measure effectively isolates fundamental uncertainty as the factor that drives the variance risk premium.
    Keywords: Variance risk premium; return predictability; VIX; GARCH-MIDAS; economic uncertainty; vol-of-vol
    Date: 2015–02–27
  10. By: Nuno Ornelas Martins (Centro de Estudos em Gestão e Economia da Universidade Católica Portuguesa)
    Abstract: In this article I compare the classical theory of value with the theory of value that emerged after the marginal revolution, taking into account the underlying conceptions of process and order that are implicit in each theory. In classical political economy, the economy is conceived of as a continuous process of reproduction, wherein a surplus is distributed through various social classes. After the classical period, the notion of reproduction is replaced with the notion of equilibrium, while the analysis of society in terms of social classes is replaced by methodological individualism. Value also starts to be seen in terms of marginal utility, rather than cost of production. This transformation brought important changes to the implicit philosophical conceptions of process and order that have underpinned the dominant economic doctrine from the classical period until today, leading to the marginalist belief that market exchange is always the most efficient coordinating mechanism of the economy. The classical perspective, however, contains a broader conception of socio-economic reproduction, which is consistent with different institutional arrangements.
    Keywords: Process, order, reproduction, exchange, value.
    JEL: B41
    Date: 2014–12
  11. By: Thomas Gall; Patrick Legros; Andrew Newman (Boston University)
    Abstract: We study the aggregate economic effects of diversity policies such as affirmative action in college admission. If agents are constrained in the side payments they can make, the free market allocation displays excessive segregation relative to the first-best. Affirmative action policies can restore diversity within colleges but also affect incentives to invest in pre-college scholastic achievement. Affirmative action policies that are achievement-based can increase aggregate investment and income, reduce inequality, and increase aggregate welfare relative to the free market outcome. They may also be more effective than decentralized policies such as cross-subsidization of students by colleges.
    Keywords: matching, misallocation, nontransferable utility, multidimensional attributes, Affirmative Action, segregation, education
    JEL: C78 I28 J78
    Date: 2015–01

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