nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2015‒03‒13
eleven papers chosen by
Alexander Harin
Modern University for the Humanities

  1. An activity choice approach towards pricing of 1:1 personal services – on the omnipresence of interpersonal utility comparisons By Mann, Stefan
  2. Game-theoretic approach to risk-sensitive benchmarked asset management By Amogh Deshpande; Saul D. Jacka
  3. A bitter choice turned sweet: How acknowledging individuals' concern at having a low relative income serves to align utilitarianism and egalitarianism By Stark, Oded; Jakubek, Marcin; Martyna, Kobus
  4. How Do Consumers Choose Health Insurance? – An Experiment on Heterogeneity in Attribute Tastes and Risk Preferences By Nadja Kairies-Schwarz; Johanna Kokot; Markus Vomhof; Jens Wessling
  5. Model Uncertainty, the Spirit of Capitalism and Asset Pricing By Wang, Gaowang
  6. Certainty and Overconfidence in Future Preferences for Food By Linda Thunström; Jonas Nordström; Jason F. Shogren
  7. The Relative Income Hypothesis: A comparison of methods By Sarah Brown; Daniel Gray; Jennifer Roberts
  8. Dynamic Games under Bounded Rationality By Zhao, Guo
  9. Cognitive (Ir)reflection: New Experimental Evidence By Carlos Cueva Herrero; Iñigo Iturbe-Ormaetxe Kortajarene; Esther Mata-Pérez; Giovanni Ponti; Marcello Sartarelli; Haihan Yu; Zhukova Vita
  10. Reference Points and Redistributive Preferences: Experimental Evidence By Jimmy Charité; Raymond Fisman; Ilyana Kuziemko
  11. Risk preference or financial literacy? Behavioural experiment on index insurance demand By Awel Y.; Azomahou T.T.

  1. By: Mann, Stefan
    Abstract: Currently, microeconomic theory is only of very limited use to understand price levels in the service sector. After a brief review of the literature on service pricing, this paper claims that price levels in the service sector are not only dependent on qualification levels, but also on the difference between the levels of non-monetary utility which customers on the one hand and providers on the other experience. An activity choice model shows why the ratio between utility differentials and prices should converge within a service segment. Theoretically, the approach finds a pragmatic alternative to the alleged impossibility of interpersonal utility comparisons in economic mainstream theory. Practically, it is able to explain the high price level for sex services compared with other service segments.
    Keywords: activity choice; utility of work; service sector
    JEL: D46 J22 J31
    Date: 2015
  2. By: Amogh Deshpande; Saul D. Jacka
    Abstract: In this article we consider a game theoretic approach to the Risk-Sensitive Benchmarked Asset Management problem (RSBAM) of Davis and Lleo \cite{DL}. In particular, we consider a stochastic differential game between two players, namely, the investor who has a power utility while the second player represents the market which tries to minimize the expected payoff of the investor. The market does this by modulating a stochastic benchmark that the investor needs to outperform. We obtain an explicit expression for the optimal pair of strategies as for both the players.
    Date: 2015–03
  3. By: Stark, Oded; Jakubek, Marcin; Martyna, Kobus
    Abstract: When individuals’ utility is a convex combination of their income and their concern at having a low relative income (the weights attached to income and to the concern at having a low relative income sum up to one), the maximization of aggregate utility yields an equal income distribution. This alignment of utilitarianism and egalitarianism is obtained for any number of individuals, and for general utility functions that are convex combinations of a power function of income and the concern at having a low relative income. The alignment can also hold when the weights sum up to a number different than one.
    Keywords: Utilitarianism, Egalitarianism, Social welfare maximization, Low relative income, Health Economics and Policy, Public Economics, H0, I0, I30, I31,
    Date: 2015–03
  4. By: Nadja Kairies-Schwarz; Johanna Kokot; Markus Vomhof; Jens Wessling
    Abstract: Recent health policy reforms try to increase consumer choice. We use a laboratory experiment to analyze consumers’ tastes in typical contract attributes of health insurances and to investigate their relationship with individual risk preferences. First, subjects make consecutive insurance choices varying in the number and types of contracts offered. Then, we elicit individual risk preferences according to Cumulative Prospect Theory. Applying a latent class model to the choice data, reveals five classes of consumers with considerable heterogeneity in tastes for contract attributes. From this, we infer distinct behavioral strategies for each class. The majority of subjects use minimax strategies focusing on contract attributes rather than evaluating probabilities in order to maximize expected payoffs. Moreover, we show that using these strategies helps consumers to choose contracts, which are in line with their individual risk preferences. Our results reveal valuable insights for policy makers of how to achieve efficient consumer choice.
    Keywords: Health insurance; risk preferences; heterogeneity; heuristics; laboratory experiment; cumulative prospect theory
    JEL: C91 I13 D81
    Date: 2014–12
  5. By: Wang, Gaowang
    Abstract: This paper examines how a preference for robustness affects optimal consumption-portfolio rules as well as the equilibrium asset returns when investors care about their social status (or they have the spirit of capitalism). It is shown that the interaction of these two preferences leads to higher equity premium by enhancing investors's effetive risk aversion and making them more conservative in risk-taking. In addition, we find that they also lead to greater precautionary savings and lower risk-free rate in general equilibrium. We then show that the interaction of the two preferences has the potential to resolve the equity premium puzzle and the risk-free rate puzzle for plausible parameter values. helps to resolve the equity premium and the risk-free rate puzzle.
    Keywords: the Spirit of Capitalism; Robustness; the Equity Premium Puzzle; the Risk-free Rate Puzzle
    JEL: D81 G11 G12
    Date: 2014–10–06
  6. By: Linda Thunström (HUI Research AB; Department of Economics and Finance, University of Wyoming); Jonas Nordström (Department of Food and Resource Economics, University of Copenhagen; Lund University School of Economics and Management); Jason F. Shogren (Department of Economics and Finance, University of Wyoming)
    Abstract: We examine consumer certainty of future preferences and overconfidence in predicting future preferences. We explore how preference certainty and overconfidence impact the option value to revise today’s decisions in the future. We design a laboratory experiment that creates a controlled choice environment, in which a subject's choice set (over food snacks) is known and constant over time, and the time frame is short -- subjects make choices for themselves today, and for one to two weeks ahead. Our results suggest that even for such a seemingly straightforward choice task, only 45 percent of subjects can predict future choices accurately, while stated certainty of future preferences (one and two weeks ahead) is around 80 percent. We define overconfidence in predicting future preferences as: the difference between actual accuracy at predicting future choices and stated certainty of future preferences. Our results suggest strong evidence of overconfidence. We find that overconfidence increases with the level of stated certainty of future preferences. Finally, we observe that the option value people attach to future choice flexibility decreases with overconfidence. Overconfidence in future preferences affects economic welfare because it says people have too much incentive to lock themselves into future suboptimal decisions.
    Keywords: Choice flexibility, Preference uncertainty, Overconfidence, Sub-optimal decisions, Food
    JEL: D03 D12 D83 D90
    Date: 2015–03
  7. By: Sarah Brown (Department of Economics, University of Sheffield); Daniel Gray (Department of Economics, University of Sheffield); Jennifer Roberts (Department of Economics, University of Sheffield)
    Abstract: Empirical studies of the relative income hypothesis have found both positive and negative effects of relative income on utility. Differences in data and methods make the results difficult to compare. To facilitate comparisons we explore the problem using a large UK household panel. Our findings highlight the sensitivity of the estimated relative income effect to the definition of the reference group and to the estimation strategy employed. Given the increasing attention paid to interdependent preferences in the economics literature, and the implications for problems such as the measurement of societal welfare, our findings are of interest for both the theoretical and empirical study of the relative income hypothesis.
    Keywords: relative income, reference group, subjective well-being
    JEL: I31
    Date: 2015–03
  8. By: Zhao, Guo
    Abstract: I propose a dynamic game model that is consistent with the paradigm of bounded rationality. Its main advantages over the traditional approach based on perfect rationality are that: (1) the strategy space is a chain-complete partially ordered set; (2) the response function is certain order-preserving map on strategy space; (3) the evolution of economic system can be described by the Dynamical System defined by the response function under iteration; (4) the existence of pure-strategy Nash equilibria can be guaranteed by fixed point theorems for ordered structures, rather than topological structures. This preference-response framework liberates economics from the utility concept, and constitutes a marriage of normal-form and extensive-form games.
    Keywords: Dynamic Games,Bounded Rationality,Dynamical System, fixed point theorems,chain-complete partially ordered set,Coase theorem,impossibility theorem, Keynesian beauty contest,Bertrand Paradox, backward induction paradox
    JEL: C7 D5 D7
    Date: 2015–03–08
  9. By: Carlos Cueva Herrero (Dpto. Análisis Económico Aplicado); Iñigo Iturbe-Ormaetxe Kortajarene (Universidad de Alicante); Esther Mata-Pérez (Dpto. Fundamentos del Análisis Económico); Giovanni Ponti (Universidad de Alicante); Marcello Sartarelli (Dpto. Fundamentos del Análisis Económico); Haihan Yu (Dpto. Fundamentos del Análisis Económico); Zhukova Vita (Dpto. Fundamentos del Análisis Económico)
    Abstract: We study whether cognitive ability explains choices in a wide variety of behavioral tasks, including riskand social preferences, by collecting evidence from almost 1,200 subjects across eight experimentalprojects. Since Frederick (2005)'s Cognitive Reflection Test (CRT) has been administered to allsubjects, our dataset is one of the largest in the literature. We divide the subjects pool into three groupsdepending on their CRT performance. Reflective subjects are those answering at least two of the threeCRT questions correctly. Impulsive ones are those who are unable to suppress the instinctive impulseto follow the intuitive although incorrect answer in at least two 2 questions, and the remaining subjectsform a residual group. We find that females score significantly worse than males in the CRT, and intheir wrong answers impulsive ones are observed more frequently. The 2D-4D ratio, which is higherfor females, is correlated negatively with subject's CRT score. In addition, we find that differencesbetween CRT groups in risk aversion depend on the elicitation method used. Finally, impulsive subjectshave higher social preferences, while reflective subjects are more likely to satisfy basic consistencyconditions in lottery choices.
    Keywords: behavioral economics, cognitive reflection, gender, laboratory experiment, personality
    JEL: C91 D81 J16
    Date: 2015–02
  10. By: Jimmy Charité; Raymond Fisman; Ilyana Kuziemko
    Abstract: If individuals evaluate outcomes relative to the status quo, then a social planner may limit redistribution from rich to poor even in the absence of moral hazard. We present two experiments suggesting that individuals, placed in the position of a social planner, do in fact respect the reference points of others. First, subjects are given the opportunity to redistribute unequal, unearned initial endowments between two anonymous recipients. They redistribute significantly less when the recipients know the initial endowments (and thus may have formed corresponding reference points) than when the recipients do not know (when we observe near-complete redistribution). Subjects who are themselves risk-seeking over losses drive the effect, suggesting they project their own loss-aversion onto the recipients. In a separate experiment, respondents are asked to choose a tax rate for someone who (due to luck) became rich either five or one year(s) ago. Subjects faced with the five-year scenario choose a lower tax rate, indicating respect for the more deeply embedded (five-year) reference point. Our results thus suggest that respect for reference points of the wealthy may help explain why voters demand less redistribution than standard models predict.
    JEL: C9 D63 H21 H23
    Date: 2015–03
  11. By: Awel Y.; Azomahou T.T. (UNU-MERIT)
    Abstract: We use unique cross-sectional household data from Ethiopia to investigate the effect of risk preference, financial literacy and other socio-economic characteristics on demand for index insurance. We measure risk preference based on survey experiments using lottery choice game with real monetary prizes. First, we find no evidence of risk aversion on demand for index insurance. Second, we find positive impact of financial literacy on purchasing insurance. Third, relaxing liquidity constraint enhance the take-up of insurance. Finally, demographic and village characteristics have little role in the decision to uptake insurance. These findings have implications on product design and marketing strategies. The product design should focus on ways that better account for liquidity constraint of the household. Interventions that strengthen efforts in provision of financial literacy programmes are worthy. Our results are robust to changes in specification and estimation method.
    Date: 2015

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