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on Utility Models and Prospect Theory |
| By: | Burghart, Daniel R. (University of Zurich); Epper, Thomas (University of St. Gallen); Fehr, Ernst (University of Zurich) |
| Abstract: | The probability triangle (also called the Marschak-Machina triangle) allows for compact and intuitive depictions of risk preferences. Here, we develop an analogous tool for choice under uncertainty – the ambiguity triangle – and show that indifference curves in this triangle capture preferences for unknown probabilities. In particular, the ambiguity triangle allows us to examine whether subjects adhere to the generalized axiom of revealed preference (GARP) and satisfy a non-parametric test for constant ambiguity attitudes. We find that more than 95% of subjects adhere to GARP and that about 60% satisfy our test for a constant ambiguity attitude. Yet, among these 60% of subjects there is substantial preference heterogeneity. We characterize this heterogeneity with finite-mixture estimates of a one-parameter extension of Expected Utility Theory wherein 48% of subjects are ambiguity averse, 22% are ambiguity seeking, and 30% are close to ambiguity neutral. The ambiguity triangle also highlights how variable ambiguity attitudes arise mainly because indifference curves are 'fanning-in' across the triangle. This fanning-in property implies that aversion to ambiguity increases as the likelihood of receiving a good outcome increases. We capture this behavior with a simple parametric model that also allows for finite mixture characterizations of preference heterogeneity for these subjects. We show that for a substantial share of these subjects (43%) their fanning-in is so strong that, although they are initially ambiguity seeking, they become strongly ambiguity averse as the likelihood of receiving a good outcome increases. |
| Keywords: | uncertainty, risk preferences |
| JEL: | D81 C91 |
| Date: | 2015–06 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp9150&r=upt |
| By: | Enrico G. De Giorgi; Ola Mahmoud |
| Abstract: | Diversification represents the idea of choosing variety over uniformity. Within the theory of choice, desirability of diversification is axiomatized as preference for a convex combination of choices that are equivalently ranked. This corresponds to the notion of risk aversion when one assumes the von-Neumann-Morgenstern expected utility model, but the equivalence fails to hold in other models. This paper reviews axiomatizations of the concept of diversification and their relationship to the related notions of risk aversion and convex preferences within different choice theoretic models. The survey covers model-independent diversification preferences, preferences within models of choice under risk, including expected utility theory and the more general rank-dependent expected utility theory, as well as models of choice under uncertainty axiomatized via Choquet expected utility theory. Remarks on interpretations of diversification preferences within models of behavioral choice are given in the conclusion. |
| Date: | 2015–07 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1507.02025&r=upt |
| By: | Akay, Alpaslan (University of Gothenburg); Bargain, Olivier (University of Aix-Marseille II); Giulietti, Corrado (IZA); Robalino, Juan David (Cornell University); Zimmermann, Klaus F. (IZA and University of Bonn) |
| Abstract: | The paper investigates the impact of remittances on the relative concerns of households in rural China. Using the Rural to Urban Migration in China (RUMiC) dataset we estimate a series of well-being functions to simultaneously explore the relative concerns with respect to income and remittances. Our results show that although rural households experience substantial utility loss due to income comparisons, they gain utility by comparing their remittances with those received by their reference group. In other words, we find evidence of a "status-effect" with respect to income and of a "signal-effect" with respect to remittances. The magnitudes of these two opposite effects are very similar, implying that the utility reduction due to relative income is compensated by the utility gain due to relative remittances. This finding is robust to various specifications, controlling for the endogeneity of remittances and selective migration, as well as a measure of current migrants' net remittances calculated using counterfactual income and expenditures. |
| Keywords: | positional concerns, remittances, subjective well-being |
| JEL: | C90 D63 |
| Date: | 2015–06 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp9163&r=upt |
| By: | Eleonora Perversi; Eugenio Regazzini |
| Abstract: | This paper attempts to find a relationship between agents' risk aversion and inequality of incomes. Specifically, a model is proposed for the evolution in time of income distribution, and the steady states are characterized almost completely. They turn out to be weak Pareto laws with exponent linked to the relative risk aversion index which, in turn, is supposed to be the same constant for every agent. On the one hand, the aforesaid link is expressed by an affine transformation. On the other hand, the level of the relative risk aversion index results from a frequency distribution of observable quantities stemming from how agents interact in an economic sense. Combination of these facts is conducive to the specification of qualitative and quantitative characteristics of actions fit for the control of income concentration. |
| Date: | 2015–07 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1507.00894&r=upt |
| By: | Crump, Richard K. (Federal Reserve Bank of New York); Eusepi, Stefano (Federal Reserve Bank of New York); Tambalotti, Andrea (Federal Reserve Bank of New York); Topa, Giorgio (Federal Reserve Bank of New York) |
| Abstract: | We estimate the elasticity of intertemporal substitution (EIS)—the elasticity of expected consumption growth with respect to variation in the real interest rate—using subjective expectations from the newly released FRBNY Survey of Consumer Expectations (SCE). This dataset is unique, since it includes consumers’ expectations of both consumption growth and inflation, with the latter providing subjective variation in ex ante real interest rates. As a result, we can estimate a subjective version of the consumption Euler equation, without having to take a stand on the process of expectation formation. Our main finding is that this subjective EIS is precisely and robustly estimated to be around 0.8 in the general population, consistent with typical macroeconomic calibrations of the Euler equation. However, we find some evidence that the EIS rises to slightly above one for high-income individuals, consistent with the assumptions in asset pricing models featuring long-run risks or rare disasters. |
| Keywords: | subjective expectations; inflation expectations; Euler equation; elasticity of intertemporal substitution |
| JEL: | D12 D84 E21 |
| Date: | 2015–07–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:734&r=upt |
| By: | Tom Horlick-Jones; Jonathan Rosenhead |
| Abstract: | Ambiguity, the existence of multiple plausible (though possibly contested) ways of making sense of the characteristics of decision situations, can present significant difficulties for a wide range of risk management tasks. We will argue that ambiguity is present in risk management situations to a far greater extent that is commonly appreciated. The concept of ambiguity has arisen in different forms across disciplinary literatures and domains of practice. In this paper, we situate our experience of finding ways of supporting planning and decision-making processes concerned with ambiguous risks in the context of those wider perspectives. Our own efforts have employed a hybrid form of problem structuring methods (drawn from operational research and management science) and ethnography (drawn from sociology and anthropology). These engagements with organisational and inter-organisational risk management issues have led us to recognise that ‘untangling’ otherwise intractable risk management problems may be regarded, in some sense, as a therapeutic process. In this paper, we develop this therapeutic interpretation of the untangling of collective ambiguities using illustrations from a concrete problem situation. We set this therapeutic reading of decision processes in the context of wider perspectives, including those drawn from Habermas’ theorisation of communication, the sociology of science and the literature on citizen engagement and deliberation processes. |
| Keywords: | organizational risk management; ambiguity; uncertainty; plural rationalities; ethnomethodology; problem structuring methods; practical reasoning; the metaphor of psychotherapy; engagement; transdisciplinarity |
| JEL: | J50 G32 |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:62497&r=upt |
| By: | Fang Yang (Louisiana State University); Mariacristina De Nardi (UCL and Federal Reserve Bank of Chicago) |
| Abstract: | This paper provides two main contributions. First, it proposes a new theory of wealth inequality that merges two sources of inequality previously proposed: bequests motives and inheritance of ability of across generations, and an earnings process that allows for more earnings risk for the richest. Second, it uses our calibrated framework to study the importance of parental background and the effects of changing estate taxation on inequality, aggregate capital accumulation, intergenerational mobility, welfare, and on family background as a source of inequality. Our calibrated model generates realistically skewed distributions for wealth, earnings, and bequests, and a correlation of lifetime earnings and wealth at retirement that is close to that in the data and is thus a good laboratory to use to study these questions. We find that parental background is a crucial determinant of one's expected lifetime utility. We also find that increasing estate taxation from its effective levels observed over many years, to levels that are closer to the statutory ones observed in year 2000, would significantly reduce wealth concentration in the hands of the richest few and the role of parental background in determining one's lot in life. The implied welfare gains of such a policy would be positive for 71% of the population. For those experiencing losses, their loss would be a one-time cost of the order of 11% of average income. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed015:92&r=upt |
| By: | Sung-Jin Cho (Seoul National University); John Rust (Georgetown University) |
| Abstract: | We analyze a new data set on installment borrowing decisions of a sample of customers of a credit card company. In an attempt to increase its market share, the company more or less randomly offers its customers free installments, i.e. opportunities to finance credit card purchases via installment loans at a zero percent interest rate for durations up to twelve months. We exploit these offers as a quasi-random field experiment to better understand consumer demand for credit. Although there is considerable customer-level heterogeneity in installment usage, we show that the average take-up rate of free installment offers is low: customers choose them only 20% of time they are offered. Further, we provide evidence of pervasive precommitment behavior by individuals who do decide to take free installment offers. For example, we estimate that of the subset of 10 month free installment offers that are taken, only 18% are taken for the full 10 month term allowed under the offer. In the other 82% of these offers, customers precommit at the time of purchase to pay the balance in fewer than 10 installments. Thus, only 3.6% (18% × 20%) of all 10 month free installment offers are taken for the full 10 month duration. It is challenging to explain this behavior using standard expected utility models since there are no pre-payment penalties and the transactions costs involved in choosing these loans are small: rational customers should take every installment offer for the maximum allowed term when the interest rate is 0%. One explanation for this behavior is that consumers have financial self-control problems and resist the temptation to take interest-free loan offers. If they absolutely must borrow, most consumers choose repayment terms that are shorter than the maximum allowed term to avoid becoming excessively indebted. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed015:33&r=upt |
| By: | Nicholas Oulton |
| Abstract: | In early 2014 the World Bank published the main findings of the 2011 International Comparison Program (ICP). The result was surprising: the world is apparently richer and more equal than we would have expected based on extrapolating from the earlier, 2005 ICP. This is an example of what I call space-time inconsistency in the national accounts. Though the 2011 findings drew attention to this problem, it is certainly present in earlier rounds of the ICP, for example in comparing the 1980 with the 2005 ICP. In this paper I show that the national accounts are in principle space-time consistent if the consumer’s utility function (or the revenue (GDP) function) is homothetic and if Divisia price indices are used to deflate nominal GDP or consumption, both over time and across countries. It follows that any observed inconsistency must be due to either (a) non-homotheticity in consumption (or production); (b) approximation error when discrete chain indices are used instead of continuous Divisia indices; or (c) errors in domestic price indices and PPPs. I develop indicators of the size of non-homotheticity and chain index approximation error using detailed, unpublished data from the 2005 ICP. I conclude that errors in price indices are most likely the major cause of inconsistency. |
| Keywords: | PPP; Divisia; Konüs; price index; path-dependence; consistency |
| JEL: | C4 C43 F4 F43 I31 O47 |
| Date: | 2015–05 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:62569&r=upt |
| By: | Pamela Wicker; John C. Whitehead; Bruce K. Johnson; Daniel S. Mason |
| Abstract: | This study shows that fans and people living in the region of 28 Football Bundesliga teams from all three divisions are willing to support their team financially. Survey respondents were asked for their willingness-to-pay to avoid a negative outcome (e.g., relegation) and to achieve a positive outcome (e.g., promotion). Fan bonds are applied as an alternative payment vehicle within the contingent valuation method. The results show that different factors affect the decision to support the team and the actual amount of willingness-to-pay – for attendees and non-attendees. Public goods are particularly relevant for reporting a positive willingness-to-pay. Key Words: Contingent valuation method; Bundesliga; Fan bonds; Public goods; Sporting success; Willingness-to-pay |
| JEL: | L83 H41 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:apl:wpaper:15-05&r=upt |