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on Utility Models and Prospect Theory |
| By: | O'Callaghan, Patrick |
| Abstract: | When sufficiently small perturbations of parameters preserve strict preference for one alternative over another, dependence on the parameters is continuous. We characterise this property with a utility function over alternatives that depends continuously on the parameter. The class of parameter spaces such that this form of representation is guaranteed to exist is also characterised. When the parameters are beliefs, these results have implications for robust portfolio choice, Bayesian games and psychological games. When alternatives are discrete, the representation is jointly continuous, and an extension of Berge’s theorem of the maximum, yields a continuous value function. We apply this result to generalise a standard consumer choice problem: where parameters are price-wealth vectors. When the parameter space is lexicographically ordered, a novel application to referencedependent preferences is possible. |
| Keywords: | Risk and Uncertainty, D8, C6, |
| Date: | 2015–04–01 |
| URL: | http://d.repec.org/n?u=RePEc:ags:uqsers:200371&r=upt |
| By: | Jonathan D. Ketcham; Nicolai V. Kuminoff; Christopher A. Powers |
| Abstract: | Neoclassical and psychological models of consumer behavior often make divergent predictions for the welfare effects of paternalistic policies, leaving wide scope for researchers’ choice of a model to influence their policy conclusions. We develop a framework to reduce this model uncertainty and apply it to administrative data on consumer decision making in Medicare Part D. Consumers’ choices for prescription drug insurance plans can be explained by Abaluck and Gruber’s (AER 2011) model of utility maximization with psychological biases or by a neoclassical version of their model that precludes such biases. We evaluate these competing hypotheses using nonparametric tests of utility maximization and a trio of model validation tests. We find that 79% of enrollment decisions in Medicare Part D from 2006-2010 satisfied basic axioms of consumer preference theory under the assumptions of full information, zero transaction cost, and no measurement error. The validation tests provide evidence against widespread psychological biases. In particular, we find that precluding psychological biases improves the structural model’s out-of-sample predictions for consumer behavior. |
| JEL: | D12 I11 I38 |
| Date: | 2015–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:21387&r=upt |
| By: | Küçük, Hande; Sutherland, Alan |
| Abstract: | This paper aims to account for the Backus-Smith puzzle in a two-country DSGE model with endogenous portfolio choice in bonds and equities. Utility is non-separable across consumption and leisure and across time. This model is shown to imply almost zero correlation between relative consumption and the real exchange rate while generating portfolio positions that broadly match the data. Furthermore, the cross-country correlation of consumption is lower than the correlation of output, which has previously been a difficult fact to match. Non-separable preferences are found to be crucial to generating these results but financial market structure plays only a minor role. |
| Keywords: | Backus-Smith puzzle; consumption-real exchange rate anomaly; incomplete markets; international risk sharing; non-separable preferences; portfolio choice |
| JEL: | F31 F41 |
| Date: | 2015–07 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10724&r=upt |
| By: | Lee, Yu Na; Bellemare, Marc F.; Just, David R. |
| Abstract: | In his seminal 1971 article, Sandmo showed that when faced with an uncertain output price, a risk-averse firm manager would hedge by producing less than he would have when faced with a certain output price. We take Sandmo’s prediction, among other things, to the lab. We study in turn the effects of price risk (i.e., uncertain prices whose distribution is known) and price ambiguity (i.e., uncertain prices whose distribution is not known, but whose range is known) while controlling for our subjects’ income risk preferences. Our experimental protocol closely mimics Sandmo’s theoretical model. For price risk, we use a two-stage randomization strategy aimed first at studying the effect of price uncertainty relative to price certainty, and then the effect of increases in price uncertainty conditional on there being price uncertainty. For price ambiguity, we use the same randomization strategy to study the effect of price ambiguity relative to price certainty while preventing our subjects from guessing the shape of the price distribution. For price risk, we find that, in stark contradiction to Sandmo’s theoretical result, the presence of price uncertainty causes subjects to produce more than they do under price certainty, but that increases in price uncertainty makes them decrease their production monotonically. For price ambiguity, results are mixed and depend on whether the portion of the experiment aimed at eliciting our subjects’ income risk aversion is played before or after the price uncertainty game. Lastly, we use our price risk data to study the problem structurally, in order to get at preference heterogeneity, and find that our structural results are consistent with our reduced-form results. |
| Keywords: | Risk and Uncertainty, Price Risk, Price Ambiguity, Experimental Economics, Institutional and Behavioral Economics, Risk and Uncertainty, |
| Date: | 2015–05–27 |
| URL: | http://d.repec.org/n?u=RePEc:ags:aaea15:205763&r=upt |
| By: | Jun Nie (Federal Reserve Bank of Kansas City); Gaowang Wang (Shandong University); Eric Young (University of Virginia); Yulei Luo (The University of Hong Kong) |
| 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. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed015:280&r=upt |
| By: | Gregory Phelan (Williams College); Alexis Akira Toda (University of California-San Diego) |
| Abstract: | We derive a parsimonious returns-based stochastic discount factor that is robust to model misspecification. We consider a general equilibrium model with heterogeneous agents who can invest their wealth in many assets. As long as (i) agents have (individual-, time-, and state-dependent) recursive preferences that are homothetic in current consumption and continuation value with a common relative risk aversion coefficient "gamma" and (ii) asset returns and individual state variables are conditionally independent (e.g., GARCH processes), we prove that the (minus "gamma")-th power of market return is a valid stochastic discount factor. Within this class of models, asset prices are determined by relative risk aversion and technology alone, and "returns-based asset pricing" is robust to model misspecification as opposed to the consumption-based approach. We recast the equity premium puzzle as a consumption/saving puzzle, not as an asset pricing puzzle. |
| Keywords: | Asset pricing puzzles, heterogeneous-agent model, model misspecification, recursive preferences |
| JEL: | D53 D58 D91 G11 G12 |
| Date: | 2015–07 |
| URL: | http://d.repec.org/n?u=RePEc:wil:wileco:2015-10&r=upt |
| By: | Jay Bhattacharya; Alan M. Garber; Jeremy D. Goldhaber-Fiebert |
| Abstract: | We consider the welfare consequences of nudges and other behavioral economic devices to encourage exercise habit formation. We analyze a randomized trial of nudged exercise commitment contracts in the context of a time-inconsistent intertemporal utility maximization model of the demand for exercise. The trial follows more than 4,000 people seeking to make exercise commitments. Each person was randomly nudged towards making longer (20 weeks) or shorter (8 weeks) exercise commitment contracts. Our empirical analysis shows that people who are interested in exercise commitment contracts choose longer contracts when nudged to do so, and are then more likely to meet their pre-stated exercise goals. People are also more likely to enroll in a subsequent commitment contract after the original expires if they receive a nudge for a longer duration initial contract. Our theoretical analysis of the welfare implications of these effects shows conditions under which nudges can reduce utility even when they succeed in the goal of promoting habitual exercise. |
| JEL: | D6 I1 I12 |
| Date: | 2015–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:21406&r=upt |
| By: | Antonella Tutino (Federal Reserve Bank of Dallas) |
| Abstract: | We study the problem of optimal communication strategy between a fully informed agent and a rationally inattentive agent. The fully informed agent observes a sequence of shocks and transmits a message to the limited-capacity agent who takes a set of actions in response to the message. The problem of the informed agent is to seek the optimal signaling strategy that induces a behavior consistent with minimal welfare loss, uniformly over a given class of bounded utility functions. We characterize the optimal signaling strategy for both the static and the dynamic cases. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed015:286&r=upt |
| By: | Sarina Steinmann und Ralph Winkler |
| Abstract: | We consider the problem of efficient emission abatement in a multi polluter setting, where agents are located along a river in which net emissions accumulate and induce negative externalities to downstream riparians. Assuming a cooperative transferable utility game, we seek welfare distributions that satisfy all agents' participation constraints and, in addition, a fairness constraint implying that no coalition of agents should be better off than it were if all non-members of the coalition would not pollute the river at all. We show that the downstream incremental distribution, as introduced by Ambec and Sprumont (2002), is the only welfare distribution satisfying both constraints. In addition, we show that this result holds true for numerous extensions of our model. |
| Keywords: | Downstream externalities; downstream incremental distribution; optimal emission abatement; river pollution |
| JEL: | C71 D62 Q53 |
| Date: | 2015–07 |
| URL: | http://d.repec.org/n?u=RePEc:ube:dpvwib:dp1508&r=upt |
| By: | Bazzani, Claudia; Caputo, Vincenzina; Nayga, Rodolfo M.; Canavari, Maurizio |
| Abstract: | Choice experiments (CE) are one of the most popular preference elicitation mechanisms used by applied economists. In CEs, respondents are normally asked to make choices at the moment they are asked to do so. They are also based on the assumption that the decision maker has access to and makes use of all relevant information concerning the good of interest when making their choices. However, real world choices are usually made in a dynamic context where individuals have the option to delay or reserve a transaction due to, among others, uncertainty about the product. So committing a decision at the present under conditions of uncertainty for the value of the good might have a cost (i.e., commitment cost). In this paper, we test commitment cost theory in a non-hypothetical choice experiment. Specifically, we test the possibility that gaining information about the product either at the present or in the future and the possibility of reversing the transaction in the future can influence choice behavior and WTP estimates. Our results partially support the Commitment Cost theory, suggesting that the construction of a dynamic decision context (i.e., reversibility of transaction) is important in choice experimental designs. |
| Keywords: | Commitment Cost, Dynamic settings, Uncertainty, Real Choice Experiment, WTP, Agricultural and Food Policy, Institutional and Behavioral Economics, Marketing, |
| Date: | 2015–05–25 |
| URL: | http://d.repec.org/n?u=RePEc:ags:aaea15:205235&r=upt |
| By: | Blanchard, Olivier J; Erceg, Christopher; Lindé, Jesper |
| Abstract: | We show that a fiscal expansion by the core economies of the euro area would have a large and positive impact on periphery GDP assuming that policy rates remain low for a prolonged period. Under our preferred model specification, an expansion of core government spending equal to one percent of euro area GDP would boost periphery GDP around 1 percent in a liquidity trap lasting three years, about half as large as the effect on core GDP. Accordingly, under a standard ad hoc loss function involving output and inflation gaps, increasing core spending would generate substantial welfare improvements, especially in the periphery. The benefits are considerably smaller under a utility-based welfare measure, reflecting in part that higher net exports play a material role in raising periphery GDP. |
| Keywords: | currency union; DSGE model; fiscal policy; liquidity trap; monetary policy; zero bound constraint |
| JEL: | E52 E58 |
| Date: | 2015–07 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10716&r=upt |
| By: | Norton, D.; Hynes, S. |
| Abstract: | This paper uses the choice experiment methodology to estimate the value of the nonmarket benefits associated with the achievement of good (marine) environmental status (GES) as specified in the EU Marine Strategy Framework Directive (MSFD). The MSFD requires that the “costs of degradation” (the benefits foregone if GES is not achieved) be considered within a broader ‘Economic and Social Assessment’ of the marine environment by EU member states. Assessing the costs of degradation as defined by the MSFD implies that changes in marine ecosystem services provided in each State should be analysed. The results show that there are high values attached with changes to the state of the marine environment by the Irish general public. The results of a random parameters logit model also demonstrate that preferences are heterogeneous, with changes in certain marine attributes generating both positive and negative utility. |
| Keywords: | Marine Strategy Framework Directive, Marine Environment, Non-market Valuation, Choice Experiment, Ecosystem Services, Environmental Economics and Policy, |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:ags:semrui:186382&r=upt |
| By: | Brown, Zachary S.; Dickinson, Katherine L.; Paskewitz, Susan |
| Abstract: | Serial nonparticipation in nonmarket valuation using choice data is a pattern of behavior in which an individual always appears to choose the status quo or ‘no program’ alternative. From a choice modelling perspective serial nonparticipation may be viewed as belonging to a class of ‘discontinuous preferences,’ which also includes other behavioral patterns, such as serial participation (never choosing the status quo), as well as lexicographic preferences (e.g. always choosing the alternative with the greatest health benefit). Discontinuous preferences are likely to be especially relevant in the context of environmental goods, due to the lack of familiarity that individuals have with valuing these goods in markets. In the case of discrete choice data, logit-based choice models are ill-equipped for identifying such preferences, because conditional logit choice probabilities cannot take a value of zero or one for any finite parameter estimates. Here we extend latent class choice models to account for discontinuous preferences. Our methodological innovation is to specify for each latent class a subset of alternatives that are avoided with certainty. This results in class membership being partially observable, since we then know with certainty that an individual does not belong to a class if she selects any alternatives avoided by that class. We apply our model to data from a discrete choice experiment on mosquito control programs to reduce West Nile virus risk and nuisance disamenities in Madison, Wisconsin. We find that our ‘generalized latent class model’ (GLCM) outperforms standard latent class models in terms of information criteria metrics, and provides significantly different estimates for willingness-to-pay. We also argue that GLCMs are useful for identifying some alternatives for which valuation estimates may not be identified in a given dataset, thus reducing the risk of invalid inference from discrete choice data. |
| Keywords: | discrete choice econometrics, latent class models, partial observability, serial nonparticipation, serial participation, discontinuous preferences, E-M algorithm, Environmental Economics and Policy, Institutional and Behavioral Economics, Public Economics, Research Methods/ Statistical Methods, Q51, C35, |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:ags:aaea15:205613&r=upt |
| By: | Yuan, Yuan; You, Wen; Boyle, Kevin J. |
| Abstract: | The literature in discrete choice modelling is increasingly recognizing the existence of attribute non-attendance, in which respondents ignore some attributes when answering an attribute-based question. This behaviour may present a serious problem for modelling and inference, because it violates fundamental assumptions of the random utility model on which choice models are based. In this study, we elicit attribute non-attendance using a six-point polytomous attendance scale, rather than restricting them to a dichotomous ignored/considered response, as in previous studies. Stated non-attendance has been found to be unreliable in previous studies, but polytomous attendance scales have the potential to address the sources of unreliability. Using data from a choice experiment in health economics, this study assesses the performance and consistency between empirical observations and theoretical expectations of a polytomous attendance scale. We find that the lowest point on the attendance scale is the part of the scale which corresponds best to attribute non-attendance, and that attendance scales longer than two or three points do not provide much additional information. Furthermore, the polytomous attendance scale had limited success in producing theoretically consistent results, suggesting that potential for polytomous attendance scales to produce more reliable attendance statements was not realized in this study. |
| Keywords: | choice experiment, choice model, attribute non-attendance, polytomous attendance scale, Health Economics and Policy, Research Methods/ Statistical Methods, |
| Date: | 2015–07 |
| URL: | http://d.repec.org/n?u=RePEc:ags:aaea15:205688&r=upt |
| By: | Lockwood, Ben (Department of Economics University of Warwick,); Rockey, James (University of Leicester) |
| Abstract: | This paper studies how voter loss-aversion affects electoral competition in a Downsian setting. Assuming that the voters’ reference point is the status quo, we show that loss-aversion has a number of effects. First, for some values of the status quo, there is policy rigidity both parties choose platforms equal to the status quo, regardless of other parameters. Second, there is a moderation effect when there is policy rigidity, the equilibrium policy outcome is closer to the moderate voters’ ideal point than in the absence of loss-aversion. In a dynamic extension of the model, we consider how parties strategically manipulate the status quo to their advantage, and we find that this increases policy rigidity. Finally, we show that with loss-aversion, incumbents adjust less than challengers to changes in voter preferences. The underlying force is that the status quo works to the advantage of the incumbent. This prediction of asymmetric adjustment is new, and we test it using elections to US state legislatures. The results are as predicted: incumbent parties respond less to shocks in the preferences of the median voter. JEL classification: electoral competition ; loss-aversion ; incumbency advantage ; platform rigidity |
| Keywords: | D72 ; D81 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:wrk:warwec:1063&r=upt |
| By: | Alhassan, Mustapha; Perrin, Richard; Fulginiti, Lilyan |
| Abstract: | This paper used the contingent valuation (CV) approach to estimate the willingness of potential producers in selected counties in 12 states in the Midwest region of U.S. to supply switchgrass, and also to lease out land for switchgrass production. We used the dichotomous choice (DC) format and a linear random utility probit model is employed to estimate the willingness to accept (WTA) in both cases in terms of revenue per acre per year. From the preliminary results of the willingness to produce, the estimated mean WTA for region 1(selected counties in Minnesota, North Dakota, South Dakota, Wisconsin, and Michigan) is $314.62 per acre, that of region 2 (selected counties in South Dakota, Nebraska, Kansas, Missouri, Indiana, and Ohio) is $462.10 per acre, and that of region 3 (selected counties in Illinois, Iowa, Minnesota, and Wisconsin) is $451.75 per acre. From the willingness to lease out land for switchgrass production results, the estimated mean WTA for region 1 is $257.45 per acre, $384.39 per acre for region 2, and $354.74 per acre for region 3. |
| Keywords: | Willingness to accept, contingent valuation, switchgrass, bioenergy crop., Production Economics, Resource /Energy Economics and Policy, |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:ags:aaea15:205281&r=upt |
| By: | Zhang, Yu Yvette; Nayga, Rodolfo M. Jr.; Depositario, Dinah Pura T |
| Abstract: | We examined gender differences in bidding and learning behavior in Second Price Auctions (SPAs). Although bidding one’s true value is a weakly dominant strategy in SPAs, overbidding has been common and persistent in laboratory SPAs, i.e., bidding above one’s value. In our study, we found that inexperienced women overbid more than inexperienced men when they were provided with endowment money in the auctions. However, when participants were asked to bid using their own money, women became more cautious, bidding lower and closer to the optimal strategy (true value) even without experiences, while inexperienced men still overbid significantly deviating from the optimal strategy. As men gained more experiences, they learned from costly overbidding and eventually lowered their bids to the same level as those of women’s bids. In conclusion, we found that although women and men initially behaved differently in SPAs, both genders would eventually bid according to the optimal strategy and obtain the same outcome given sufficient learning experiences. |
| Keywords: | Gender, Learning, Auctions, Overbidding, Experiments, Institutional and Behavioral Economics, A1, C91, D44, D83, J16, |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:ags:aaea15:205699&r=upt |
| By: | de Sousa, José; Disdier, Anne-Célia; Gaigné, Carl |
| Abstract: | Does demand volatility matter for exports? How do exporting firms deal with skewed demand? A simple model of downside risk aversion shows that on average exporters increase export prices and reduce export volumes when demand volatility in destination markets increases. They behave the opposite way when demand skewness rises. We find that the moments of the demand distribution also affect the number of exporting firms and the industry supply. These adjustments may lead some firms to increase their exports when demand volatility increases. These theoretical predictions are put to the test by using French firm-level exports across destination markets with different levels of demand volatility and skewness. The firm-level results, over the period 2000-2009, are consistent with our predictions. |
| Keywords: | Uncertainty, Demand volatility, Firm exports, Skewness, International Relations/Trade, Risk and Uncertainty, D81, F12, L25, |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:ags:aaea15:205584&r=upt |