nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2015‒08‒19
eleven papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Revealed preference and consumption behaviour at retirement By Peter Levell
  2. Long-run effects of capital market integration using OLG model By Philippe Darreau; François Pigalle
  3. Testing the Optimality of Consumption Decisions of the Representative Household: Evidence from Brazil By Gesteira, Marcos; Carrasco Gutierrez, Carlos Enrique
  4. How General Are Time Preferences? Eliciting Good-Specific Discount Rates By Diego Ubfal
  5. Are Survey Risk Aversion Measurements Adequate in a Low Income Context? By Carole Treibich
  6. Conditional Cooperation and Betrayal Aversion By Cubitt, Robin; Gächter, Simon; Quercia, Simone
  7. The effect of decentralized behavioral decision making on system-level risk By Kaivanto, Kim
  8. An Improvement to Jensen's Inequality and its Application to Mating Market Clearing when Paternity is Uncertain By Dirk Bethmann
  9. Does height affect labor supply? Implications of product variety and caloric needs By Micheli, Martin
  10. Revealed Preference Test and Shortest Path Problem; Graph Theoretic Structure of the Rationalizability Test By Kohei Shiozawa
  11. (Mis-)Predicted Subjective Well-Being Following Life Events By Odermatt, Reto; Stutzer, Alois

  1. By: Peter Levell (Institute for Fiscal Studies)
    Abstract: This paper sets out revealed preference tests for different models of consumption behaviour over retirement that we applied to a Spanish consumption panel dataset. We reject the perfect foresight model both with separable preferences and allowing for preference change. The first order conditions for the life-cycle model allowing for uncertainty do not provide very strong restrictions on possible choices. In fact they are no stronger than those implied by the most basic revealed preference requirement: GARP. We then go on to investigate the patterns of deviations from a perfectly smoothed marginal utility of wealth and ask whether they fit the predictions of the life-cycle model. We find a tendency of these to increase over time, suggesting consumption falls more than we'd expect. After considering various possible explanations, we settle on non-rational behaviour as the most plausible.
    Date: 2014–10
  2. By: Philippe Darreau (LAPE - Laboratoire d'Analyse et de Prospective Economique - unilim - Université de Limoges - Institut Sciences de l'Homme et de la Société); François Pigalle (LAPE - Laboratoire d'Analyse et de Prospective Economique - unilim - Université de Limoges - Institut Sciences de l'Homme et de la Société)
    Abstract: Buiter (1981) illustrates that in the OLG model, the ranking of stationary utility levels under autarky and openness, is ambiguous. We show that both countries increase their stationary utility levels only if the autarky capital-labor ratios are on opposite sides of the golden rule.
    Date: 2014–08–20
  3. By: Gesteira, Marcos; Carrasco Gutierrez, Carlos Enrique
    Abstract: This paper investigates whether there is a fraction of consumers that do not behave as fully forward-looking optimal consumers in the Brazilian economy. The generalized method of moments technique was applied to nonlinear Euler equations of the consumption-based capital assets model contemplating utility functions with time separability and non-separability. The results show that when the household utility function was modeled as constant relative risk aversion, external habits and Kreps-Porteus, estimates of the fraction of rule-of-thumb households was, respectively, 89%, 78% and 22%. According to this, a portion of disposable income goes to households who consume their current incomes in violation of the permanent income hypothesis.
    Keywords: Rule of thumb; aggregate consumption; permanent income hypothesis, Euler equations.
    JEL: C32 E21
    Date: 2015
  4. By: Diego Ubfal
    Abstract: This paper tests the commonly-used assumption that people apply a single discount rate to the utility from different sources of consumption. Using survey data from Uganda with both hypothetical and incentivized choices over different goods, we elicit time preferences from about 2,400 subjects. We reject the null of equal discount rates across goods; the average person in our sample is more impatient about sugar, meat and starchy plantains than about money and a list of other goods. We review theassumptions to recover discount rates from experimental choices for the case of goodspecific discounting. Consistently with the theoretical framework, we find convergence in discount rates across goods for two groups expected to engage in or think about arbitraging the rewards: traders and individuals with large quantities of the good at home. As an application, we evaluate empirically the conditions under which goodspecific discounting could predict a low-asset poverty trap. JEL Classification: D03, D90, O12, C90, D14 Keywords: time preferences, good-specific discounting, narrow-bracketing, selfcontrol problems, poverty traps.
    Date: 2015
  5. By: Carole Treibich (AMSE - Aix-Marseille School of Economics - EHESS - École des hautes études en sciences sociales - Centre national de la recherche scientifique (CNRS) - Ecole Centrale Marseille (ECM) - AMU - Aix-Marseille Université)
    Abstract: Using an original dataset collected among motorcyclists in New Delhi (2011), this paper compares three different survey measures of risk attitudes: self-assessment, hypothetical lotteries and income prospect choices. While previous research on risk aversion measurement methods in developing countries mainly looked at specific groups such as rural farmers or students, the dataset I use covers a large and heterogeneous urban population. I first show that all measurements are positively and highly correlated with one another, this being even more the case within methodologies and within domains. Subsequently, I investigate the predictive power of these different individual risk-aversion measurements on occupation choices and health decisions. Most of my elicited risk preferences appear to predict risky health behaviors well. Puzzling results are found with the lotteries and may be interpreted either as evidence of risk-compensation between domains or as an incapacity to capture the desired characteristic. Finally, thanks to information on religious beliefs and practices, I am able to verify that cultural background does not impact on the relationship between risk preferences and risky conducts. Overall, this analysis highlights that elicitation of risk-aversion measurements through surveys in a developing country like India thus appears possible.
    Date: 2015–04
  6. By: Cubitt, Robin (University of Nottingham); Gächter, Simon (University of Nottingham); Quercia, Simone (University of Bonn)
    Abstract: We investigate whether there is a link between conditional cooperation and betrayal aversion. We use a public goods game to classify subjects by type of contribution preference and by belief about the contributions of others; and we measure betrayal aversion for different categories of subject. We find that, among conditional cooperators, only those who expect others to contribute little to the public good are significantly betrayal averse, while there is no evidence of betrayal aversion for those who expect substantial contributions by others. This is consistent with their social risk taking in public goods games, as the pessimistic conditional cooperators tend to avoid contribution to avoid exploitation, whereas the optimistic ones typically contribute to the public good and thus take the social risk of being exploited.
    Keywords: exploitation aversion, betrayal aversion, trust, conditional cooperation, public goods game, free riding, experiments
    JEL: H41 C91 C72 D03
    Date: 2015–07
  7. By: Kaivanto, Kim
    Abstract: Certain classes of system-level risk depend partly on decentralized lay decision making. For instance, an organization's network security risk depends partly on its employees' responses to phishing attacks. On a larger scale, the risk within a financial system depends partly on households' responses to mortgage sales pitches. Behavioral economics shows that lay decision makers typically depart in systematic ways from the normative rationality of Expected Utility (EU), and instead display heuristics and biases as captured in the more descriptively accurate Prospect Theory (PT). In turn psychological studies show that successful deception ploys eschew direct logical argumentation and instead employ peripheral-route persuasion, manipulation of visceral emotions, urgency, and familiar contextual cues. The detection of phishing emails and inappropriate mortgage contracts may be framed as a binary classification task. Signal Detection Theory (SDT) offers the standard normative solution, formulated as an optimal cutoff threshold, for distinguishing between good/bad emails or mortgages. In this paper we extend SDT behaviorally by re-deriving the optimal cutoff threshold under PT. Furthermore we incorporate the psychology of deception into determination of SDT's discriminability parameter. With the neo-additive probability weighting function, the optimal cutoff threshold under PT is rendered unique under well-behaved sampling distributions, tractable in computation, and transparent in interpretation. The PT-based cutoff threshold is (i) independent of loss aversion and (ii) more conservative than the classical SDT cutoff threshold. Independently of any possible misalignment between individual-level and system-level misclassification costs, decentralized behavioral decision makers are biased toward under-detection, and system-level risk is consequently greater than in analyses predicated upon normative rationality.
    Keywords: prospect theory; psychology of deception; signal detection theory; spear phishing; system-level risk
    JEL: D81
    Date: 2014
  8. By: Dirk Bethmann (Department of Economics, Korea University, Seoul, Republic of Korea)
    Abstract: Jensen's inequality can be tightened in the context of binomially distributed random variables. The suggested new inequality coincides with Jensen's inequality only when the expected value of the random variable is an integer, in all other cases the inequality is tighter than Jensen's. This improvement is used to derive a welfare result in the context of a mating market where male agents are exposed to paternal uncertainty. It is shown that social welfare is highest when paternity is certain, a result that can not be obtained when relying on Jensen's inequality.
    Keywords: Expected Utility, Binomial Distribution, Jensen's Inequality, Mating Market, Uncertain Paternity
    JEL: C65 J11 J13
    Date: 2015
  9. By: Micheli, Martin
    Abstract: The positive correlation between hourly wages and height, which results in higher labor supply of tall individuals, is well-documented in the literature. Accepting the utilitarian perspective and assuming that height does not affect utility implies that linking income taxes to height is welfare improving. This paper argues that height might not only affect an individual's income but also utility from consumption. Higher caloric needs of tall individuals should result in higher consumption expenditures for food to satisfy these needs. Size specific products should result in lower product variety for sizes where aggregate demand is low, typically sizes for individuals in the tails of the height distribution. Introducing these two channels into a household's maximization problem we derive a labor supply equation that allows for an empirical test for the relevance of these two channels. We use the German Socio-Economic Panel Study to estimate this labor supply equation. Caloric needs do not have a significant effect on labor supply. Product choice, on the other hand, does increase labor supply significantly. This implies that purely focusing on income might not be optimal under the utilitarian framework for tax analysis.
    Abstract: Die positive Korrelation zwischen Stundenlöhnen und Körpergröße, welche in einem höheren Arbeitsangebot großer Individuen resultiert, ist in der einschlägigen Literatur hinreichend dokumentiert. Gegeben die utilitaristische Sichtweise und die Annahme, die Körpergröße habe keinen weiteren Einfluss auf den individuellen Nutzen, spräche dies für eine Ausrichtung der Einkommensteuer an der Körpergröße. In diesem Papier wird argumentiert, dass die Körpergröße jedoch nicht nur das Einkommen, sondern über weitere Kanäle auch den Nutzen eines Individuums beeinflusst. Ein höherer Kalorienverbrauch großer Individuen sollte in höheren Ausgaben für Nahrungsmittel resultieren. Größenspezifische Produkte sollten zu einer geringeren Produktauswahl für Größen mit geringerer Nachfrage führen, typischerweise für solche am Rand der Körpergrößenverteilung. Durch Einführung dieser beiden Kanäle in das Nutzenmaximierungskalkül von Haushalten leiten wir eine Arbeitsangebotsfunktion her, welche einen empirischen Test auf die Relevanz der beiden Kanäle erlaubt. Wir nutzen das Deutsche Sozioökonomische Panel, um die hergeleitete Arbeitsangebotsfunktion zu schätzen. Für Unterschiede beim Kalorienverbrauch finden wir keinen signifikanten Effekt auf das Arbeitsangebot. Eine höhere Produktauswahl steigert das Arbeitsangebot hingegen signifikant. Dies impliziert, dass im Rahmen der Steueranalyse nach utilitaristischer Sichtweise eine ausschließliche Fokussierung auf das Einkommen nicht optimal ist.
    Keywords: height,labor supply,utility,product variety,optimal taxation
    JEL: D11 D12 H21 J22
    Date: 2015
  10. By: Kohei Shiozawa (Graduate School of Economics, Osaka University)
    Abstract: This paper presents some substantial relationships between revealed preference tests for a data set and the shortest path problem in a network (a directed graph with weighted edges), using a simple and straightforward graph theoretic argument. We clarify the interpretation of revealed preference tests, refine Afriat inequalities, and give a unified perspective of several forms of rationalizability tests and the classical utility representation problem of preferences. Furthermore, we provide an additional graph theoretic structure, which we call the shortest path problem with weight adjustment. This is a common structure for several rationalizability tests. The proposed structure leads to effcient algorithms for checking rationalizability conditions, and for computing a solution to the Afriat inequalities if the data are rationalizable in several settings.
    Keywords: Revealed preference; Afriat inequalities; shortest path problem
    JEL: C60 D11
    Date: 2015–06
  11. By: Odermatt, Reto (University of Basel); Stutzer, Alois (University of Basel)
    Abstract: The correct prediction of how alternative states of the world affect our lives is a cornerstone of economics. We study how accurate people are in predicting their future well-being when facing major life events. Based on individual panel data, we compare people's forecast of their life satisfaction in five years' time to their actual realisations later on. This is done after the individuals experience widowhood, marriage, unemployment or disability. We find systematic prediction errors that are at least partly driven by unforeseen adaptation.
    Keywords: adaptation, life satisfaction, life events, projection-bias, subjective well-being, utility prediction, unemployment
    JEL: D03 D12 D60 I31
    Date: 2015–08

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