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on Utility Models and Prospect Theory |
| By: | Harin, Alexander |
| Abstract: | An existence theorem is proved for the case of a discrete random variable with finite support. If the random variable takes on values in a finite interval and there is a lower non-zero bound on its dispersion, then non-zero bounds (or non-zero “forbidden zones”) on its expectation exist near the borders of the interval. The theorem can be used in utility and prospect theories, in particular, in the analysis of Prelec’s probability weighting function. |
| Keywords: | probability theory; dispersion; scatter; scattering; noise; economics; utility theory; prospect theory; decision theories; human behavior; Prelec; probability weighting function; |
| JEL: | C1 D8 D81 |
| Date: | 2015–09–16 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:66692&r=all |
| By: | RAFAL Raciborski |
| Abstract: | The thesis consists of four chapters. The introductory chapter clarifies different notions of rationality used by economists and gives a summary of the remainder of the thesis. Chapter 2 proposes an explanation for the common empirical observation of the coexistence of infrequently-changing regular price ceilings and promotion-like price patterns. The results derive from enriching an otherwise standard, albeit stylized, general equilibrium model with two elements. First, the consumer-producer interaction is modeled in the spirit of the price dispersion literature, by introducing oligopolistic markets, consumer search costs and heterogeneity. Second, consumers are assumed to be boundedly-rational: In order to incorporate new information about the general price level, they have to incur a small cognitive cost. The decision whether to re-optimize or act according to the obsolete knowledge about prices is itself a result of optimization. It is shown that in this economy, individual retail prices are capped below the monopoly price, but are otherwise flexible. Moreover, they have the following three properties: 1) An individual price has a positive probability of being equal to the ceiling. 2) Prices have a tendency to fall below the ceiling and then be reset back to the cap value. 3) The ceiling remains constant for extended time intervals even when the mean rate of inflation is positive. Properties 1) and 2) can be associated with promotions and properties 1) and 3) imply the emergence of nominal price rigidity. The results do not rely on any type of direct costs of price adjustment. Instead, price stickiness derives from frictions on the consumers’ side of the market, in line with the results of several managerial surveys. It is shown that the developed theory, compared to the classic menu costs-based approach, does better in matching the stylized facts about the reaction of individual prices to inflation. In terms of quantitative assessment, the model, when calibrated to realistic parameter values, produces median price ceiling durations that match values reported in empirical studies.<p><p>The starting point of the essay in Chapter 3 is the observation that the baseline New-Keynesian model, which relies solely on the notion of infrequent price adjustment, cannot account for the observed degree of inflation sluggishness. Therefore, it is a common practice among macro- modelers to introduce an ad hoc additional source of persistence to their models, by assuming that price setters, when adjusting a price of their product, do not set it equal to its unobserved individual optimal level, but instead catch up with the optimal price only gradually. In the paper, a model of incomplete adjustment is built which allows for explicitly testing whether price-setters adjust to the shocks to the unobserved optimal price only gradually and, if so, measure the speed of the catching up process. According to the author, a similar test has not been performed before. It is found that new prices do not generally match their estimated optimal level. However, only in some sectors, e.g. for some industrial goods and services, prices adjust to this level gradually, which should add to the aggregate inflation sluggishness. In other sectors, particularly food, price-setters seem to overreact to shocks, with new prices overshooting the optimal level. These sectors are likely to contribute to decreasing the aggregate inflation sluggishness. Overall, these findings are consistent with the view that price-setters are boundedly-rational. However, they do not provide clear-cut support for the existence of an additional source of inflation persistence due to gradual individual price adjustment. Instead, they suggest that general equilibrium macroeconomic models may need to include at least two types of production sectors, characterized by a contrasting behavior of price-setters. An additional finding stemming from this work is that the idiosyncratic component of the optimal individual price is well approximated by a random walk. This is in line with the assumptions maintained in most of the theoretical literature. <p><p>Chapter 4 of the thesis has been co-authored by Julia Lendvai. In this paper a full-fledged production economy model with Kahneman and Tversky’s Prospect Theory features is constructed. The agents’ objective function is assumed to be a weighted sum of the usual utility over consumption and leisure and the utility over relative changes of agents’ wealth. It is also assumed that agents are loss-averse: They are more sensitive to wealth losses than to gains. Apart from the changes in the utility, the model is set-up in a standard Real Business Cycle framework. The authors study prices of stocks and risk-free bonds in this economy. Their work shows that under plausible parameterizations of the objective function, the model is able to explain a wide set of unconditional asset return moments, including the mean return on risk-free bonds, equity premium and the Sharpe Ratio. When the degree of loss aversion in the model is additionally assumed to be state-dependent, the model also produces countercyclical risk premia. This helps it match an array of conditional moments and in particular the predictability pattern of stock returns. |
| Keywords: | Business cycles -- Mathematical models; Inflation (Finance) -- Mathematical models; Cycles économiques -- Modèles mathématiques; Inflation -- Modèles mathématiques; incomplete price adjustment; loss aversion; equity premium puzzle; prospect theory; Sharpe ratio; real business cycle model; consumer search costs; promotions; inflation sluggishness; countercyclical risk premia; nominal rigidity; bounded rationality |
| Date: | 2014–10–06 |
| URL: | http://d.repec.org/n?u=RePEc:ulb:ulbeco:2013/209211&r=all |
| By: | Cueva, Carloa (Universidad de Alicante); Iturbe-Ormaetxe, Iñigo (Universidad de Alicante); Mata-Pérez, Esther (Universidad de Alicante); Ponti, Giovanni (Universidad de Alicante); Sartarelli, Marcello (Universidad de Alicante, Departamento de Métodos Cuantitativos y Teoría Económica); Yu, Haihan (Universidad de Alicante); Zhukova, Vita (Universidad de Alicante) |
| Abstract: | We study how cognitive abilities correlate with behavioral choices by collecting evidence from almost 1,200 subjects across eight experimental projects concerning a wide variety of tasks, including some classic risk and social preference elicitation protocols. The Cognitive Reflection Test (CRT) has been administered to all our experimental subjects, which makes our dataset one of the largest in the literature. We partition our subject pool into three groups depending on their CRT performance. Reflective subjects are those answering at least two of the three CRT questions correctly. Impulsive subjects are those who are unable to suppress the instinctive impulse to follow the intuitive -although incorrect- answer in at least two 2 questions. The remaining subjects form a residual group. We find that females score significantly less than males in the CRT and that, in their wrong answers, impulsive ones are observed more frequently. The 2D-4D ratio, which is higher for females, is correlated negatively with subject's CRT score. We also find that differences in risk attitudes across CRT groups crucially depend on the elicitation task. Finally, impulsive subjects have higher social (inequity-averse) concerns, while reflective subjects are more likely to satisfy basic consistency requirements in lottery choices. |
| Keywords: | behavioral economics; cognitive reflection; gender effects; experiments |
| JEL: | C91 D81 J16 |
| Date: | 2015–09–07 |
| URL: | http://d.repec.org/n?u=RePEc:ris:qmetal:2015_006&r=all |
| By: | Bayrak, Oben K. (CERE and Department of Forest Economics, SLU); Hey, John D. (Department of Economics, University of York) |
| Abstract: | This paper presents a new theory, called Preference Cloud Theory, of decision-making under uncertainty. This new theory provides an explanation for empirically-observed Preference reversals. Central to the theory is the incorporation of preference imprecision which arises because of individuals’ vague understanding of numerical probabilities. We combine this concept with the use of the Alpha model (which builds on Hurwicz’s criterion) and construct a simple model which helps us to understand various anomalies discovered in the experimental economics literature that standard models cannot explain. |
| Keywords: | Imprecise Preferences; Preference Reversals; Decision under Uncertainty; Anomalies in Expected Utility Theory |
| JEL: | D81 |
| Date: | 2015–09–08 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:slucer:2015_009&r=all |
| By: | Marc Dubois (LAMETA, Universite Montpellier I); Stephane Mussard (CHROME, Universite de Nimes; GREDI, Universite de Sherbrooke; CEPS Luxembourg) |
| Abstract: | The aim of the paper is to investigate the interplay between both transfer principles dened on incomes and utilities. For instance, a social planner who respects an income transfer principle of a given order is not necessarily incline to support the utility transfer principle of the corresponding order. Utility transfer principles are useful to characterize social planners' attitudes towards inequality but redistributive justice is often empirically assessed on income transfers, and as such it seems interesting to have an overview of dierent types of social planners who respect (or not) an income transfer principle. The main result of the paper is the determination of a generalised critical value that displays attitudes towards inequality which are necessary and sucient for the respect of all income transfer principles up to any order. By using Bell's polynomial, we demonstrate that such a critical value alternates in sign according to the considered order. Our results give sucient conditions to state stochastic dominance of income distributions as a factual moral statement. |
| Keywords: |  Bell's polynomial, Inequality aversion, Prioritarianism, Transfer principles. |
| JEL: | D3 D6 H2 |
| Date: | 2015–09 |
| URL: | http://d.repec.org/n?u=RePEc:shr:wpaper:15-09&r=all |