nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2015‒10‒17
fourteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Climate risk and state-contingent technology adoption: The role of risk preferences and probability weighting By Holden , Stein T.; Quiggin, John
  2. Optimality of deductible for Yaari's model: a reappraisal By Alain Chateauneuf; Michèle Cohen; Mina Mostoufi; Jean-Christophe Vergnaud
  3. Performance analysis of the optimal strategy under partial information By Ahmed Bel Hadj Ayed; Gr\'egoire Loeper; Sofiene El Aoud; Fr\'ed\'eric Abergel
  4. Regularity properties in a state-constrained expected utility maximization problem By Mourad Lazgham
  5. Financial Competence, Overconfidence, and Trusting Investments: Results from an Experiment By Bryan C. McCannon; Colleen Tokar Asaad; Mark Wilson
  6. A State-Dependent Dual Risk Model By Lingjiong Zhu
  7. Viscosity properties with singularities in a state-constrained expected utility maximization problem By Mourad Lazgham
  8. The impact of violence on individual risk preferences : evidence from a natural experiment By Jakiela,Pamela; Ozier,Owen
  9. Islamic Consumer Model, Fairness Behavior and Asymptotic Utility By Ghassan, Hassan B.
  10. On the decomposition of Generalized Additive Independence models By Michel Grabisch; Christophe Labreuche
  11. Optimal Risk Sharing with Optimistic and Pessimistic Decision Makers By Aloisio Araujo; Laurence Jean-Marc Bonnisseau; Alain Chateauneuf; Rodrigo Novinski
  12. Fair management of social risk By Marc Fleurbaey; Stéphane Zuber
  13. Harsanyi's theorem without the sure-thing principle: On the consistent aggregation of Monotonic Bernoullian and Archimedean preferences By Stéphane Zuber
  14. Stochastic income and conditional generosity By Kellner, Christian; Reinstein, David; Riener, Gerhard

  1. By: Holden , Stein T. (School of Economics and Business, Norwegian University of Life Sciences); Quiggin, John (School of Economics, University of Queensland)
    Abstract: Climate risk represents an increasing threat to poor and vulnerable farmers in drought-prone areas of Africa. This study assesses the maize and fertilizer adoption responses of food insecure farmers in Malawi, where Drought Tolerant (DT) maize was recently introduced. A Field experiment, eliciting relative risk aversion, loss aversion and subjective probability weighting parameters of farmers, is combined with a detailed farm household survey. A state-contingent production model with cumulative prospect theory preferences is estimated. More risk averse households were more likely to have adopted DT maize, less likely to have adopted other improved maize varieties and less likely to have dis-adopted traditional local maize. Exposure to past drought shocks stimulated adoption of DT maize and dis-adoption of local maize. Over-weighting of small probabilities was associated with less use of fertilizer on all maize types.
    Keywords: Climate risk; state-contingent production; subjective probability weighting; loss aversion; technology adoption; adaptation; maize; Drought Tolerant maize; fertilizer use.
    JEL: C93 D03 O33 Q12 Q18
    Date: 2015–10–12
  2. By: Alain Chateauneuf (IPAG - Centre d'Economie de la Sorbonne - Paris School of Economics); Michèle Cohen (Centre d'Economie de la Sorbonne - Paris School of Economics); Mina Mostoufi (Centre d'Economie de la Sorbonne - Paris School of Economics); Jean-Christophe Vergnaud (Centre d'Economie de la Sorbonne - Paris School of Economics)
    Abstract: The main purpose of this paper is to show that left monotone risk aversion, a meaningful refinement of strong risk aversion, characterizes Yaari's decision makers for whom deductible insurance is optimal. A second goal is to offer a detailed proof of the deductible's computation, which proves the tractability of Yaari's model under left-monotone risk aversion
    Keywords: Yaari's model; Jewitt's left-monotone risk aversion; optimality of deductible
    JEL: D80 D81
    Date: 2015–09
  3. By: Ahmed Bel Hadj Ayed; Gr\'egoire Loeper; Sofiene El Aoud; Fr\'ed\'eric Abergel
    Abstract: The question addressed in this paper is the performance of the optimal strategy, and the impact of partial information. The setting we consider is that of a stochastic asset price model where the trend follows an unobservable Ornstein-Uhlenbeck process. We focus on the optimal strategy with a logarithmic utility function under full or partial information. For both cases, we provide the asymptotic expectation and variance of the logarithmic return as functions of the signal-to-noise ratio and of the trend mean reversion speed. Finally, we compare the asymptotic Sharpe ratios of these strategies in order to quantify the loss of performance due to partial information.
    Date: 2015–10
  4. By: Mourad Lazgham
    Abstract: We consider a stochastic optimal control problem in a market model with temporary and permanent price impact, which is related to an expected utility maximization problem under finite fuel constraint. We establish the initial condition fulfilled by the corresponding value function and show its first regularity property. Moreover, we can prove the existence and uniqueness of optimal strategies under rather mild model assumptions. On the one hand, this result is of independent interest. On the other hand, it will then allow us to derive further regularity properties of the corresponding value function, in particular its continuity and partial differentiability. As a consequence of the continuity of the value function, we will prove the dynamic programming principle without appealing to the classical measurable selection arguments.
    Date: 2015–10
  5. By: Bryan C. McCannon (West Virginia University, Department of Economics); Colleen Tokar Asaad (Baldwin-Wallace University); Mark Wilson (St. Bonaventure University)
    Abstract: Financial transactions sometimes occur in an environment where third-party enforcement is lacking. Behavioral explanations typically allude to the social preferences, where an individual’s utility is directly affected by another’s outcome, as the driver of the trusting investments and reciprocal returns. We hypothesize that, in part, these decisions are determined by an individual’s financial literacy. Experimental evidence is coupled with an innovative financial literacy assessment, which measures general competence, numeracy skills, and overconfidence in one’s knowledge. Results indicate that overconfidence is a significant determinant of behavior. Specifically, overconfident individuals make larger contributions in the investment game. We also document that there is an escalated effect in overconfident individuals who are also exhibit risk loving preferences.
    Keywords: experiment, financial literacy, investment, overconfidence, social preferences, risk preferences
    JEL: G02 C91 D03
    Date: 2015–08
  6. By: Lingjiong Zhu
    Abstract: In a dual risk model, the premiums are considered as the costs and the claims are regarded as the profits. The surplus can be interpreted as the wealth of a venture capital, whose profits depend on research and development. In most of the existing literature of dual risk models, the profits follow the compound Poisson model and the cost is constant. In this paper, we develop a state-dependent dual risk model, in which the arrival rate of the profits and the costs depend on the current state of the wealth process. Ruin probabilities are obtained in closed-forms. Further properties and results will also be discussed.
    Date: 2015–10
  7. By: Mourad Lazgham
    Abstract: We consider the value function originating from an expected utility maximization problem with finite fuel constraint and show its close relation to a nonlinear parabolic degenerated Hamilton-Jacobi-Bellman (HJB) equation with singularity. On one hand, we give a so-called verification argument based on the dynamic programming principle, which allows us to derive conditions under which a classical solution of the HJB equation coincides with our value function (provided that it is smooth enough). On the other hand, we establish a comparison principle, which allows us to characterize our value function as the unique viscosity solution of the HJB equation.
    Date: 2015–10
  8. By: Jakiela,Pamela; Ozier,Owen
    Abstract: This study estimates the impact of Kenya?s post-election violence on individual risk preferences. Because the crisis interrupted a longitudinal survey of more than five thousand Kenyan youth, this timing creates plausibly exogenous variation in exposure to civil conflict by the time of the survey. The study measures individual risk preferences using hypothetical lottery choice questions, which are validated by showing that they predict migration and entrepreneurship in the cross-section. The results indicate that the post-election violence sharply increased individual risk aversion. Immediately after the crisis, the fraction of subjects who are classified as either risk neutral or risk loving dropped by roughly 26 percent. The findings remain robust to an IV estimation strategy that exploits random assignment of respondents to waves of surveying.
    Keywords: Economic Theory&Research,Banks&Banking Reform,Statistical&Mathematical Sciences,Labor Policies,Hazard Risk Management
    Date: 2015–10–14
  9. By: Ghassan, Hassan B.
    Abstract: Islamic faith and the ethical dimensions of the individual and the community play a significant role in guiding economic behavior by connecting the worldly life to the hereafter. The Shariah-compliant faith and ethical values generate specific behavior that requires Halal earning, fairness in spending and Halal utility leading to materialistic satisfaction and metaphysic reward. To analyze the Muslim consumer utility, in addition to the Islamic economics heritage, we rely on the instruments and prevailing assumptions in economics. Shaibani’s (750-805 AD) analysis of earning/spending/utility is based on three successive layers of earning/spending/utility; namely, the imperative, recommended, and the permissible. In this paper, we firstly contribute to developing a measure of the overspending and underspending. Secondly, based on the social solidarity, we show that the marginal earning has an effect on the macro MPC and depends mostly on the first differences between the MPC of the lower and upper social groups. Thirdly, according to the social welfare function, the permissible marginal utility is related to the faith interaction driving to an efficient transfer of purchasing capabilities to the targeted group. The optimal faithful behavior of affluent group leads, in the worldly life, to an elasticity of marginal utility less than or equal to one. The belief holding produces a hidden support in the worldly life but also engenders hereafter rewards through a steady eternal utility function, which generates an optimum of the marginal utility with elasticity greater than one.
    Keywords: Belief, Faith, Ethics, Consumption spending, Halal utility, Halal earning, Shaibani, Fairness.
    JEL: A13 B41 D11 D6 H3 I3 K4 N45 P46 Z12
    Date: 2015–09–10
  10. By: Michel Grabisch (Centre d'Economie de la Sorbonne - Paris School of Economics); Christophe Labreuche (Thales Research and Technology)
    Abstract: The GAI (Generalized Additive Independence) model proposed by Fishburn is a generalization of the additive utility model, which need not satisfy mutual preferential independence. Its great generality makes however its application and study difficult. We consider a significant subclass of GAI models, namely the discrete 2-additive GAI models, and provide for this class a decomposition into nonnegative monotone terms. This decomposition allows a reduction from exponential to quadratic complexity in any optimization problem involving discrete 2-additive models, making them usable in practice
    Keywords: multiattribute utility; multichoice games
    JEL: C4 C6 C71
    Date: 2015–09
  11. By: Aloisio Araujo (IMPA and EPGE/FGV - Rio de Janeiro); Laurence Jean-Marc Bonnisseau (Centre d'Economie de la Sorbonne - Paris School of Economics); Alain Chateauneuf (IPAG - Centre d'Economie de la Sorbonne - Paris School of Economics); Rodrigo Novinski (Faculdades Ibmec - Rio de Janeiro)
    Abstract: We prove that under mild conditions individually rational Pareto optima will exist even in presence of non-convex preferences. We consider decision makers dealing with a countable flow of payoffs or choosing among financial assets whose outcomes depend on the realization of a countable set of states of the world. Our conditions for the existence of Pareto optima can be interpreted as a requirement of impatience in the first context and of some pessimism or not unrealistic optimism in the second context. A non-existence example is provided when, in the second context, some decision maker is too optimistic. We furthermore show that at an individually rational Pareto optimum at most one strictly optimistic decision maker will avoid ruin at each state or date. Considering a risky context this entails that even is risk averters will share risk in a comonotonic way as usual, at most one classical strong risk lover will avoid ruin at each state or date. Finally some examples illustrate circumstances when a risk averter could take advantage of sharing risk with a risk lover rather than with a risk averter
    Keywords: Risk sharing; Pareto optimum; impatience; optimistic
    JEL: D80 D81
    Date: 2015–09
  12. By: Marc Fleurbaey (Woodrow Wilson School and Center for Human Values - Princeton University); Stéphane Zuber (Centre d'Economie de la Sorbonne - Paris School of Economics)
    Abstract: We provide a general method for extending social preferences defined for riskless economic environments to the context of risk and uncertainty. We apply the method to the problems of managing unemployment allowances (in the context of macroeconomic fluctuations) and catastrophic risks (in the context of climate change). The method guarantees ex post fairness and pays attention to individuals' risk attitudes, while ensuring rationality properties for social preferences, revisiting basic ideas from Harsanyi's celebrated aggregation theorem (Harsanyi, 1955). The social preferences that we obtain do not always take the form of an expected utility criterion, but they always satisfy statewise dominance. We obtain a new characterization of the maximin criterion when expected utility and minimal equity are combined. We also show non-expected utility individual preferences can be accommodated in the approach, although it raises issues regarding belief aggregation
    Keywords: Social choice; fairness; uncertainty; social risk
    JEL: D63
    Date: 2014–03
  13. By: Stéphane Zuber (Centre d'Economie de la Sorbonne - Paris School of Economics)
    Abstract: This paper studies the extension of Harsanyi's theorem (Harsanyi, 1995) in a framework involving uncertainty. It seeks to extend the aggregation result to a wide class of Monotonic Bernoullian and Archimedean preferences (Cerreia-Vioglio et al., 2011) that subsumes many models of choice under uncertainty proposed in the literature. An impossibility result is obtained, unless we are in the specific framework where all individuals and the decision-maker are subjective expected utility maximizers sharing the same beliefs. This implies that non-expected utility preferences cannot be aggregated consistently
    Keywords: Harsanyi's theorem; Pareto principle; Monotonic Bernoullian and Archimedean preferences; Subjective Expected Utility
    JEL: D71 D81
    Date: 2015–09
  14. By: Kellner, Christian; Reinstein, David; Riener, Gerhard
    Abstract: We study how other-regarding behavior extends to environments with uncertain income and conditional commitments. Should fundraisers ask a banker to donate "if he earns a bonus" or wait and ask after the bonus is known? Standard EU theory predicts these are equivalent; loss-aversion and signaling models both predict a larger commitment before the bonus is known; theories of affect predict the reverse. In field and lab experiments, we allow people to donate from lottery winnings, varying whether they decide before or after learning the lottery's outcome. Males are more generous when making conditional donations before knowing the outcome, while females' donations are unaffected. Males also commit more in treatments where income is certain but the donation's collection is uncertain. This supports a signaling explanation: it is cheaper to commit to donate before the uncertainty is unresolved, thus a larger donation is required to maintain a positive image. This has implications for experimental methodology, for fundraisers, and for our understanding of pro-social behavior.
    Keywords: social preferences,contingent decision-making,signaling,uncertainty,prospect theory,affective state,gender,charitable giving,public goods,experiments,field experiments,bonuses
    JEL: D64 C91 L30 D01 D84
    Date: 2015

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