nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2015‒11‒01
twelve papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Modeling Risk and Ambiguity-on-Nature in Normal-form Games By Jian Yang
  2. Probability weighting functions By Martina Nardon; Paolo Pianca
  3. Trade Bounded Rationality and Bounded Individuality By Davis, John
  4. Simulation Methods Comparison in Business Process Domain By Roman Šperka
  5. Revealed Preferences and Spatial Segregation By Henri Busson
  6. Behavior in Group Contests: A Review of Experimental Research By Sheremeta, Roman
  7. Nonparametric Euler equation identification and estimation By Juan Carlos Escanciano; Stefan Hoderlein; Arthur Lewbel; Oliver Linton; Sorawoot Srisuma
  8. The asymmetric effect of expectations on subjective well-being By Marta Barazzetta
  9. Deceptive Advertising with Rational Buyers By Salvatore Piccolo; Piero Tedeschi; Giovanni Ursino
  10. Natural Disaster, Migration, and Regional Development By Daisuke Ikazaki
  11. Myopic behavior and overall utility maximization - A study of linked hawks and doves - By Siegfried Berninghaus; Stephan Schosser; Bodo Vogt
  12. Knowledge spillovers from foreign direct invesments ? Czech case study By Jan Stejskal; Abdelwalid Rouag

  1. By: Jian Yang
    Abstract: We propose multi-player frameworks that mitigate decision-theoretical difficulties with the traditional normal-form game, where players are concerned with expected utility functions of their payoffs. We react to Allais's (1953) paradox by concerning players with potentially nonlinear functionals of the payoff distributions they encounter. To counter Ellsberg's (1961) paradox, we let players optimize on vectors of payoff distributions in which every component is a payoff distribution corresponding to one particular nature action. In the preference game we introduce, players merely express preferences over payoff-distribution vectors. Depending on ways in which players' mixed strategies are verified, there will emerge two equilibrium concepts, namely, the ex post and ex ante types. Conditions for equilibrium existence are identified; also, the unification of the two concepts at the traditional game is explained. When the preference relations lead to real-valued satisfaction functions, we have a satisfaction game. Two notable special cases are one coping with Gilboa and Schmeidler's (1989) ambiguity-averse worst-prior setup and another involving Artzner et al.'s (1999) coherent-risk measure with risk-averse tendencies. For both, searching for ex post equilibria boils down to solving sequences of simple nonlinear programs (NLPs).
    Date: 2015–10
  2. By: Martina Nardon (Department of Economics, Cà Foscari University Of Venice); Paolo Pianca (Department of Economics, Cà Foscari University Of Venice)
    Abstract: Cumulative prospect theory (CPT) has been proposed as an alternative to expected utility theory to explain irregular behavior by economic agents. CPT comprises two key transformations: one of outcome values and the other of objective probabilities. Risk attitudes are derived from the shapes of these transformations as well as their interaction. The focus of this contribution is on the transformation of objective probability, which is commonly referred as probability weighting function. We review different families of weighting functions proposed in the literature and study their features.
    Keywords: Cumulative prospect theory, probability weighting function.
    JEL: C63 D81 G13
    Date: 2015
  3. By: Davis, John (Department of Economics Marquette University)
    Abstract: This paper argues that since the utility function conception of the individual is derived from standard rationality theory, the view that rationality is bounded suggests that individuality should also be seen as bounded. The meaning of this idea is developed in terms of two ways in which individuality can be said to be bounded, with one bound associated with Kahneman and Tversky's prospect theory and the "new" behavioral economics and a second bound associated with Simon's evolutionary thinking and the "old" behavioral economics. The paper then shows how different bounded individuality conceptions operate in nudge economics, agent-based modeling, and social identity theory, explaining these conceptions in terms of how they relate to these two behavioral economics views of bounded rationality. How both the "new" and "old" individuality bounds might then be combined in a single account is briefly explored in connection with Kirman's Marseille fish market analysis.
    Keywords: bounded rationality, bounded individuality, nudge economics, agent-based modeling, social identity theory, Marseille fish market
    Date: 2014–07
  4. By: Roman Šperka (Department of Business Economics and Management, School of Business Administration, Silesian University)
    Abstract: The main goal of this paper is to compare the results of an agent-based and Monte Carlo simulation experiments in business process negotiation between sellers and customers of a simple trading commodity. The motivation of the presented research is to find suitable method for predicting key performance indicators of a business company. The intention is to develop a software module in the future which might help the management of business companies to support their decisions. Microeconomic demand functions were used as a core element in the negotiation. Specifically, Marshallian demand function and Cobb-Douglas utility functions is introduced. The paper firstly presents some of the principles of agent-based and Monte Carlo simulation techniques, and demand function theory. Secondly, we present a conceptual model of a business company in terms of a simulation framework. Thirdly, a formalization of demand functions and their implementation in a seller-to-customer negotiation is introduced. Lastly, we discuss some of the simulation results in one year of selling commodities. The results obtained show that agent-based method is more suitable than Monte Carlo in the presented domain, and the demand functions could be used to predict the trading results of a company in some metrics.
    Keywords: simulation, agent-based, Monte Carlo, trading, price negotiation, commodity, key performance indicators.
    JEL: C63 C99 L21 M21
    Date: 2015–10–22
  5. By: Henri Busson
    Abstract: The relationship income / distance to CBD is basically nonlinear and its form varies a lot across the world. We often consider classic forms such as the typical US city one, where rich people live in the suburbs and the European city where they live downtown. Nevertheless, more complex patterns could be observed like in New York City. In this city, the area which is the closest to the city center is very rich; poor people live further away from CBD and the middle class lives in the suburbs. To explain these stylized facts, we use a model inspired by Turnbull (1997). Instead of employing the classical utility functions, this model applies the revealed preference theory. In his original paper, Turnbull established several propositions that made his model consistent with the main results obtained in urban economics (for instance that the prices decrease in relation to the distance from the CBD). Despite its consistence, the model gives different predictions than the main studies regarding the relationship between income and distance to CBD. This model allows us to deal with a great heterogeneity among the households (regarding incomes, tastes, transportation modes, amenities consumption) and thus enables many different potential equilibria. This diversity of equilibria permits to represent in a more accurate way cities and patterns and thus justifies the use of this model. Moreover, we try to take into account every parameter that could influence location choice in a single framework. Some model focuses on access to public transportation (Glaeser et al. (2008), other on amenities (Brueckner et al. (1999)). But no model has ever succeeded in giving a complete framework for studying the income sorting. Utility functions are usually used because the revealed preferences method is highly complex. But our model is quite simple because we demonstrated that the GARP axiom used in the revealed preference theory is equivalent to a simple equation. In our paper, several differences are found when comparing our results to the classic method using utility functions. Firstly, the ratio commuting costs per mile over demand land for rent is found constant between income groups, which is consistent with Wheaton (1977). As this variable is no longer supposed to explain the income sorting, the model focuses on other variables to explain it: income elasticity of housing demand, commuting time or amenity consumption. Moreover, in our model, some of the richer households will locate closer from CBD than a poorer one while other rich households will locate further away. This leads to an overlapping of the different income groups unlike the utility functions models that often predict complete segregation (except in De Bartolome and Ross (2003)).
    Keywords: income sorting; revealed preferences; segregation;
    JEL: R20 D01 D11
    Date: 2015–10
  6. By: Sheremeta, Roman
    Abstract: Group contests are ubiquitous. Some examples include warfare between countries, competition between political parties, team-incentives within firms, group sports, and rent-seeking. In order to succeed, members of the same group have incentives to cooperate with each other by expending individual efforts. However, since effort is costly, each member also has an incentive to abstain from expending any effort and instead free-ride on the efforts of other members. Contest theory shows that the intensity of competition between groups and the amount of free-riding within groups depend on the group size, sharing rule, group impact function, contest success function, and heterogeneity of players. We review experimental studies testing these theoretical predictions. Almost all studies of behavior in group contests find significant over-expenditure of effort relative to the theory. We discuss potential explanations for such over-expenditure, including the utility of winning, bounded rationality, relative payoff maximization, parochial altruism, and social identity. Despite over-expenditure, most studies find support for the comparative statics predictions of the theory (with the exception of the “group size paradox”). Finally, studies show that there are effective mechanisms that can promote within-group cooperation and conflict resolution mechanisms that can de-escalate and potentially eliminate between-group conflict.
    Keywords: groups, contests, experiments
    JEL: C7 C9 D7 H4 J4 K4 L2 M5
    Date: 2015–10–29
  7. By: Juan Carlos Escanciano (Institute for Fiscal Studies); Stefan Hoderlein (Institute for Fiscal Studies and Boston College); Arthur Lewbel (Institute for Fiscal Studies and Boston College); Oliver Linton (Institute for Fiscal Studies and University of Cambridge); Sorawoot Srisuma (Institute for Fiscal Studies)
    Abstract: We consider nonparametric identification and estimation of pricing kernels, or equivalently of marginal utility functions up to scale, in consumption based asset pricing Euler equations. Ours is the first paper to prove nonparametric identification of Euler equations under low level conditions (without imposing functional restrictions or just assuming completeness). We also propose a novel nonparametric estimator based on our identification analysis, which combines standard kernel estimation with the computation of a matrix eigenvector problem. Our estimator avoids the ill-posed inverse issues associated with existing nonparametric instrumental variables based Euler equation estimators. We derive limiting distributions for our estimator and for relevant associated functionals. We provide a Monte Carlo analysis and an empirical application to US household-level consumption data.
    Keywords: Euler equations; marginal utility; pricing kernel; Fredholm equations; integral equations; nonparametric identification; asset pricing
    JEL: C14 D91 E21 G12
    Date: 2015–10
  8. By: Marta Barazzetta (Université du Luxembourg)
    Abstract: We empirically explore the relationship between expectations and subjective well-being. Theoretical models predict that expectations can influence experienced utility in two ways: (i) directly as anticipatory emotions in the form of savouring or dread; (ii) indirectly as internal reference levels in the form of deviations between expectations and actual achievements. We use twelve waves of the British Household Panel Survey to empirically investigate the double effect of expectations on experienced utility, as proxied by subjective well-being. We find a strong asymmetry in the way expectations affect subjective well-being. Negative deviations from expectations have a strong negative effect on subjective well-being, while the effect of positive deviations is weaker and sometimes insignificant. Expecting a worsening has a larger impact on subjective well-being than expecting an improvement.
    Keywords: Subjective well-being, expectations, disappointment aversion, panel data, BHPS.
    JEL: C23 D84 I31
    Date: 2015–09
  9. By: Salvatore Piccolo (Dipartimento di Economia e Finanza, Università Cattolica del Sacro Cuore); Piero Tedeschi (Dipartimento di Economia e Finanza, Università Cattolica del Sacro Cuore); Giovanni Ursino (Università Cattolica del Sacro Cuore; Dipartimento di Economia e Finanza, Università Cattolica del Sacro Cuore)
    Abstract: We study a game in which two competing sellers supplying experience goods of different quality can induce a perspective buyer into a bad purchase through (costly) deceptive advertising. We characterize the equilibrium set of the game and argue that an important class of these outcomes features pooling behavior at the pricing stage while requiring low quality sellers to air false claims about their product. These claims deceive the buyer and induce a bad purchase with positive probability. Although the low-quality product is purchased with positive probability in these equilibria, the buyer's (expected) utility can be higher than in a fully separating equilibrium. This result suggests that, surprisingly, deceptive practices may actually enhance competition. Finally, we characterize the optimal deterrence by a regulatory agency that seeks to punish deceptive practices. We show that consumer surplus maximization requires lower deterrence than social welfare maximization. The analysis is robust to various extensions.
    Keywords: Asymmetric Information, Bayesian Consumers, Deception, Misleading Advertising, Signaling
    JEL: L13 L15 L4
    Date: 2015–06
  10. By: Daisuke Ikazaki
    Abstract: As described in this paper, a simple matching theory is constructed to ascertain how natural disasters affect regional economic activities and migration. Section 2 introduces a simple matching theory model based on previous studies. This theory explains how the unemployment rate, a measure of market tightness, the wage rate, and other important variables are determined. Section 3 describes integration of the elements of natural disasters into the model of section 2. Assuming that agglomeration increases productivity, then in a typical case, one can infer an inverted U-shaped relation between utility (Wu) and the regional population (L). When a natural disaster occurs, production factors are decreased, thereby reducing productivity. Consequently, people move from the affected areas to other cities: population drain occurs. Section 4 extends the model presented in section 3. In section 4.1, regional loyalty is considered. Damage caused by natural disasters decreases the utility of each household in the affected areas. However, presuming that the utility difference between the domicile (hometown) and other regions is low, then it seems likely that people will tend to remain in their hometown even if monetary gains could be made by migrating to other areas. Consequently, multiple steady states exist. In 4.2, we assume that productivity depends on public capital, which is degraded by a natural disaster.Â@Immediately following the natural disaster, people in the affected areas might migrate to other regions. The effects of fiscal policies to recover public capital are also discussed. Results show that once migration and a population drain occur, such fiscal policies might deteriorate the regional economy further: excess supply of public capital increases the onus of the region. Such reconstruction policies decrease the household utility. Fiscal policies might engender further population outflow.
    Keywords: atural disaster; Migration; Matching theory; Regional economics
    JEL: C78 Q54 R11 R23
    Date: 2015–10
  11. By: Siegfried Berninghaus (Karlsruhe Institute of Technology); Stephan Schosser (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg); Bodo Vogt (Faculty of Management, Economics and Social Sciences, University of Cologne)
    Abstract: At present, in the domain of simultaneous action selection and network formation games, game-theoretic behavior and experimental observations are not consistent. While theory typically predicts inefficient outcomes for (anti- )co-ordination games, experiments show that subjects tend to play efficient (non-Nash) strategy profiles. One reason for this discrepancy is the tendency to model corresponding games as one-shot and derive predictions. In this paper, we calculate the equilibria for a finitely repeated version of the Hawk-Dove game with endogenous network formation and show that the repetition leads to additional sub-game perfect equilibria; namely, the efficient strategy profiles played by human subjects. However, efficiency crucially depends on the design of the game. This paper theoretically demonstrates that, although technically feasible, the efficient profiles are not sub-game perfect equilibria if actions are fixed after an initial period. We confirm this result using an experimental study that demonstrates how payoffs are higher if actions are never fixed.
    Keywords: Network; Hawk-Dove; Game theory; Behavioral experiment; Finitely re- peated game
    JEL: D85 C72 C73 C92
    Date: 2015–07
  12. By: Jan Stejskal; Abdelwalid Rouag
    Abstract: The foreign direct investments (FDI) spillovers are probably the most extensively analyzed channel of knowledge spillovers (the most important channel for the transfer of knowledge and technology to firms of the host country). Scholars as well as policy makers increasingly treat FDI spillovers as very or the most important development effect for host country. However, whether this knowledge and technology are hypothesized to spill over depends on the absorptive capacity of the host country which stems from well-equipped human resources such as scientists and cumulative expenditure in research and development (R&D). In this paper, we examine for the single time the extent of knowledge spillovers and the absorptive capacity of the Czech Republic regions. Our empirical analysis is based on two main sources. First, the confidential micro-data derived from an annual census of R&D collected by the Czech statistical office with the collaboration of the Czech industrial property office. The data measures inputs in R&D such as the financial means and human resources in the entire entities that carry out R&D and their primary and secondary activities. The mico-data includes also indicators about the R&D outputs in the form of new knowledge used in several practical applications such as patents and utility models. The second source of Data consists on the inflow of FDI at the regional level. The data is collected and published by the Czech National bank according to the international standards adopted by the Organization for Economic Cooperation and development (OECD), European commission and the International Monetary Fund (IMF) data compilation of balance of payments. The paper finds that there is a significant knowledge inflow from the FDI to local firms. Our results state that coefficient of FDI inflows is always positive for both models so that the empirical evidence supports that FDI generates spillover effects on the domestic regional innovation capability of the Czech Republic. As advised by the literature, the spillover effects occur through the absorptive capacity such as the skilled labor turnovers and the R&D expenditure in both entrepreneurial and public sector. In this context, our two models suggest a positive impact of labor in private sector and even significant in both models for the public sector which highlights the important role played by universities, scientific institutes and NGO´s. On the other hand, the correlation matrix of both patents application and utility models show a negative relation between two independent variables; FDI inflows and R&D government expenditure that fosters the assumption that the government expenditure in R&D crowds out the FDI inflow and hinder the beneficial effects of the latter.
    Keywords: foreign Direct Investment; knowledge spillovers; absorptive capacity; patent app
    JEL: D83 D92 O11
    Date: 2015–10

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