nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2015‒12‒28
twelve papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Risk Assessment under Ambiguity: Precautionary Learning vs. Research Pessimism By Heyen, Daniel; Goeschl, Timo; Wiesenfarth , Boris
  2. Feasible sets, comparative risk aversion, and comparative uncertainty aversion in bargaining By Driesen B.W.I.; Lombardi M.; Peters H.J.M.
  3. Optimization problem for a portfolio with an illiquid asset: Lie group analysis By Ljudmila A. Bordag; Ivan P. Yamshchikov
  4. Risk attitudes of foresters, farmers and students: An experimental multimethod comparison By Sauter, Philipp; Hermann, Daniel; Mußhoff, Oliver
  6. Inferring Risk Perceptions and Preferences using Choice from Insurance Menus: Theory and Evidence By Keith Marzilli Ericson; Philipp Kircher; Johannes Spinnewijn; Amanda Starc
  7. A global factor in variance risk premia and local bond pricing By Kaminska, Iryna; Roberts-Sklar, Matt
  8. Should a Non-rival Public Good Always be Provided Centrally? By Nicolas GRAVEL; Michel POITEVIN
  9. Social network and private provision of public goods By Bulat Sanditov; Saurabh Arora
  10. Voluntary Contributions to a Mutual Insurance Pool By Louis Lévy-Garboua; Claude Montmarquette; Jonathan Vaksmann; Marie Claire Villeval
  11. Industry based equity premium forecasts By Nuno Silva

  1. By: Heyen, Daniel; Goeschl, Timo; Wiesenfarth , Boris
    Abstract: Agencies charged with regulating complex risks such as food safety or novel substances frequently need to take decisions on risk assessment and risk management under conditions of ambiguity, i.e. where probabilities cannot be assigned to possible outcomes of regulatory actions. What mandates should society write for such agencies? Two approaches stand out in the current discussion. One charges the agency to apply welfare economics based on expected utility theory. This approach underpins conventional cost-benet analysis (CBA). The other requires that an ambiguity-averse decision-rule - of which maxmin expected utility (MEU) is the best known - be applied in order to build a margin of safety in accordance with the Precautionary Principle (PP). The contribution of the present paper is a relative assessment of how a CBA and a PP mandate impact on the regulatory task of risk assessment. In our parsimonious model, a decision maker can decide on the precision of a signal which provides noisy information on a payoff-relevant parameter. We find a complex interplay of MEU on information acquisition shaped by two countervailing forces that we dub 'Precautionary Learning' and 'Research Pessimism'. We find that - contrary to intuition - a mandate of PP rather than CBA will often give rise to a less informed regulator. PP can therefore lead to a higher likelihood of regulatory mistakes, such as the approval of harmful new substances.
    Keywords: scientific uncertainty; ambiguity; learning; risk assessment; precautionary principle; active information acquisition; regulatory mandates.
    Date: 2015–12–18
  2. By: Driesen B.W.I.; Lombardi M.; Peters H.J.M. (GSBE)
    Abstract: We study feasible sets of the bargaining problem under two different assumptions the players are subjective expected utility maximizers or the players are Choquet expected utility maximizers. For the latter case, we consider the effects on bargaining solutions when players become more risk averse and when they become more uncertainty averse.
    Keywords: Bargaining Theory; Matching Theory; Criteria for Decision-Making under Risk and Uncertainty;
    JEL: C78 D81
    Date: 2015
  3. By: Ljudmila A. Bordag; Ivan P. Yamshchikov
    Abstract: Management of a portfolio that includes an illiquid asset is an important problem of modern mathematical finance. One of the ways to model illiquidity among others is to build an optimization problem and assume that one of the assets in a portfolio can not be sold until a certain finite, infinite or random moment of time. This approach arises a certain amount of models that are actively studied at the moment. Working in the Merton's optimal consumption framework with continuous time we consider an optimization problem for a portfolio with an illiquid, a risky and a risk-free asset. Our goal in this paper is to carry out a complete Lie group analysis of PDEs describing value function and investment and consumption strategies for a portfolio with an illiquid asset that is sold in an exogenous random moment of time with a prescribed liquidation time distribution. The problem of such type leads to three dimensional nonlinear Hamilton-Jacobi-Bellman (HJB) equations. Such equations are not only tedious for analytical methods but are also quite challenging form a numeric point of view. To reduce the three-dimensional problem to a two-dimensional one or even to an ODE one usually uses some substitutions, yet the methods used to find such substitutions are rarely discussed by the authors. We find the admitted Lie algebra for a broad class of liquidation time distributions in cases of HARA and log utility functions and formulate corresponding theorems for all these cases. We use found Lie algebras to obtain reductions of the studied equations. Several of similar substitutions were used in other papers before whereas others are new to our knowledge. This method gives us the possibility to provide a complete set of non-equivalent substitutions and reduced equations.
    Date: 2015–12
  4. By: Sauter, Philipp; Hermann, Daniel; Mußhoff, Oliver
    Abstract: Many economic decision situations of foresters and farmers are characterized by risk. Thereby, the individual risk attitude is of particular interest for understanding decision behaviour and, thus, is fundamental for valuable policy recommendations. The literature provides various methods to measure risk attitude, however, their respective suitability has not been sufficiently tested. Furthermore, existing analyses focus mostly on students and the field of resource economics for farmers. However, there is a lack of knowledge regarding the risk attitude of foresters and how it compares to farmers and students' attitudes. Therefore, we investigate to what extent results are comparable across different methods and whether the risk attitude of foresters differs from that of farmers and forestry students. To analyse this issue, we conduct an incentivized online experiment using the Holt and Laury (HL) task, the Eckel and Grossman (EG) task and a self-assessment (SA) questionnaire. As a result, SA values do not correlate with the HL values, but the EG values correlate with the HL values across all groups, although, risk-aversion coefficients differ. According to the HL task and the EG task, we reveal higher risk aversion for foresters in comparison to farmers, while forestry students do not differ from foresters.
    Keywords: risk attitude,foresters,farmers,Holt and Laury task,Eckel and Grossman task,self-assessment of risk attitude
    Date: 2015
  5. By: A Banerji and Jeevant Rampal (Centre for Development Economics, Delhi School of Economics, University of Delhi, India)
    Abstract: This paper reports and models the discrepancy between the full bidding and endow and upgrade findings from a willingness-to-pay (WTP) elicitation Becker-Degroot-Marschak (BDM) experiment for an improved food, conducted in rural India. We found that the distribution of the WTP for exchanging 1kg local pearl millet (LPM) for 1 kg of biofortified high-iron pearl millet (HIPM) first-order stochastically dominated the distribution of the difference between the WTPs for 1kg HIPM and 1kg LPM. Thus the data (i) rejects preferences that are standard or have status quo reference points, in favor of an expectations-based reference dependence model of loss aversion for the new product, and (ii) is used to identify and estimate the loss aversion parameter and latent consumer valuations for HIPM in the consumer model. These point to a significant downward bias in conventional WTP estimates Of HIPM using the BDM procedure, suggesting caution when one is using standard incentive compatible mechanisms for value elicitation.
    Date: 2015–11
  6. By: Keith Marzilli Ericson; Philipp Kircher; Johannes Spinnewijn; Amanda Starc
    Abstract: Demand for insurance can be driven by high risk aversion or high risk. We show how to separately identify risk preferences and risk types using only choices from menus of insurance plans. Our revealed preference approach does not rely on rational expectations, nor does it require access to claims data. We show what can be learned non-parametrically from variation in insurance plans, offered separately to random cross-sections or offered as part of the same menu to one cross-section. We prove that our approach allows for full identification in the textbook model with binary risks and extend our results to continuous risks. We illustrate our approach using the Massachusetts Health Insurance Exchange, where choices provide informative bounds on the type distributions, especially for risks, but do not allow us to reject homogeneity in preferences.
    JEL: D8 I13
    Date: 2015–12
  7. By: Kaminska, Iryna (Bank of England); Roberts-Sklar, Matt (Bank of England)
    Abstract: In a world of interconnected financial markets it is plausible that risk appetite — an important factor in asset pricing — is determined globally. By constructing an estimate of variance risk premia (VRP) for UK, US and euro-area equity markets, we are able to estimate international variance risk premia and use them to construct a proxy for global risk aversion. The impact of this time-varying risk aversion proxy on bond risk premia is then analysed within an arbitrage-free term structure model of UK interest rates, where it is introduced explicitly as a pricing factor. By linking VRP to a stochastic discount factor, we find that the risk aversion factor has significantly affected UK government bond yields. The changes in the risk aversion factor have been particularly important in the period of the 2008–09 financial crisis, with medium maturity yields being affected the most.
    Keywords: Affine term structure models; option implied volatility; realized volatility; risk aversion; stochastic discount factor; variance risk premium; volatility forecasting
    JEL: C22 C52 E43 G12
    Date: 2015–12–21
  8. By: Nicolas GRAVEL; Michel POITEVIN
    Abstract: This paper discusses the problem of optimal design of a jurisdiction structure from the view point of a utilitarian social planner when individuals with identical utility functions for a non-rival public good and private consumption have private information about their contributive capacities. It shows that the superiority of a centralized provision of a non-rival public good over a federal one does not always hold. Specifi…cally, when differences in individuals' contributive capacities are large, it is better to provide the public good in several distinct jurisdictions rather than to pool these jurisdictions into a single one. In the specifi…c situation where individuals have logarithmic utilities, the paper provides a complete characterization of the optimal jurisdiction structure in the two-type case.
    Keywords: federalism, jurisdictions, asymmetric information, equalization, second best, public goods, city mergers
    JEL: D6 H2 H7
    Date: 2015
  9. By: Bulat Sanditov (TELECOM Ecole de Management, Institut Mines-T´el´ecom, France); Saurabh Arora (Science Policy Research Unit, University of Sussex, UK)
    Abstract: Using a simple model with interdependent utilities, we study how social networks influence individual voluntary contributions to the provision of a public good. Departing from the stan- dard model of public good provision, we assume that an agent’s utility has two terms: (a) ‘ego’-utility derived from the agent’s consumption of public and private goods, and (b) a so- cial utility which is the sum of utility spillovers from other agents with whom the agent has social relationships. We establish conditions for the existence of a unique interior Nash equi- librium and describe the equilibrium in terms of network characteristics. We show that social network always has a positive effect on the provision of the public good. We also find that, in networks with “small world”-like modular structures, ‘bridging’ ties connecting distant parts of social network play an important role inducing the agent’s contribution to public good. Assumptions and results of the model are discussed in relation to the role of social capital in community-level development projects and to the effect of innovation networks on firms’ R&D investments.
    Keywords: public goods, interrelated utilities, social capital, R&D networks
    JEL: H41 D85 O31
    Date: 2015–12
  10. By: Louis Lévy-Garboua (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics); Claude Montmarquette (CIRANO - Centre Interuniversitaire de Recherche en ANalyse des Organisations); Jonathan Vaksmann (UM - Université du Maine); Marie Claire Villeval (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - ENS Lyon - École normale supérieure - Lyon - UL2 - Université Lumière - Lyon 2 - UCBL - Université Claude Bernard Lyon 1 - Université Jean Monnet - Saint-Etienne - PRES Université de Lyon - CNRS - Centre National de la Recherche Scientifique)
    Abstract: We study mutual-aid games in which individuals choose to contribute to an informal mutual insurance pool. Individual coverage is determined by the aggregate level of contributions and a sharing rule. We analyze theoretically and experimentally the (ex ante) efficiency of equal and contribution-based coverage. The equal coverage mechanism leads to a unique no-insurance equilibrium while contribution-based coverage develops multiple equilibria and improves efficiency. Experimentally, the latter treatment reduces the amount of transfers from high contributors to low contributors and generates a "dual interior equilibrium". That dual equilibrium is consistent with the coexistence of different prior norms which correspond to notable equilibria derived in the theory. This results in asymmetric outcomes with a majority of high contributors less than fully reimbursing the global losses and a signi cant minority of low contributors less than fully defecting. Such behavioral heterogeneity may be attributed to risk attitudes (risk tolerance vs risk aversion) which is natural in a risky context.
    Keywords: Mutual insurance pool, voluntary contribution mechanism, equal coverage, contribution-based coverage, heterogeneity of risk attitudes, experiment
    Date: 2015–12–14
  11. By: Nuno Silva (University of Coimbra/GEMF)
    Abstract: In this paper we used industry indexes to predict the equity premium in the US. We considered several types of predictive models: i) constant coefficients and constant volatility, ii) drifting coefficients and constant volatility, iii) constant coefficients and stochastic volatility and iv) drifting coefficients and stochastic volatility. The models were estimated through the particle learning algorithm, which is suitable for dealing with the problem that an investor faces in practice, given that it allows the investor to revise the parameters as new information arrives. All the models exhibit similar statistical predictive ability, but stochastic volatility models generate slightly higher utility gains.
    Keywords: equity premium prediction, industries, particle filter, combination of forecasts.
    JEL: C11 G11 G14 G17
    Date: 2015–12
  12. By: Maria De Paola; Michela Ponzo; Vincenzo Scoppa (Dipartimento di Economia, Statistica e Finanza, Università della Calabria)
    Abstract: We exploit a natural experiment based on the Italian promotion system for associate and full professor positions to investigate gender differences in the willingness to enter competition. Using data on about 42,000 professors and controlling for productivity and a number of individual and field characteristics, we find that females have a lower probability of applying for competition of about 4 percentage points. The determinants of this gap seem to be gender differences in risk-aversion and self-confidence and women’s fear of discrimination: the lower tendency to enter competition is especially relevant for women in the lower tail of the distribution of scientific productivity and in fields in which productivity is not easily measurable; furthermore, women are less likely to apply for promotion in fields in which promotions of females in the past were rare.
    Keywords: Attitudes towards competition, Gender gaps, Risk-aversion, Self-confidence, Discrimination, Academic Promotions, Natural Experiment
    JEL: J71 M51 J45 J16 D72 D78
    Date: 2015–12

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