nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2016‒02‒17
fourteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Violations of scale compatibility: results from pricing tasks and choice tasks in choice experiments By Merk, Christine; Rehdanz, Katrin; Schmidt, Ulrich; Schröder, Carsten
  2. Contract Nonperformance and Ambiguity in Insurance Markets By Landmann, Andreas; Biener, Christian; Eling, Martin; Santana, Maria Isabel
  3. Global Warming and a Potential Tipping Point in the Atlantic Thermohaline Circulation: The Role of Risk Aversion By Glanemann, Nicole; Belaia, Mariia; Funke, Michael
  4. Asymmetric Labor-Supply Responses to Wage-Rate Changes: Evidence from a Field Experiment By Doerrenberg, Philipp; Duncan, Denvil; Loeffler, Max
  5. Risk-Sensitive Linear Approximations By Meyer-Gohde, Alexander
  6. Social Reference Points and Risk Taking By Schwerter, Frederik
  7. Attention and Endogenous Framing By Dertwinkel-Kalt, Markus; Wenzel, Tobias
  8. Uncertainty shocks and non-fundamental debt crises: An ambiguity approach By Große Steffen, Christoph
  9. The Compromise Effect in Action: Lessons from a Restaurant's Menu By Pinger, Pia; Ruhmer-Krell, Isabel; Schumacher, Heiner
  10. The 2016 Power Trading Agent Competition By Ketter, W.; Collins, J.; Weerdt, M.M.
  11. How Soon Is Now? Evidence of Present Bias from Convex Time Budget Experiments By Balakrishnan, Uttara; Haushofer, Johannes; Jakiela, Pamela
  12. The El Farol Problem Revisited By Böhm, Volker
  13. Does Self-Control Depletion Affect Risk Attitudes? By Gerhardt, Holger; Schildberg-Hörisch, Hannah; Willrodt, Jana
  14. Ex-post Optimal Knapsack Procurement By Jarman, Felix; Meisner, Vincent

  1. By: Merk, Christine; Rehdanz, Katrin; Schmidt, Ulrich; Schröder, Carsten
    Abstract: According to rational choice theory, preference orderings should be invariant with respect to the elicitation procedure. The contingent trade-off model (Tversky et al., 1988), however, argues that if an attribute of decision alterna-tives is also used as response mode (scale compatibility), then the attribute will be weighted more heavily. We propose a two-stage design for a systemat-ic assessment of how scale compatibility impacts willingness to pay (WTP) es-timates in choice experiments. At the first stage, a pricing task is implemented. Respondents face two alternative goods. For one good, the price is given. For the alternative good, respondents state the price (WTP) that makes them indifferent between the alternatives. In the second stage, a choice task is implemented: another group of respondents makes pairwise choices between two alternative goods with the price being one of several attributes. Our empirical findings support the contingent trade-off model, as pricing tasks yield systematically lower WTP estimates than choice tasks. While the trade-offs between the other attributes do not differ between the pricing and the choice task. Thus, in the choice task the weight shifts away from the price attribute but does not change the relative weight of the other attributes.
    JEL: D10 D60 Q50
    Date: 2015
  2. By: Landmann, Andreas; Biener, Christian; Eling, Martin; Santana, Maria Isabel
    Abstract: Insurance contract nonperformance relates to situations when valid claims are not paid by the insurer. We extend probabilistic insurance models to allow for such nonperformance risk as well as ambiguity regarding nonperformance and loss probabilities. We empirically test theoretical predictions from our model within a field lab experiment in a low-income setting. This is a persuasive context, since especially in emerging and poorly regulated markets there is a higher chance of contract nonperformance. In line with our predictions, insurance demand decreases by 17 percentage points in the presence of contract nonperformance risk and is reduced by a further 14 percentage points when contract nonperformance risk is ambiguous. It also seems that ambiguity does not easily disappear with experience. The results have implications for both industrialized and developing insurance markets.
    JEL: C91 D81 G22
    Date: 2015
  3. By: Glanemann, Nicole; Belaia, Mariia; Funke, Michael
    Abstract: The risk of catastrophes is one of the greatest threats by climate change. Yet, the most common Integrated Assessment Models produce the counterintuitive result that a higher concern about climate change risks does not lead to stronger near-term abatement efforts. This paper probes whether this result still holds in a more refined DICE model that features Epstein-Zin utility, uncertainty about climate sensitivity and is fully coupled with a dynamic representation of the Atlantic thermohaline circulation. This modelling allows posing the question of whether aversion to this specific tipping point risk has a significant effect on the climate policy efforts. The simulations, however, show that near-term policy is insensitive to this climate change risk. For the more likely climate sensitivity values, a collapse of the circulation would occur in the more distant future, which allows acting after learning. For the more unlikely and higher climate sensitivity values, the collapse is not prevented as climate policy costs would be too high.
    JEL: Q54 C61 C63
    Date: 2015
  4. By: Doerrenberg, Philipp (ZEW Mannheim); Duncan, Denvil (Indiana University); Loeffler, Max (ZEW Mannheim)
    Abstract: The standard labor-supply literature typically assumes that the labor supply response to wage increases is the same as that for equivalent wage decreases. However, evidence from the behavioral-economics literature suggests that people are loss averse and thus perceive losses differently than gains. This behavioral insight may imply that workers respond differently to wage increases than to wage decreases. We estimate the effect of wage increases and decreases on labor supply using a randomized field experiment with workers on Amazon's Mechanical Turk. The results provide evidence that wage increases have smaller effects than wage decreases, suggesting that the labor-supply response to wage changes is asymmetric. This finding is especially strong on the extensive margin where the elasticity for a wage decrease is twice that for a wage increase. These findings suggest that a reference-dependent utility function that incorporates loss aversion is the most appropriate way to model labor supply.
    Keywords: labor supply, loss aversion, labor supply elasticities, w.r.t. wages
    JEL: J22 J31 D03
    Date: 2016–01
  5. By: Meyer-Gohde, Alexander
    Abstract: I construct risk-sensitive approximations of policy functions of DSGE models around the stochastic steady state and ergodic mean that are linear in the state variables. The method requires only the solution of linear equations using standard perturbation output to construct the approximation and is uniformly more accurate than standard linear approximations. In an application to real business cycles with recursive utility and growth risk, the approximation successfully estimates risk aversion using the Kalman filter, where a standard linear approximation provides no information and alternative methods require computationally intensive procedures such as particle filters. At the posterior mode, the model s market price of risk is brought in line with the postwar US Sharpe ratio without compromising the fit of the macroeconomy.
    JEL: C61 C63 E17
    Date: 2015
  6. By: Schwerter, Frederik
    Abstract: We test whether social reference points impact individual risk taking. In a laboratory experiment, decision makers observe the earnings of a peer subject before making a risky choice. We exogenously manipulate the peer earnings across two treatments. We find a significant treatment effect on risk taking: decision makers vary their risk taking in order to surpass or stay ahead of their peer. Our findings are consistent with a social-comparison-based, reference-dependent preference model that formalizes relative concerns via social loss aversion. Additionally, we relate our findings to the impact of private reference points on risk taking.
    JEL: C91 D03 D81
    Date: 2015
  7. By: Dertwinkel-Kalt, Markus; Wenzel, Tobias
    Abstract: This paper develops a theory of framing in an intertemporal context with risky choices. We provide a unifying account of existing theories of focusing by allowing a decision maker to choose her frame such that her attention is either drawn to salient events associated with an option or to the expected utilities an option yields in different time periods. Our key assumption is that a decision maker can choose her frame in a self-serving manner. We predict that the selected frame induces overoptimistic actions in the sense that subjects underrate risk but overrate chances and accordingly reveal overoptimistic actions. Hence, our theory can explain phenomena such as excessive harmful consumption (smoking, unhealthy diet) and risky investments (enterpreneurship, lotteries, gambling). We also apply our theory to static lotteries and find that classical phenomena of decision making under risk (such as the Common Ratio Allais paradox) can be rationalized by our model. We provide experimental evidence to support our claims.
    JEL: D03 D11 D90
    Date: 2015
  8. By: Große Steffen, Christoph
    Abstract: This paper analyses empirically and theoretically the effects of uncertainty shocks on sovereign default risk. It describes a novel mechanism for non-fundamental debt crises induced by uncertainty shocks that are defined as time-varying levels of ambiguity surrounding the macroeconomic fundamental of the economy. A business cycle model with strategic sovereign default is augmented with ambiguity averse investors with multiple-priors utility. I find that uncertainty shocks increase the risk of default as perceived by worst case investors' beliefs. Sovereign and private sector interest rates rise due to a spillover channel that unfolds through the domestic banking sector. A crisis zone is characterised where worst case investors' beliefs lead to non-fundamental debt crises. The model's predictions are shown to be in line with impulse responses obtained from a VAR analysis for a panel of four Euro area countries. Specifically, the dichotomy of sovereign debt pricing in the core and periphery countries can partly be rationalised by accounting for ambiguity premia.
    JEL: D81 E44 F34
    Date: 2015
  9. By: Pinger, Pia (University of Bonn); Ruhmer-Krell, Isabel; Schumacher, Heiner (KU Leuven)
    Abstract: The compromise effect refers to individuals' tendency to choose intermediate options. Its existence has been demonstrated in a large number of hypothetical choice experiments. This paper uses field data from a specialties restaurant to investigate the existence and strength of the compromise effect in a natural environment. Despite the presence of many factors that potentially weaken the compromise effect (e.g., a very large choice set, the opportunity to choose familiar options), we find evidence for it both in descriptive statistics and regression analyses. Options which become a compromise after a change in the choice set gain on average five percent in market share. We also find that the compromise effect is especially pronounced in groups, while for single customers it is statistically insignificant.
    Keywords: utility theory, restaurant data, compromise effect
    JEL: D03 M31
    Date: 2016–01
  10. By: Ketter, W.; Collins, J.; Weerdt, M.M.
    Abstract: This is the specification for the Power Trading Agent Competition for 2016 (Power TAC 2016). Power TAC is a competitive simulation that models a “liberalized” retail electrical energy market, where competing business entities or “brokers” offer energy services to customers through tariff contracts, and must then serve those customers by trading in a wholesale market. Brokers are challenged to maximize their profits by buying and selling energy in the wholesale and retail markets, subject to fixed costs and constraints; the winner of an individual “game” is the broker with the highest bank balance at the end of a simulation run. Costs include fees for publication and withdrawal of tariffs, and distribution fees for transporting energy to their contracted customers. Costs are also incurred whenever there is an imbalance between a broker’s total contracted energy supply and demand within a given time slot. The simulation environment models a wholesale market, a regulated distribution utility, and a population of energy customers, situated in a real location on Earth during a specific period for which weather data is available. The wholesale market is a relatively simple call market, similar to many existing wholesale electric power markets, such as Nord Pool in Scandinavia or FERC markets in North America, but unlike the FERC markets we are modeling a single region, and therefore we approximate locational-marginal pricing through a simple manipulation of the wholesale supply curve. Customer models include households, electric vehicles, and a variety of commercial and industrial entities, many of which have production capacity such as solar panels or wind turbines. All have “real-time” metering to support allocation of their hourly supply and demand to their subscribed brokers, and all are approximate utility maximizers with respect to tariff selection, although the factors making up their utility functions may include aversion to change and complexity that can retard uptake of marginally better tariff offers. The distribution utility models the regulated natural monopoly that owns the regional distribution network, and is responsible for maintenance of its infrastructure. Real-time balancing of supply and demand is managed by a market-based mechanism that uses economic incentives to encourage brokers to achieve balance within their portfolios of tariff subscribers and wholesale market posi- tions, in the face of stochastic customer behaviors and weather-dependent renewable energy sources. Changes for 2016 are focused on a more realistic cost model for brokers, and are highlighted by change bars in the margins. See Section 7 for details.
    Keywords: autonomous agents, electronic commerce, energy, preferences, portfolio management, power, policy guidance, sustainability, trading agent competiton
    Date: 2016–01–12
  11. By: Balakrishnan, Uttara (University of Maryland); Haushofer, Johannes (Princeton University); Jakiela, Pamela (University of Maryland)
    Abstract: Empirically observed intertemporal choices about money have long been thought to exhibit present bias, i.e. higher short-term compared to long-term discount rates. Recently, this view has been called into question on both empirical and theoretical grounds, and a spate of recent findings suggest that present bias for money is minimal or non-existent when one allows for curvature in the utility function and transaction costs are tightly controlled. However, an alternative interpretation of many of these findings is that, in the interest of equalizing transaction costs across earlier and later payments, small delays were introduced between the time of the experiment and the soonest payment. We conduct a laboratory experiment in Kenya in which we elicit time and risk preference parameters from 291 participants, using convex time budgets and tightly controlling for transaction costs. We make the soonest payments truly immediate, using the Kenyan mobile money system M-Pesa to make real-time transfers to subjects' phones. We find strong evidence of present bias, with estimates of the present bias parameter ranging from 0.901 to 0.937. This result suggests that present bias for money does in fact exist, but only for truly immediate payments.
    Keywords: discount rate, present bias, experiment, mobile money
    JEL: C91 D90 O12
    Date: 2016–01
  12. By: Böhm, Volker
    Abstract: This note shows that in a large class of El Farol models the failure of agents to find rational prediction rules which stabilize is not due to a non-existence of perfect rules, but rather to the failure of agents to identify the correct class of predictors from which the perfect ones can be chosen. What appears as a need to search for boundedly rational predictors originates from the non existence of stable confirming self-referential orbits induced by predictors selected from the wrong class. Specifically, it is shown that, within a specified class of the model and due to a structural non-convexity (or discontinuity), symmetric Nash equilibria of the associated static game may fail to exist generically depending on the utility level of the outside option. If they exist, they may induce the least desired outcome while, generically, asymmetric equilibria are uniquely determined by a positive maximal rate of attendance. The sequential setting turns the static game into a dynamic economic law of the Cobweb type for which there always exist nontrivial epsilon-perfect predictors implementing epsilon-perfect steady states as stable outcomes. If zero participation is a Nash equilibrium of the game there exists a unique perfect predictor implementing the trivial equilibrium as a stable steady state. In general, Nash equilibria of the one-shot game are among the $\epsilon-$perfect foresight steady states of the dynamic model. If agents randomize in an i.i.d. fashion over indifferent decisions the induced random Cobweb law together with recursive predictors becomes an iterated function system (IFS). There exist unbiased predictors with associated stable stationary solutions for appropriate randomizations supporting nonzero asymmetric equilibria which are not mixed Nash equilibria of the one-shot game. However, the least desired outcome remains as the unique stable stationary outcome for epsilon=0 if it is a Nash equilibrium of the static game.
    JEL: C70 C72 D84
    Date: 2015
  13. By: Gerhardt, Holger (University of Bonn); Schildberg-Hörisch, Hannah (University of Bonn); Willrodt, Jana (University of Bonn)
    Abstract: A core prediction of recent "dual-self" models is that a person's risk attitudes depend on her current level of self-control. While these models have received a lot of attention, empirical studies tailored to testing their core prediction are lacking. Using two prominent models, we derive precise hypotheses for choices between risky monetary payoffs in a state of low self-control, compared to regular self-control; in particular, lower levels of self-control should induce stronger risk aversion for stakes within a particular range. We test the hypotheses in a lab experiment with a large number of subjects (N = 308), using a well-established self-control depletion task and measuring risk attitudes via finely graduated choice lists. While independent manipulation checks document the effectiveness of our depletion task, we do not find any evidence for increased risk aversion after self-control depletion. Our findings have important implications for the future modeling of decision making under risk.
    Keywords: risk attitudes, self-control, ego depletion, dual-self models, experiment
    JEL: D03 D81 C91
    Date: 2015–12
  14. By: Jarman, Felix; Meisner, Vincent
    Abstract: We consider a budget-constrained mechanism designer who wants to select an optimal subset of projects to maximize her utility. Project costs are private information and the value the designer derives from their provision may vary. In this allocation problem the choice of projects - both which and how many - is endogenously determined by the mechanism. The designer faces hard ex-post constraints: The participation and budget constraint must hold for each possible outcome while the mechanism must be implementable in dominant strategies. We derive the class of optimal mechanisms and show that it allows an implementation through a descending clock auction. Only in the case of symmetric projects, price clocks do descend synchronously such that always the cheapest projects are executed. The asymmetric case, where values or costs are asymmetrically distributed, features a novel tradeoff between quantity and quality. Interestingly, this tradeoff mitigates the distortion due to the informational asymmetry compared to environments where quantity is exogenous.
    JEL: D44 D45 D82
    Date: 2015

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