nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2016‒02‒29
sixteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Stochastic dominance, risk and disappointment: a synthesis. By Thierry Chauveau
  2. Bayesian Updating for Complementarily Additive Beliefs under Ambiguity By Mayumi Horie
  3. Asymmetric labor-supply responses to wage-rate changes: Evidence from a field experiment By Doerrenberg, Philipp; Duncan, Denvil; Löffler, Max
  4. Measuring Ambiguity Aversion By Gallant, A. Ronald; Jahan-Parvar, Mohammad; Liu, Hening
  5. The Implications of Daylight Saving Time: A Field Experiment on Cognitive Performance and Risk Taking By Markus Schaffner; Jayanta Sarkar; Benno Torgler; Uwe Dulleck
  6. Measuring utility without mixing apples and oranges and eliciting beliefs about stock prices By O'Callaghan, Patrick
  7. Are Individuals Luck Egalitarians?: An Experiment on the Influence of Brute and Option Luck on Social Preferences By Tinghög, Gustav; Andersson, David
  8. Voting over Selfishly Optimal Nonlinear Income Tax Schedules with a Minimum-Utility Constraint By Craig Brett; John A Weymark
  9. Knowing me, imagining you: Projection and overbidding in auctions By Breitmoser, Yves
  10. An Egalitarian Value for Cooperative Games with Incomplete Information By Salamanca Lugo, Andrés
  11. Willingness to Pay for Firm Reputation: Paying for Risk Rating in the Annuity Market By Alcalde, Pilar; Vial, Bernardita
  12. A comparison of the GAI model and the Choquet integral with respect to a k-ary capacity By Christophe Labreuche; Michel Grabisch
  13. Welfare Evaluation in a Heterogeneous Agent Model: How Representative is the CES Representative Consumer? By Tito, Maria D.
  14. Rural Bound: Determinants of Metro to Non-Metro Migration in the U.S. By Anil Rupasingha; Yongzheng Liu; Mark Partridge
  15. On the Existence of Equilibrium in Bewley Economies with Production By Acikgoz, Omer
  16. Taxing Capital? The Importance of How Human Capital is Accumulated By Peterman, William B.

  1. By: Thierry Chauveau (Centre d'Economie de la Sorbonne)
    Abstract: In this article, utilities are substituted for monetary values in the definition of second order stochastic dominance (SSD). Doing so yields a family of preorders induced by SSD among which one is the "closest" to the original preorder of preferences. The corresponding utility function is the most likely to be that of the decision maker. It may be defined before behavioural axioms are set. Theories of decision making under risk can then be restated in a more general and consistent way. As an example, a new theory of disappointment is developed, which is endowed with three important properties: (a) risk premia are invariant by translation, (b) when constant marginal utility is assumed, preferences are represented by a functional which is the opposite to a convex measure of risk and (c) the functional representing preferences and the utility function can be easily elicited through experimental testing
    Keywords: Disappointment; risk-aversion; expected utility; risk premium; stochastic dominance; subjective risk
    JEL: D81
    Date: 2014–06
  2. By: Mayumi Horie (Hiroshima University of Economics)
    Abstract: This paper proposes a formal characterization of extended Bayesian updating for complementarily additive subjective beliefs under ambiguity, which are compatible with a wide range of choice behavior toward ambiguity. The main result shows that, based on the biseparability of Ghirardato and Marinacci (2001), extended Bayesian updating characterizes the update rule which is a step-by-step composite updating for priors, where one of Dempster-Shafer rule, Bayes'update rule and Fagin-Halpern rule is applied to each step. As applications, more speci c preference relations are examined, such as the maxmin expected utility, the rank-dependent expected utility, and the concave expected utility preferences by Lehrer (2009).
    Keywords: ambiguous belief, Bayesian update rule, multiple priors, non-additive measure, subjective probability, biseparable preference
    JEL: D81
    Date: 2016–02
  3. By: Doerrenberg, Philipp; Duncan, Denvil; Löffler, Max
    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
  4. By: Gallant, A. Ronald (Pennsylvania State University); Jahan-Parvar, Mohammad (Board of Governors of the Federal Reserve System (U.S.)); Liu, Hening (University of Manchester)
    Abstract: We confront the generalized recursive smooth ambiguity aversion preferences of Klibanoff, Marinacci, and Mukerji (2005, 2009) with data using Bayesian methods introduced by Gallant and McCulloch (2009) to close two existing gaps in the literature. First, we use macroeconomic and financial data to estimate the size of ambiguity aversion as well as other structural parameters in a representative-agent consumption-based asset pricing model. Second, we use estimated structural parameters to investigate asset pricing implications of ambiguity aversion. Our structural parameter estimates are comparable with those from existing calibration studies, demonstrate sensitivity to sampling frequencies, and suggest ample scope for ambiguity aversion.
    Keywords: Ambiguity aversion; Bayesian estimation; Equity premium puzzle; Markov switching
    JEL: C61 D81 G11 G12
    Date: 2015–11–23
  5. By: Markus Schaffner; Jayanta Sarkar; Benno Torgler; Uwe Dulleck
    Abstract: To explore the effects of daylights saving time (DST) transition on cognitive performance and risk-taking behaviour immediately before and one week after the shift to DST, this study examines two Australian populations living in similar geographic surroundings who experience either no DST transition (Queensland) or a one-hour DST desynchronization (New South Wales). This exogenous variation creates natural control (QLD) and treatment (NSW) groups that enable isolation and identification of the DST transition's effect on the two outcome variables. Proximity to the border ensures similar socio-demographic and socio-economic conditions and thus permits comparison of the cognitive performance and risk-taking behaviour of affected versus unaffected individuals. The results suggest that exposure to the DST transition has no significant impact on either cognitive performance or risk-taking behaviour.
    Keywords: Daylight saving time, Risk-taking behaviour, Cognitive performance, Field experiment
    Date: 2015–02–06
  6. By: O'Callaghan, Patrick
    Abstract: In day-to-day life we encounter decisions amongst prospects that do not have a convex structure. To address this concern, Herstein and Milnor introduce mixture sets and provide necessary and sufficient conditions for a cardinal and linear utility representation. We derive the same utility representation for partial mixture sets: where the mixture operation is only partially defined. The resulting model has an interesting application to finance. In particular, we use paths instead of events to elicit utility and beliefs about stock prices. This feature is promising for settings where the dimension of the state space is large.
    Keywords: Decision theory, Brownian bridge, Mixture set
    JEL: C6 C9 D8
    Date: 2016–02–09
  7. By: Tinghög, Gustav (Division of Economics, Department of Management and Engineering, Linköping University); Andersson, David (Division of Economics, Department of Management and Engineering, Linköping University)
    Abstract: According to luck egalitarianism, inequalities should be deemed fair as long as they follow from individuals’ deliberate and fully informed choices, i.e. option luck – while inequalities should be deemed unfair if they follow from choices over which the individual has no control, i.e. brute luck. This study investigates if individuals’ fairness preferences correspond with the luck egalitarian fairness position. More specifically, in a laboratory experiment we test how individuals choose to redistribute gains and losses that stem from option luck compared to brute luck. A two-stage experimental design with real incentives was employed. In total, 226 subjects were randomly assigned to either the brute luck or option luck treatment. Treatments were identical except for how monetary compensation for participation in the experiment was settled in stage one. In the option luck treatment, subjects were given the option to chose between a safe option (50 SEK) and a risky option (a 50/50 gamble between 0 SEK and 150 SEK). In the brute luck treatment no such choice was given, instead all subjects were compensated based on outcome of the risky option. In the second stage, subjects were asked to distribute additional endowments (100 SEK) in an anonymous dictator game using the strategy method, i.e. making decisions contingent on the recipient losing or wining in the gamble. Individuals change their action associated with re-allocation depending on the underlying conception of luck. Subjects in the brute luck treatment equalized outcomes to larger extent (p=0.0069). Thus, subjects redistributed a larger amount to unlucky losers and a smaller amount to lucky winners compared to equivalent choices made in the option luck treatment. We find strong support for people having a fairness preference not just for outcomes, but also for how those outcomes are reached. Our findings are potentially important for understanding the role citizens assign individual responsibility for life outcomes, i.e. health and wealth.
    Keywords: fairness; luck egalitarianism; brute luck; option luck; dictator game; laboratory experiment
    JEL: D03
    Date: 2016–02–19
  8. By: Craig Brett (Mount Allison University); John A Weymark (Vanderbilt University)
    Abstract: Pairwise majority voting over alternative nonlinear income tax schedules is considered when there is a continuum of individuals who differ in their labor productivities, which is private information, but share the same quasilinear-in-consumption preferences for labor and consumption. Voting is restricted to those schedules that are selfishly optimal for some individual. The analysis extends that of Brett and Weymark (Games and Economic Behavior, forthcoming) by adding a minimum-utility constraint to their incentive-compatibility and government budget constraints. It also extends the analysis of Röell (unpublished manuscript, 2012) and Bohn and Stuart (unpublished manuscript, 2013) by providing a complete characterization of the selfishly optimal tax schedules. It is shown that individuals have single-peaked preferences over the set of selfishly optimal tax schedules, and so the schedule proposed by the median skill type is a Condorcet winner.
    Keywords: Mirrlees tax problem, nonlinear income taxation, political economy of taxation, redistributive taxation, voting over tax schedules
    JEL: H2 D7
    Date: 2016–02–12
  9. By: Breitmoser, Yves
    Abstract: Overbidding in auctions has been attributed to risk aversion, loser regret, level-k, and cursedness, though relying on different identifying assumptions. I argue that "type projection" organizes these findings and better captures observed behavior. Type projection formally models that people tend to believe others have object values similar to their own -- a robust psychological phenomenon that naturally applies to auctions. First, I show that type projection implies the main behavioral phenomena in auctions, including increased sense of competition (like loser regret) and broken Bayesian updating (like cursedness). Second, re-analyzing data from seven experiments, I show that type projection explains the stylized facts of behavior across private and common value auctions. Third, in a structural analysis nesting existing approaches and emphasizing robustness, type projection consistently captures behavior best, in-sample and out-of-sample. The results reconcile bidding patterns across conditions and have implications for behavioral and empirical analyses as well as policy.
    Keywords: auctions, overbidding, winner's curse, projection, risk aversion, cursed equilibrium, limited depth of reasoning
    JEL: C7 C91 D44
    Date: 2016–01–22
  10. By: Salamanca Lugo, Andrés
    Abstract: A bargaining solution concept generalizing the Harsanyi (1963) NTU value is defined for cooperative games with incomplete information. When compared with Myerson's (1984a) bargaining solution, our solution concept differs from the former in that we require coalitional agreements to be equitable when players make interpersonal utility comparisons in terms of some virtual utility scales. When there are only two players, the two solutions are easily seen to coincide (whenever utility weights are strictly positive), however they may differ for general n-person games. By using the concept of virtual utility, our bargaining solution reflects the fact that players negotiate at the interim stage.
    Keywords: Cooperative games, incomplete information, virtual utility.
    JEL: C71 C78 D82
  11. By: Alcalde, Pilar; Vial, Bernardita
    Abstract: In this paper we test the existence of a reputation premium in the context of the annuity market in Chile. This market provides an exceptionally good setting to measure consumers’ willingness to pay: retirees choose between a set of offers that vary only in the quote and the risk rating –a measure of the firm’s solvency– within each class of product. We find that willingness to pay for the reputation linked to the firm’s risk rating is statistically and economically significant. We also find a strong relationship between willingness to pay and intermediary choice, and we explore four potential sources of correlation between them.
    Keywords: reputation premium, willingness to pay, demand estimation, annuity markets
    JEL: D12 D53 L14
    Date: 2016–01–22
  12. By: Christophe Labreuche (Thales Research and Technology); Michel Grabisch (Centre d'Economie de la Sorbonne - Paris School of Economics)
    Abstract: Two utility models are classically used to represent interaction among criteria: the Choquet integral and the Generalized Additive Independence (GAI) model. We propose a comparison of these models. Looking at their mathematical expression, it seems that the second one is much more general than the first one. The GAI model has been mostly studied in the case where attributes are discrete. We propose an extension of the GAI model to continuous attributes, using the multi-linear interpolation. The values that are interpolated can in fact be interpreted as a k-ary capacity, or its extension – called p-ary capacity – where p is a vector and pi is the number of levels attached to criterion i. In order to push the comparison further, the Choquet integral with respect to a p-ary capacity is generalized to preferences that are not necessarily monotonically increasing or decreasing on the attributes. Then the Choquet integral with respect to a p-ary capacity differs from a GAI model only by the type of interpolation model. The Choquet integral is the Lovász extension of a p-ary capacity whereas the GAI model is the multi-linear extension of a p-ary capacity
    Keywords: Multiple criteria analysis; Generalized Additive Independence; Choquet integral; interpolation
    JEL: C44
    Date: 2016–01
  13. By: Tito, Maria D. (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: The present paper investigates the impact of asymmetric price changes on welfare in a model with heterogeneous consumers. I consider consumer heterogeneity a la Anderson et al. (1992). The standard welfare equivalence between the CES representative consumer and the discrete choice model breaks down in presence of asymmetric price changes. In fact, asymmetric variation in prices produce differential gains among heterogeneous consumers. I show that there exists no feasible Kaldor-Hicks income transfer such that the gains are equally redistributed. Intuitively, in presence of decreasing marginal utility, aggregation creates an insurance mechanism: the CES representative consumer softens the impact of price changes reallocating consumption among the available varieties. Individual consumers, instead, purchase a single product and do not internalize the effects of changes in prices of other available varieties. This result suggests that only symmetric policy-induced price changes minimize the utility losses across heterogeneous consumers.
    JEL: D11 D60
    Date: 2015–12–02
  14. By: Anil Rupasingha (Federal Reserve Bank of Atlanta); Yongzheng Liu (Renmin University of China); Mark Partridge (Ohio State University)
    Abstract: A general global precept is that agglomeration forces lead to migration from rural to urban areas. Yet, for much of the period since the early 1970s, more people moved from metro to nonmetro U.S. counties. The underlying causes of this pattern have changed over time with economic shocks and changing household preferences. For instance, the post 2000 period has seen a significant decline in domestic migration rates, significant increase in commodity prices that favor rural areas, and potential changes in the valuation of natural amenities that would affect migration. This study investigates the determinants of U.S. gross migration from metro to nonmetro counties and nonmetro to metro counties for the 1995-2000 and 2005-2009 periods in order to compare the differences in rural to urban and urban to rural migration as well as compare the 1990s to the 2005 to 2009 periods. The paper uses (1) extensive county-to-county migration flows and (2) uses the utility maximization theory that extends the framework of discrete choice model. The results show that population density, distance to urban areas, industry mix employment growth, natural amenities, and percent of older people are key factors underlying these migration patterns. We also find a slight fading of effects of natural amenities and population density and slight increase in the effects of wage and employment growth during 2005 to 2009 period.
    Keywords: metro to nonmetro migration, urban to rural migration, county-to-county migration, natural amenities
    Date: 2014–06–28
  15. By: Acikgoz, Omer
    Abstract: I provide a proof of existence of stationary recursive competitive equilibrium in Bewley economies with production under very permissive assumptions. In particular, (i) utility function is allowed to be unbounded, and (ii) the underlying discrete idiosyncratic productivity process is allowed to take any form, aside from mild restrictions. Some of the intermediate results provide theoretical basis for assumptions often made in the quantitative macroeconomics literature.
    Keywords: Recursive Competitive Equilibrium, Bewley/Huggett/Aiyagari model
    JEL: C62 E00 E21
    Date: 2015–12–20
  16. By: Peterman, William B. (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: This paper considers the impact of how human capital is accumulated on optimal capital tax policy in a life cycle model. In particular, it compares the optimal capital tax when human capital is accumulated exogenously, endogenously through learning-by-doing, and endogenously through learning-or-doing. Previous work demonstrates that in a simple two generation life cycle model with exogenous human capital accumulation, if the utility function is separable and homothetic in each consumption and labor, then the government has no motive to condition taxes on age or tax capital. In contrast, this paper demonstrates analytically that adding either form of endogenous human capital accumulation creates a motive for the government to use age-dependent labor income taxes. Moreover, if the government cannot condition taxes on age, then a capital tax can be optimal in order to mimic such taxes. This paper quantitatively explores the strength of this channel and finds that, including human capital accumulation with learning-by-doing, as opposed to exogenously, causes the optimal capital tax to increase by between 7.3 and 14.5 percentage points. In contrast, introducing learning-or-doing causes a much smaller increase in the optimal capital tax of between 0.7 and 3.7 percentage points. Taken as a whole, this paper finds that the specific formulation by which human capital is accumulated can have notable implications on the optimal capital tax.
    Keywords: Optimal Taxation; Capital Taxation; Human Capital
    JEL: E24 E62 H21
    Date: 2015–12–29

This nep-upt issue is ©2016 by Alexander Harin. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.