nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2016‒03‒06
twenty papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Max-Min optimization problem for Variable Annuities pricing By Christophette Blanchet-Scalliet; Etienne Chevalier; Idriss Kharroubi; Thomas Lim
  2. Social comparison and gender differences in risk taking By Schmidt, Ulrich; Friedl, Andreas; Lima de Miranda, Katharina
  3. Sunspot Fluctuations in Two-Sector Models with Variable Income Effects By Frédéric Dufourt; Kazuo Nishimura; Carine Nourry; Alain Venditti
  4. Note on the Stock-Wise utility function used in their option-value analysis By Börsch-Supan, Axel
  5. Use of maximum entropy in estimating production risks in crop farms By Kevorchian, Cristian; Gavrilescu, Camelia
  6. Demonstration Effect and Dynamic Efficiency By Thibault, Emmanuel
  7. Evidence that waste aversion begets insurance aversion By David de Meza; Liza C. Fessner; Diane J. Reyniers
  8. CoCo Design, Risk Shifting and Financial Fragility By Chan, Stephanie; van Wijnbergen, Sweder
  9. The 2015 Power Trading Agent Competition By Ketter, W.; Collins, J.; Reddy, P.; Weerdt, M.M.
  10. Malicious Litigation By Guha, Brishti
  11. The Marginal Rate of Substitution and the Specification of Labour Supply Models By Lanot, Gauthier
  12. A Simple Model of Two-Stage Choice By Sean HORAN
  13. The asymmetric effects of monetary policy on housing across the level of development By Juan C. Medina; Robert R. Reed; Ejindu S. Ume
  14. An incomplete markets explanation of the UIP puzzle By Rabitsch, Katrin
  15. The Associated Solidarity Game of n-Person Transferable Utility Games: Linking the Solidarity Value to the Shapley Value. By Miamo Wendji, Clovis
  16. Ambiguous Games without a State Space and Full Rationality By Giuseppe De Marco
  17. On the definition of externality as a missing market By Nathalie Berta
  18. Regulating an observable M/M/1 queue By Moshe Haviv; Binyamin Oz
  19. Distaste for centralization: evidence from a quasi-natural experiment in Switzerland By Sarah Flèche
  20. Tariff-mediated network effects with incompletely informed consumers By Muck, Johannes

  1. By: Christophette Blanchet-Scalliet (ICJ - Institut Camille Jordan [Villeurbanne] - ECL - École Centrale de Lyon - UCBL - Université Claude Bernard Lyon 1 - Université Jean Monnet - Saint-Etienne - INSA - Institut National des Sciences Appliquées - CNRS - Centre National de la Recherche Scientifique); Etienne Chevalier (LaMME - Laboratoire de Mathématiques et Modélisation d'Evry - CNRS - Centre National de la Recherche Scientifique - Institut national de la recherche agronomique (INRA) - UPEC UP12 - Université Paris-Est Créteil Val-de-Marne - Paris 12 - Université d'Evry-Val d'Essonne - UPD5 - Université Paris Descartes - Paris 5 - ENSIIE); Idriss Kharroubi (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS - Centre National de la Recherche Scientifique - Université Paris IX - Paris Dauphine); Thomas Lim (LaMME - Laboratoire de Mathématiques et Modélisation d'Evry - CNRS - Centre National de la Recherche Scientifique - Institut national de la recherche agronomique (INRA) - UPEC UP12 - Université Paris-Est Créteil Val-de-Marne - Paris 12 - Université d'Evry-Val d'Essonne - UPD5 - Université Paris Descartes - Paris 5 - ENSIIE)
    Abstract: We study the valuation of variable annuities for an insurer. We concentrate on two types of these contracts that are the guaranteed minimum death benefits and the guaranteed minimum living benefits ones and that allow the insured to withdraw money from the associated account. As for many insurance contracts, the price of variable annuities consists in a fee, fixed at the beginning of the contract, that is continuously taken from the associated account. We use a utility indifference approach to determine this fee and, in particular, we consider the indifference fee rate in the worst case for the insurer i.e. when the insured makes the withdrawals that minimize the expected utility of the insurer. To compute this indifference fee rate, we link the utility maximization in the worst case for the insurer to a sequence of maximization and minimization problems that can be computed recursively. This allows to provide an optimal investment strategy for the insurer when the insured follows the worst withdrawals strategy and to compute the indifference fee. We finally explain how to approximate these quantities via the previous results and give numerical illustrations of parameter sensibility.
    Keywords: backward stochastic differential equation,indifference pricing,insurance,Variable annuities,utility maximization,insurance.
    Date: 2015
  2. By: Schmidt, Ulrich; Friedl, Andreas; Lima de Miranda, Katharina
    Abstract: The present paper contributes to the controversy regarding gender differences in risk taking by investigating the impact of social comparison. Social comparison is formalized by integrating a social reference point into the model of Köszegi and Rabin. Drawing on previous results from evolutionary biology, we hypothesize that men (women) focus more on relative (absolute) income, i.e., the relative weight of social gain-loss utility is higher for men than for women. Our model predicts that risk taking is higher for correlated than for uncorrelated risks and that this effect is stronger for men than for women. These predictions are confirmed by a simple classroom experiment. We conclude that social comparison and the correlation of risks play an important role in the discussion of gender differences in risk taking.
    Keywords: risk taking,gender differences,correlation of risks,social reference point
    JEL: C91 D81 J16
    Date: 2015
  3. By: Frédéric Dufourt (AMSE - Aix-Marseille School of Economics - EHESS - École des hautes études en sciences sociales - Centre national de la recherche scientifique (CNRS) - Ecole Centrale Marseille (ECM) - AMU - Aix-Marseille Université); Kazuo Nishimura (KIER, Kyoto University - Kyoto University [Kyoto], RIEB, Kobe University - Kobe University); Carine Nourry (AMSE - Aix-Marseille School of Economics - EHESS - École des hautes études en sciences sociales - Centre national de la recherche scientifique (CNRS) - Ecole Centrale Marseille (ECM) - AMU - Aix-Marseille Université); Alain Venditti (Edhec Business School - Edhec - Edhec, AMSE - Aix-Marseille School of Economics - EHESS - École des hautes études en sciences sociales - Centre national de la recherche scientifique (CNRS) - Ecole Centrale Marseille (ECM) - AMU - Aix-Marseille Université)
    Abstract: We analyze a version of the Benhabib and Farmer [3] two-sector model with sector-specific externalities in which we consider a class of utility functions inspired from the one considered in Jaimovich and Rebelo [14] which is flexible enough to encompass varying degrees of income effect. First, we show that local indeterminacy and sunspot fluctuations occur in 2-sector models under plausible configurations regarding all structural parameters – in particular regarding the intensity of income effects. Second, we prove that there even exist some configurations for which local indeterminacy arises under any degree of income effect. More precisely, for any given size of income effect, we show that there is a non-empty range of values for the Frisch elasticity of labor and the elasticity of intertemporal substitution in consumption such that indeterminacy occurs. This contrasts with the results obtained in one-sector models in both Nishimura et al. [19], in which it is shown that indeterminacy cannot occur under either GHH and KPR preferences, and in Jaimovich [13] in which local indeterminacy only arises for intermediary income effects.
    Keywords: indeterminacy,sunspots,income and substitution effects,sector-specific externalities,infinite-horizon two-sector model
    Date: 2015–12
  4. By: Börsch-Supan, Axel (Munich Center for the Economics of Aging (MEA))
    Abstract: The option value of postponing retirement is the difference between the utility when retiring at the age that maximizes utility minus the utility when retiring now. This note shows that a utility function which depends only weakly on the value of leisure such as the utility function proposed by Stock and Wise (1990) and used in many applications (see Gruber and Wise, various issues) makes this difference flat relative to a more leisure-sensitive utility function. This explains the poor results observed in many European countries which have participated in the Gruber-Wise exercise where the option value was based on the Stock-Wise utility function and in which leisure (here: early retirement) is much more highly valued than in the United States.
    Date: 2014–10–01
  5. By: Kevorchian, Cristian; Gavrilescu, Camelia
    Abstract: The entropic value of the production risk is closely linked to the farmer’s aversion to this type of risk. Since risk aversion is difficult to quantify, it is preferable to use the MaxEnt model as a quantitative benchmark in assessing and covering the production risk through adequate financial resources. The classification of the Selyaninov index value as measure of the production risk based on the MaxEnt model utilization makes it possible to evaluate the production risk and the transfer decision to an adequate market implicitly. The authors’ previous research investigated the risk coverage through derivative financial instruments that diminish the farmer’s exposure to the production risk; the present paper adds to previous research by investigating an equally important issue: sizing the risk that is the object of coverage. Through the utilization of the stochastic methods in estimating the risk measure, a less rigid method is obtained that can be adapted and applied to the risk management processes in agriculture.
    Keywords: Production risk, crop farms, Markov models, MaxEnt
    JEL: C12 C63 D81 Q12
    Date: 2015–11–20
  6. By: Thibault, Emmanuel
    Abstract: We show that contrary to conventional wisdom intergenerational family transfers dominate fiscal policies as a remedy to the dynamic inefficiency arising in a Diamond (1965, American Economic Review) economy with logarithmic utility and Cobb-Douglas technology. Using the demonstration-effect approach popularized by Cox and Stark (2005, Journal of Public Economics), we prove that, differently from public debt, family transfers can serve the role of automatic stabilizers. Indeed, they are nil under dynamic efficiency, implying that both capital accumulation and welfare are not worsened. They are positive under dynamic inefficiency, and instrumental to depress capital accumulation so to approach the Golden Rule capital stock.
    Keywords: OLG model, Dynamic efficiency, Intergenerational family transfers.
    JEL: C62 D91 O41
    Date: 2016–01
  7. By: David de Meza; Liza C. Fessner; Diane J. Reyniers
    Abstract: Paying an insurance premium but not needing to claim is sometimes viewed as pouring money down the drain. Aversion to the perceived waste may lead to the rejection of fair insurance. Although policies paying rebates if no claim is made are not attractive to expected utility maximisers, this paper finds strong evidence they appeal to waste averters..
    Keywords: Insurance; waste aversion; no-claim rebate; prospect theory
    JEL: D8 G22
    Date: 2014–11–22
  8. By: Chan, Stephanie; van Wijnbergen, Sweder
    Abstract: We highlight the ex ante risk-shifting incentives faced by a bank's shareholders/managers when CoCos (contingent convertible capital) are part of the capital structure. The risk shifting incentive arises from the wealth transfers that the shareholders will receive upon the CoCo's conversion under CoCo designs widely used in practice. Specifically we show that for principal writedown and nondilutive equity-converting CoCos, shareholders/managers have an incentive to take on more risk to make conversion more likely because of those wealth transfers. As a consequence, wide spread use of CoCos will increase systemic fragility. We show that such improperly designed CoCos should not be allowed to fill in loss absorption capacity requirements unless accompanied by higher required equity ratios to mitigate the increased risk taking incentives they lead to. Sufficiently dilutive CoCos do not lead to undesired risk taking behavior.
    Keywords: capital requirements; contingent convertible capital; risk shifting incentives; systemic risk
    JEL: G01 G13 G21 G28 G32
    Date: 2016–02
  9. By: Ketter, W.; Collins, J.; Reddy, P.; Weerdt, M.M.
    Abstract: This is the specification for the Power Trading Agent Competition for 2015 (Power TAC 2015). 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. 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 model 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 positions, in the face of stochastic customer behaviors and weather-dependent renewable energy sources. The broker with the highest bank balance at the end of the simulation wins.
    Keywords: autonomous agents, electric commerce, energy, preferences, portfolio management, power, policy guidance, sustainability, trading agent competition
    Date: 2015–02–03
  10. By: Guha, Brishti
    Abstract: It has long been recognized that some plaintiffs sue defendants out of malice, but malicious litigation has not been previously modeled in the law and economics literature. I construct a simple model of malicious litigation, wherein malice is defined by the plaintiff’s obtaining some utility whenever the defendant incurs costs. When plaintiffs are malicious, they are more likely to file even non-meritorious suits; both probability of filing and the plaintiff’s settlement payoff increase in the plaintiff’s malice. However, if the defendant is also malicious, obtaining utility when the plaintiff incurs litigation expenses, settlements may fail even with complete information. Two-sided malice deters filing over a certain parameter range; outside it, it raises the ratio of cases that go to trial instead of being resolved through settlement. Giving the defendant the right to call for a bar on settlement is less effective at deterring malicious lawsuits relative to non-malicious “negative-expected-value” (NEV) or “nuisance” suits. However, combining the optional settlement bar with a “commitment requirement” stipulating that the plaintiff commit to going to trial (rather than withdraw) whenever the defendant opts to defend discourages malicious litigation for a wider range of parameters.
    Keywords: Malice, lawsuits, settlement, withdrawal, trial.
    JEL: K10 K4 K41
    Date: 2016–02–15
  11. By: Lanot, Gauthier (Department of Economics, Umeå University)
    Abstract: In this note I revisit Heckman's proposal, [Heckman, 1974], to specify a static labour supply model using a simple formulation for the Marginal Rate of Substitution between total expenditure on consumption and hours of work. I describe the analytical form of the expenditure function and I show how the direct and indirect utility functions can be recovered. I propose an alternative specification for the MRS and in this case I describe analytically the labour supply functions, the indirect and direct utility functions as well as the expenditure function.
    Keywords: Labour Supply Model; Specification; Marginal Rate of Substitution
    JEL: C51 D11 J22
    Date: 2016–02–17
  12. By: Sean HORAN
    Abstract: I provide choice-theoretic foundations for a simple two-stage model, called transitive shortlist methods, where choices are made by sequentially applying a pair of transitive preferences (or rationales) to eliminate inferior alternatives. Despite its simplicity, the model accommodates a wide range of choice phenomena including the status quo bias, framing, homophily, compromise, and limited willpower. I establish that the model can be succinctly characterized in terms of some well-documented context effects in choice. I also show that the underlying rationales are straightforward to determine from readily observable reversals in choice. Finally, I highlight the usefulness of these results in a variety of applications.
    Keywords: shortlisting; axiomatization; revealed preference; identification
    JEL: D01
    Date: 2016
  13. By: Juan C. Medina (Universidad Autónoma de Ciudad Juárez); Robert R. Reed (Universidad de Alabama); Ejindu S. Ume (Universidad de Ohio)
    Abstract: We study the effects of money growth in a neoclassical growth model with wealth effects. As the capital stock is the only component of wealth which contributes to an individual’s utility, the model should be interpreted as a model of housing production and housing wealth since the capital stock affects utility. Consistent with empirical evidence on the relationship between residential investment and GDP across countries, there are significant non-linearities between housing market activity and aggregate income in our framework.
    Keywords: Development, housing, monetary policy, inflation.
    JEL: E31 E52 E58
    Date: 2015–11–01
  14. By: Rabitsch, Katrin
    Abstract: A large literature attributes failure of uncovered interest rate parity (UIP) to the existence of a timevarying risk premium. This paper presents a mechanism in a simple two-country two-good endowment economy with incomplete markets that generates sizeable deviations from UIP. In a parameterization where international wealth effects are important, liquidity constraints on an internationally traded bond and agents' strong resulting precautionary motives successfully generates a time-varying risk premium: countries that have accumulated large outstanding external positions have, being closer to the constraints, stronger precautionary motives and their asset carries a risk premium.
    Keywords: Uncovered Interest Rate Parity,Incomplete Markets Precautionary Savings,Time-Varying Risk Premium
    JEL: F31 F41 G12 G15
    Date: 2016
  15. By: Miamo Wendji, Clovis
    Abstract: We introduce for any TU-game, a new TU-game referred as its associated solidarity game (ASG). The ASG gives more power to the grand coalition by reducing the payoffs of others coalitions. It comes that, the Shapley value of the ASG is the Solidarity value of the initial game.
    Keywords: TU-game, Shapley value, Solidarity value
    JEL: C71 D63
    Date: 2015–05
  16. By: Giuseppe De Marco (Università di Napoli Parthenope and CSEF)
    Abstract: Aim of this paper to differentiate and to better understand the assumptions that must be imposed on the structure of ambiguity and on the attitudes towards ambiguity in order to have the existence of equilibria in games under ambiguous belief correspondences. In the present paper, this class of games is studied under weaker restrictions on preferences which are not required to be rational. This paper shows that the assumption of imprecision averse (resp. loving) preferences is key to obtain equilibrium existence whenever it is combined with the property of convexity (resp. concavity) of the ambiguous belief correspondences. The paper also studies the role played by these assumptions in different specific models, so as to illustrate the applicability of the results of equilibrium existence.
    Date: 2016–01–18
  17. By: Nathalie Berta (REGARDS - Université de Reims et Centre d'Economie de la Sorbonne)
    Abstract: Despite its increasing role in economic theory, the concept of externality seems to elude any attempt at rigorous and consensual definition. While problems of definition have emerged with the concept itself in the 1950s, the paper focuses on the definition of externality within the general equilibrium theory. In the Arrow-Debreu framevork, externality is a kind of “missing market” (Arrow 1969) – an unpriced effect that upsets the assumption of the complete system of markets – and its formalization is achieved by introducing a direct interdependence between utility or production functions. The paper shows that this Arrovian definition allows some ambiguities to persist. As witnessed by some authors' positions in the 1970s (Mishan 1971, Baumol and Oates 1975, Heller and Starrett 1976, Laffont 1988), it does not highlight two features associated with the traditional meaning of externalities: whether or not it is an exogenous effect and an unintended effect. This raises, although differently, the issue of the dilution of externality within the larger notion of individual interdependences. Beyond the conceptual importance of clarifying the definition of externality, this issue has also a strong normative content: giving a strict definition of externality amounts, implicitly, to drawing the frontier of legitimate internalisation and economic policy
    Keywords: Externality; K. Arrow; missing market; market failure; utility interdependences
    JEL: B21 B41 H23 Q02
    Date: 2016–01
  18. By: Moshe Haviv; Binyamin Oz
    Abstract: Naor (1969) was the first to observe that in a single-server memoryless queue, customers who inspect the queue length upon arrival and accordingly decide whether to join or not may join even if from the social point of view they are worse of. The question then is how to mechanically design the system such that customers will join only queue lengths that are advised by society, while still minding their own selfish utility. After reviewing some existing mechanisms (some involving money transfers and some not), we suggest novel ones that do not involve money transfers. They possess some advantages over the existing ones, which we itemize.
    Date: 2015–09
  19. By: Sarah Flèche
    Abstract: Do people care about the degree of centralization? This paper examines the effects of local centralization reforms on individuals' well-being using a quasi-natural experiment in Switzerland. The results reveal that centralization has a causal negative impact on individuals' life satisfaction. Consistent with the concept of procedural utility, centralization reduces individuals' feeling of having political influence and interest in politics. In contrast, there are no impacts on individuals' satisfaction with local governments' performance. These findings shed new light on what people value in decentralized institutions.
    Keywords: decentralization; life satisfaction; public spending; procedural utility
    JEL: H11 H40 I31
    Date: 2015–11
  20. By: Muck, Johannes
    Abstract: I explore the competitive effects of on-net/off-net differentiation in a market with two asymmetric networks by combining the literature on on-net/off-net differentiation with research on costly consumer search in an agent-based simulation model. All consumers in the market are subscribed to one of two networks, whereby, initially, clusters of subscribers to network B exist. A priori, consumers lack information on the market shares of both network and, hence, have to engage in costly fixed-sample search. With respect to the extent of search costs, I distinguish between three types of consumers: (1) fully informed consumers (FICs) have non-positive search costs and, accordingly, are always perfectly informed about networks' market shares; (2) partly informed consumers (PICs) have moderate search costs, which allow them to observe market shares within a circular sensing field; and (3) locally informed consumers (LICs) have high search costs and, hence, only observe market shares among their immediate eight neighbours. Irrespective of their type, consumers maximize their expected utility by subscribing to the network offering the lowest expected cost for a call to a random consumer. The results of a systematic variation of the key parameters of the model show that the larger network's probability to increase its market share or to corner the market is negatively affected by the fraction of PICs and LICs, whereas it is positively affected by PICs's sensing radius, the larger network's initial market share, and the number of clusters. The introduction of calling clubs reveals that the probability of calling a friend inflicts a negative effect while the size of the calling clubs has a positive effect. These findings highlight the pivotal role of the amount of information available to consumers for the distribution of market shares.
    Keywords: on-net/off-net differentiation,tariff-mediated network effects,agent-based computational economics,search costs
    JEL: C63 D83 K23 L14 L96
    Date: 2016

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