
on Utility Models and Prospect Theory 
By:  Paola Manzini (School of Economics and Finance, University of St Andrews); Marco Mariotti (School of Economics and Finance, Queen Mary University of London) 
Abstract:  Dual Random Utility Maximisation (dRUM) is Random Utility Maximisation when utility depends on only two states. This class has many relevant behavioural interpretations and practical applications. We show that dRUM is (generically) the only stochastic choice rule that satisfies Regularity and two new properties: Con stant Expansion (if the choice probability of an alternative is the same across two menus, then it is the same in the merged menu), and Negative Expansion (if the choice probability of an alternative is less than one and differs across two menus, then it vanishes in the merged menu). We extend the theory to menudependent state probabilities. This accommodates prominent violations of Regularity such as the attraction, similarity and compromise effects. 
Keywords:  Stochastic Choice, Attraction Effect, Similarity Effect 
JEL:  D90 
Date:  2016–03–23 
URL:  http://d.repec.org/n?u=RePEc:san:wpecon:1605&r=upt 
By:  Curatola, Giuliano 
Abstract:  This paper analyses the consumptioninvestment problem of a loss averse investor equipped with sshaped utility over consumption relative to a timevarying reference level. Optimal consumption exceeds the reference level in good times and descend to the subsistence level in bad times. Accordingly, the optimal portfolio is dominated by a meanvariance component in good times and rebalanced more aggressively toward stocks in bad times. This consumptioninvestment strategy contrasts with customary portfolio theory and is consistent with several recent stylized facts about investors' behaviour. I also analyse the joint effect of loss aversion and persistence of the reference level on optimal choices. Finally, the strategy of the loss averse investor outperforms the conventional Mertonstyle strategies in bad times, but tend to be dominated by the conventional strategies in good times. 
Keywords:  Lossaversion,Habitformation,Consumptionportfolio choice 
JEL:  G11 G12 
Date:  2016 
URL:  http://d.repec.org/n?u=RePEc:zbw:safewp:130&r=upt 
By:  Pan He (ETH Zurich); Marcella Veronesi (Department of Economics (University of Verona)); Stefanie Engel (Institute for Environmental Decisions, ETH Zurich) 
Abstract:  A variety of measures have been developed to elicit individual risk preferences. How these measures perform in the field, in particular in developing countries with nonstudent subjects, is still an open question. We implement an artefactual field experiment using a large sample of Chinese farmers to investigate (i) whether subjects behave in a consistent manner across incentivized experimental risk measures, (ii) whether nonincentivized survey measures can elicit actual risk preferences, and (iii) possible explanations for risk preference inconsistency across measures. We find that inconsistent risk preferences across survey and experimental measures may be explained by ambiguity preferences. In the survey, subjects seem to mix risk and ambiguity preferences. 
Keywords:  risk preferences, ambiguity preferences, field experiments, socioeconomic survey, China 
JEL:  C93 D81 O1 
Date:  2016–03 
URL:  http://d.repec.org/n?u=RePEc:ver:wpaper:03/2016&r=upt 
By:  Ray C. Fair (Cowles Foundation, Yale University) 
Abstract:  This paper revisits the optimal distribution of income model in Fair (1971). This model is the same as in Mirrlees (1971) except that education is also a decision variable and tax rates are restricted to lie on a tax function. In the current paper the taxrate restriction is relaxed. As in Fair (1971), a numerical method is used. The current method uses the DFP algorithm with numeric derivatives. Because no analytic derivatives have to be taken,it is easy to change assumptions and functional forms and run alternative experiments. Gini coefficients are computed, which provides a metric for comparing the redistributive effects under different assumptions. Ten optimal marginal tax rates are computed per experiment corresponding to ten tax brackets. The sensitivity of the results to the four main assumptions of the model are examined: 1) the form of the social welfare function that the government maximizes, 2) the form of the utility function that each individual maximizes, 3) the distribution of ability across individuals, and 4) the rate of return to education. The changes in the Gini coefficient from beforetax income to aftertax income for the experiments are compared to actual changes from various countries. Experiments using a lognormal distribution of ability match the data better than those using a lognormal distribution with a Pareto tailthere is less actual redistribution than a Pareto tail implies. The numerical approach in this paper has advantages over the use of analytic expressions. When functional forms are changed, it may be easier to run a new numerical experiment then use an analytic expression, which can be complicated. Also, although not done in this paper, individual heterogeneity is straightforward to handle. The coding can have a different utility function for each individual. And different assumptions about education can be easily incorporated. The approach also shows the problematic nature of assuming a quasilinear utility functiona utility function with no income effects. 
Keywords:  optimal taxation, income distribution 
JEL:  H21 
Date:  2016–03 
URL:  http://d.repec.org/n?u=RePEc:cwl:cwldpp:2031&r=upt 
By:  Ispano, Alessandro; Schwardmann, Peter 
Abstract:  Evidence from studies in international relations, the politics of reform, collective action and price competition suggests that economic agents in social dilemma situations cooperate more to avoid losses than in the pursuit of gains. To test whether the prospect of losses can induce cooperation, we let experimental subjects play the traveler’s dilemma in the gain and loss domain. Subjects cooperate substantially more over losses. Our experimental design allows us to show that this treatment effect is best explained by referencedependent risk preferences and referencedependent strategic sophistication. We discuss policy implications and relate our findings to other experimental games played in the loss domain. 
Keywords:  cooperation; traveler’s dilemma; social dilemma; loss domain; diminishing sensitivity; cognitive hierarchy 
JEL:  C90 D01 D03 D81 
Date:  2016–03 
URL:  http://d.repec.org/n?u=RePEc:lmu:muenec:27576&r=upt 
By:  Philomena M. Bacon (Aviva UK & Ireland); Anna Conte (University of Westminster); Peter G. Moffatt (University of East Anglia) 
Abstract:  Panel data from the German SOEP is used to test for risk vulnerability (RV) in the wider population. Two different survey responses are analysed: the response to the question about willingnesstotake risk in general; and the chosen investment in a hypothetical lottery. A con venient indicator of background risk is the VDAX index, an established measure of volatility in the German stock market. This is used as an explanatory variable in conjunction with HDAX, the stock market index, which proxies wealth. The impacts of these measures on risk attitude are identifiable by exploiting the time dimension of the panel, and matching survey months with corresponding observations from these timevarying factors. Both of the survey responses allow us to test for decreasing absolute risk aversion (DARA); in one case we find strong evidence of DARA, while in the other, we do not. Both survey responses also allow us to test for RV, and in both cases we find strong evidence. In the case of the hypothetical lottery response we are also able to estimate a "coefficient of risk vulnerability" (CRV). This is defined as the absolute amount by which absolute risk aversion rises in response to a doubling of background risk. We estimate CRV to be between 1.03 and 1.27. 
Keywords:  risk vulnerability, background risk, panel data, survey data 
JEL:  D81 D91 C23 
Date:  2016–01–26 
URL:  http://d.repec.org/n?u=RePEc:uea:ueaeco:2016_01&r=upt 
By:  Juan Carlos Escanciano; Stefan Hoderlein; Arthur Lewbel; Oliver Linton 
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 illposed 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 householdlevel consumption data. 
Keywords:  Euler equations, marginal utility, pricing kernel, Fredholm equations, integral equations, nonparametric identification, asset pricing. 
JEL:  C14 D91 E21 G12 
Date:  2015–10–01 
URL:  http://d.repec.org/n?u=RePEc:cam:camdae:1560&r=upt 
By:  Kollmann, Robert 
Abstract:  This paper analyzes the effects of output volatility shocks on the dynamics of consumption, trade flows and the real exchange rate, in a twocountry, twogood world with consumption home bias, recursive preferences, and complete financial markets. When the risk aversion coefficient exceeds the inverse of the intertemporal substitution elasticity, then an exogenous rise in a country’s output volatility triggers a wealth transfer to that country, to compensate for the greater riskiness of the country’s output stream. This risk sharing transfer raises the country’s consumption, lowers its trade balance and appreciates its real exchange rate. In the recursive preferences framework here, volatility shocks account for a nonnegligible share of the fluctuations of net exports, net foreign assets and the real exchange rate. These shocks help to explain the high empirical volatility of the real exchange rate and the disconnect between relative consumption and the real exchange rate. 
Keywords:  uncertainty shocks, international business cycles, international risk sharing, external balance, exchange rate, consumptionreal exchange rate anomaly 
JEL:  E3 F3 F4 
Date:  2016 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:70183&r=upt 
By:  Sandra, Kendo 
Abstract:  Market segmentation characterized by price heterogeneity appears as a failure of classical view of market equilibrium. We suppose that an existence of specific asset pricing determines the wealth level of lenders. In microfinance, we look at the linkages between the welfare of lenders and market segmentation degree. For that, we used a maximization program where a lender utility function is defined. One of the results is that high number of lenders determines their portfolio diversification capacity. In a context of price inelasticity and price discrimination of financial demand for microfinance products, the microfinance market appears as highly segmented but not highly efficient if we consider lenders’ returns. Moreover, an increase of average yield and average amount of initial loans positively improve the utility level of lenders. So, the improvement of microfinance lenders welfare is probable, but highly constrained by the behavior of some important financial factors. 
Keywords:  Market segmentation, microfinance, lender utility function, asset pricing and lender welfare 
JEL:  G21 L11 L25 M20 
Date:  2016–02 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:70229&r=upt 
By:  Elvis Oltean 
Abstract:  In the present paper, we identify several distributions from Physics and study their applicability to phenomena such as distribution of income, wealth, and expenditure. Firstly, we apply logistic distribution to these data and we find that it fits very well the annual data for the entire income interval including for upper income segment of population. Secondly, we apply FermiDirac distribution to these data. We seek to explain possible correlations and analogies between economic systems and statistical thermodynamics systems. We try to explain their behavior and properties when we correlate physical variables with macroeconomic aggregates and indicators. Then we draw some analogies between parameters of the FermiDirac distribution and macroeconomic variables. Thirdly, as complex systems are modeled using polynomial distributions, we apply polynomials to the annual sets of data and we find that it fits very well also the entire income interval. Fourthly, we develop a new methodology to approach dynamically the income, wealth, and expenditure distribution similarly with dynamical complex systems. This methodology was applied to different time intervals consisting of consecutive years up to 35 years. Finally, we develop a mathematical model based on a Hamiltonian that maximizes utility function applied to Ramsey model using FermiDirac and polynomial utility functions. We find some theoretical connections with time preference theory. We apply these distributions to a large pool of data from countries with different levels of development, using different methods for calculation of income, wealth, and expenditure. 
Date:  2016–03 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1603.08383&r=upt 
By:  Luo, Yulei; Nie, Jun (Federal Reserve Bank of Kansas City); Young, Eric R. 
Abstract:  This paper provides a tractable continuoustime constantabsoluterisk averse (CARA)Gaussian framework to quantitatively explore how the preference for robustness (RB) affects the interest rate, the dynamics of consumption and income, and the welfare costs of model uncertainty in general equilibrium. We show that RB significantly reduces the equilibrium interest rate, and reduces the relative volatility of consumption growth to income growth when the income process is stationary. Furthermore, we find that the welfare costs of model uncertainty are nontrivial for plausibly estimated income processes and calibrated RB parameter values. Finally, we extend the benchmark model to consider the separation of risk aversion and intertemporal substitution and regimeswitching in income growth. 
Keywords:  Interest rates; Savings; Income; Consumption; General equilibrium 
JEL:  C61 D81 E21 
Date:  2015–10–29 
URL:  http://d.repec.org/n?u=RePEc:fip:fedkrw:rwp1514&r=upt 
By:  Doh, Taeyoung (Federal Reserve Bank of Kansas City); Wu, Shu 
Abstract:  Under linear approximations for asset prices and the assumption of independence between expected consumption growth and timevarying volatility, longrun risks models imply constant market prices of risks and often generate counterfactual results about asset return and cash ﬂow predictability. We develop and estimate a nonlinear equilibrium asset pricing model with recursive preferences and a ﬂexible econometric speciﬁcation of cash ﬂow processes. While in many longrun risks models timevarying volatility inﬂuences only risk premium but not expected cash ﬂows, in our model a common set of risk factors drive both expected cash ﬂow and risk premium dynamics. This feature helps the model to overcome two main criticisms against longrun risk models following Bansal and Yaron (2004): the overpredictability of cash ﬂows by asset prices and the tight relation between timevarying risk premia and growth volatility. Our model extends the approach in Le and Singleton (2010) to a setting with multiple cash ﬂows. We estimate the model using the longrun historical data in the U.S. and ﬁnd that the model with generalized market prices of risks produces cash ﬂow and return predictability that are more consistent with the data. 
Keywords:  Recursive preferences; Consumption risks 
JEL:  E21 G12 
Date:  2015–10–01 
URL:  http://d.repec.org/n?u=RePEc:fip:fedkrw:rwp1512&r=upt 
By:  Gerardo Infante (University of East Anglia); Guilhem Lecouteux (Ecole Polytechnique); Robert Sugden (University of East Anglia) 
Abstract:  Neoclassical economics assumes that individuals have stable and contextindependent preferences, and uses preferencesatisfaction as a normative criterion. By calling this assumption into question, behavioural findings cause fundamental problems for normative economics. A common response to these problems is to treat deviations from conventional rationalchoice theory as mistakes, and to try to reconstruct the preferences that individuals would have acted on, had they reasoned correctly. We argue that this preference purification approach implicitly uses a dualistic model of the human being, in which an inner rational agent is trapped in an outer psychological shell. This model is psychologically and philosophically problematic. 
Keywords:  preference purification, inner rational agent, behavioural welfare economics, libertarian paternalism, contextdependent preferences 
JEL:  B41 D03 D60 
Date:  2016–02 
URL:  http://d.repec.org/n?u=RePEc:uea:wcbess:1602&r=upt 
By:  Andrés Salamanca Lugo (TSE (GREMAQ, Université Toulouse I)  GREMAQ  Groupe de recherche en économie mathématique et quantitative  UT1  Université Toulouse 1 Capitole  EHESS  École des hautes études en sciences sociales  Institut national de la recherche agronomique (INRA)  CNRS  Centre National de la Recherche Scientifique) 
Abstract:  Kamenica and Gentzkow (2011) consider a model in which a sender chooses a public communication device for signaling his information to an uninformed receiver, who then takes an action that affects the welfare of both individuals. In their model, the sender is fully committed to truthfully communicate the signal to the receiver, so that they abstract from incentive compatibility issues. By considering mediated communication, we provide an analytical framework overcoming this overly restrictive assumption. We use the concept of virtual utility to develop a geometric approach to the sender's optimization problem. We characterize the value of persuasion from the concavification of a nonrevealing function over beliefs. We apply our approach to a model of information transmission based on Crawford and Sobel (1982). In this setting, we provide necessary and sufficient conditions for the sender to benefit from his private information. 
Keywords:  Bayesian persuasion,mediated communication,incentive compatibility,virtual utility 
Date:  2016–01–11 
URL:  http://d.repec.org/n?u=RePEc:hal:wpaper:hal01289379&r=upt 
By:  Kim, Minseong 
Abstract:  In this paper, another factor that affects equity risk premium is derived from a simple classical monetary model, which basically adds back laborleisure to a simple consumptiononly consumptionbased asset pricing model. If every present/future good is traded at time $t=0$, just as in traditional ArrowDebreu general equilibrium models and understanding bonds as essentially trading labor with future goods, it is inevitable that riskfree bonds have lower interest rate than ideal riskfree bonds of classical monetary models. 
Keywords:  equity premium puzzle, ArrowDebreu, futures market, equity risk premium 
JEL:  E21 E44 G12 G13 
Date:  2016–03–15 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:70310&r=upt 
By:  Matthias Greiff (University of Giessen); Kurt A. Ackermann (Fehr Advice & Partners); Ryan O. Murphy (University of Zürich) 
Abstract:  A variety of different social contexts have been used when measuring distributional preferences. This could be problematic as different degrees of social interdependence may affect people’s distributional preferences, and this contextual variance may inadvertently muddle the measurement process and complicate comparisons between different strands of research. In the present study, we systematically measure distributional preferences embedded within different social contexts, as well as cooperative choices in a strategic setting. More specifically, we use a withinsubjects design and compare the choices people make in resource allocation tasks with role certainty, role uncertainty, decomposed games, and matrix games. Results show that, at the aggregate level, role uncertainty and decomposed games both lead to higher degrees of prosociality when compared to role certainty. At the individual level, we observe considerable differences in behavior across the social contexts, indicating that the majority of people are sensitive to these different social settings but respond in different ways. We conclude with some recommendations for measuring distributional preferences as an individual difference and reiterate that social context is an inherent part of measurement methodology when considering social motivations. 
Keywords:  Distributional Preferences, Social Preferences, Other Regarding Preferences, Social Value Orientation (SVO), Measurement Methods, Individual Differences 
JEL:  C91 D03 D64 
Date:  2016 
URL:  http://d.repec.org/n?u=RePEc:mar:magkse:201606&r=upt 
By:  Marilda Sotomayor 
Abstract:  For a general coalitional game with nontransferable utility (NTU game) and a finite set of players, (N,V), Scarf (1967) proved that every balanced game has a nonempty core. Billera (1970) showed, through an example, that this condition is not always necessary when V(N) has a supremum. By using the concepts of simple outcome and Pareto simple outcome, the present paper provides a weaker condition than balancedness, which is sufficient for the nonemptiness of the core in the general case and is necessary when V(N) has a supremum. It is also necessary for any TU game. Our proof avoids the use of balancedness and specialized mathematical tools. Instead, it is elementary and only employs simple combinatorial arguments. 
Keywords:  Core; simple payoff vector; Pareto optimal simple outcome 
JEL:  C78 D78 
Date:  2016–03–04 
URL:  http://d.repec.org/n?u=RePEc:spa:wpaper:2016wpecon5&r=upt 
By:  Andrea Marcellusi (CEIS University of Rome "Tor Vergata"); Raffaella Viti (CEIS University of Rome "Tor Vergata"); Francesco Damele (Health Economics & Outcomes Research Manager HEMAR Manager Infectious Diseases JanssenCilag SpA Italia); Calogero Cammà (Sezione di Gastroenterologia, Di.Bi.M.I.S, Università di Palermo, Italia); Gloria Taliani (Infectious and Tropical Diseases Unit, Department of Clinical Medicine, Sapienza University of Rome, Italy); Francesco Saverio Mennini (CEISEEHTA and DEF University of Rome "Tor Vergata") 
Abstract:  Background: The aim of this study is to perform an economic analysis to estimate the costutility of the early innovative therapy in Italy for managing HCVinfected patients. Methods: The incremental costutility analysis was carried out to quantify the benefits of the early treatment approach in HCV subjects. A Markov simulation model including direct and indirect costs and health outcomes was developed from Italian National Healthcare Service and societal perspective. 5,000 Monte Carlo simulations were performed on two distinct scenarios: Standard of Care (SoC) which includes 14.000 Genotype 1 patients in Italy treated with innovative interferonfree in the Fibrosis stage 3 and 4 (F3F4) vs Earlytreatment Scenario (ETS) where 2.000 patients were additionally treated with simeprevir plus peginterferon and ribavirin in the Fibrosis stage 2 (F2) (based on AIFA reimbursement criteria). A systematic literature review was carried out to identify epidemiological and economic data, which were subsequently used to inform the model. Furthermore, a oneway probabilistic sensitivity was performed in order to measure the relationship between the main parameters of the model and the costutility results. Results: The model shows that, in terms of Incremental Cost Effectiveness Ratio (ICER) per QALY gained, ETS appeared to be the most costeffective option compared from both perspective Societal (ICER = €11.396) and NHS (ICER = €14.733) over a time horizon of 10 years. The costeffectiveness of ETS is more sustainable as it extends the time horizon analysis (ICER = € 6.778 per QALY to 20 years and € 4,474 per QALY to 30 years). From the societal perspective the ETS represents the dominant option at a time horizon of 30 years. If we consider the subgroup population of treated patients (16.000 patients of which 2.000 not treated in the SoC), the ETS scenario was dominant after only 5 years horizon and costeffective at 2 years of simulation. The oneway sensitivity analysis on the main variables confirmed the robustness of the model for the earlytreatment approach. Conclusions: In conclusion, our model represents a tool for policy makers and health care professionals provide information on the costeffectiveness of earlytreatment approach in patients HCVinfected in Italy. Starting innovative treatment earlier regimens keeps HCVinfected patients in better health and reduces the incidence of HCV related events; this generating a gain both in terms of health of the patients and correct resource allocation. 
Keywords:  costutility, early treatment, HCV management 
JEL:  I19 
Date:  2016–03–23 
URL:  http://d.repec.org/n?u=RePEc:rtv:ceisrp:370&r=upt 
By:  Kurusu, Kaoru 
Abstract:  Conceptual debates on what constitutes human security have continued for two decades. However, the question remains as to whether the introduction of ‘human security’ offers any added value to the thinking and ways of achieving wellbeing and security. To provide a preliminary answer to this question, this paper focuses on the case of Japan, a country acknowledged as being one of the most committed advocates of human security in its foreign policy. This paper aims at collecting data on Japanese key stakeholder perceptions on the utility of the human security concept by conducting interviews with those who are active in the field of human security in government, academia, civil society and the private sector. Based on these interviews, this paper presents ‘issues for further research’ on the question of the added value of human security by observing how the human security concept has been understood and evaluated as well as actually applied in practice by Japanese stakeholders. The Japanese interviewees working in various sectors not only found at least some utility in the human security concept but also our interviews revealed some essential possibilities that the human security notion might bring: greater emphasis could be placed on ‘onsite needs and peoplerelated needs’; the ‘comprehensiveness’ of the notion can provide a totally different approach to complex situations of human insecurities; and the ‘freedom to live in dignity’ might add a stronger human face to development and securityrelated projects. Many of the interviewees pointed out the utility of human security in addressing human insecurities in Japan as well. The paper suggests areas for future human security research. Such will include whether a stronger crosssectoral/interdepartmental approach could increase the effectiveness of human security approach; how reluctant authorities can be persuaded to accept international assistance; how transnational actors can improve human security when state sovereignty is at issue; how human dignity aspect can be developed in human security policy and research. 
Keywords:  human security , Japan , perception , stakeholder , interview 
Date:  2016–03–22 
URL:  http://d.repec.org/n?u=RePEc:jic:wpaper:122&r=upt 