nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2016‒04‒16
fifteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Endogenous Stock Price Fluctuations with Dynamic Self-Control Preferences By Airaudo, Marco
  2. The subjective discount factor and the coefficient of relative risk aversion under time-additive isoelastic expected utility model By Dominique Pepin
  3. Utility, Risk, and Demand for Incomplete Insurance: Lab Experiments with Guatemalan Cooperatives By McIntosh, Craig; Povel, Felix; Sadoulet, Elisabeth
  4. Irrational Exuberance and Herding in Financial Markets By Christopher Boortz; ; ;
  5. An Economical Business-Cycle Model By Pascal Michaillat; Emmanuel Saez
  6. Sharp convex bounds on the aggregate sums--An alternative proof By Chuancun Yin; Dan Zhu
  7. Single-Crossing Random Utility Models By Jose Apesteguia; Miguel Ángel Ballester
  8. Non-trading behaviour in choice experiments By Ahlheim, Michael; Neidhardt, Jan
  9. Single Stock Call Options as Lottery Tickets By Luiz Félix; Roman Kräussl; Philip Stork
  10. Overconfidence, Incentives and Digit Ratio By Neyse, Levent; Bosworth, Steven; Ring, Patrick; Schmidt, Ulrich
  11. Risk-Constrained Kelly Gambling By Enzo Busseti; Ernest K. Ryu; Stephen Boyd
  12. Aggregating time preferences with decreasing impatience By Nina Anchugina; Matthew Ryan; Arkadii Slinko
  13. Sharing is caring - is this always true? A note on sharing gains and losses in modified dictator games. By Kene Boun My; Nicolas Lampach
  14. Corporate social responsibility in a competitive business environment By Carol Newman; John Rand; Finn Tarp; Neda Trifkovi.
  15. Un modèle de décroissance optimale By Marc Germain

  1. By: Airaudo, Marco (School of Economics)
    Abstract: This paper studies the global equilibrium dynamics implied by a Lucas’ tree asset pricing model where the representative agent has dynamic self-control preferences, as defined by Gul and Pesendorfer (Econometrica, 2004). It shows that endogenous cycles of period 2 and higher, as well as chaotic dynamics exist provided temptation utility is sufficiently important (with respect to standard commitment utility) and sufficiently convex. For parameterizations leading to complex deterministic dynamics, the model also admits stationary and non-stationary sunspot equilibria.
    Keywords: Asset Pricing; Temptation; Self-Control; Endogenous Cycles; Chaotic Dynamics; Sunspot Equilibrium
    JEL: C62 E32 G12
    Date: 2016–01–21
  2. By: Dominique Pepin (CRIEF)
    Abstract: By analysing the restrictions that ensure the existence of capital market equilibrium, we show that the coefficient of relative risk aversion and the subjective discount factor cannot be high simultaneously as they are supposed to be to make the standard asset pricing consistent with financial stylised facts.
    Date: 2016–04
  3. By: McIntosh, Craig; Povel, Felix; Sadoulet, Elisabeth
    Abstract: We play a series of incentivized laboratory games with risk-exposed cooperative- based coffee farmers in Guatemala to understand the demand for index-based rainfall insurance. We show that insurance demand goes up as increasingly severe risk makes insurance payouts more partial (payouts are smaller than losses), but demand is ad- versely effected by more complex risk structures in which payouts are probabilistic (it is possible that a shock occurs with no payout). We use numerical techniques to esti- mate a flexible utility function for each player and consequently can put exact dollar values on the magnitude of the behavioral response triggered by probabilistic insur- ance. Exploiting the group structure of the cooperative, we investigate the possibility of using group loss adjustment to smooth idiosyncratic risk. Our results suggest that consumers value probabilistic insurance using a prospect-style utility function that is concave both in probabilities and in income, and that group insurance mechanisms are unlikely to solve the issues of low demand that have bedeviled index insurance markets.
    Keywords: Social and Behavioral Sciences, Risk, Index Insurance, Utility Estimation
    Date: 2015–01–01
  4. By: Christopher Boortz; ; ;
    Abstract: In the context of a two-state, two-trader financial market herd model introduced by Avery and Zemsky (1998) we investigate how informational ambiguity in conjunction with waves of optimism and pessimism affect investor behavior, social learning and price dynamics. Without ambiguity, neither herding nor contrarianism is possible. If there is ambiguity and agents have invariant ambiguity preferences, only contrarianism is possible. If on the other hand ambiguity is high and traders become overly exuberant (or desperate) as the asset price surges (or plummets), we establish that investor herding may drive prices away from fundamentals with economically relevant probability.
    Keywords: Social Learning, Herding, Contrarianism, (Partial) Informational Cascade, Ambiguity, Choquet Expected Utility, NEO-Additive Capacities
    JEL: D81 D82 G12 G14
    Date: 2016–03
  5. By: Pascal Michaillat (Department of Economics and Centre for Macroeconomics, London School of Economics); Emmanuel Saez (Department of Economics, University of California, Berkeley)
    Abstract: In recent decades, advanced economies have experienced low and stable inflation and long periods of liquidity trap. We construct an alternative business-cycle model capturing these two features by adding two assumptions to a money-in-the-utility-function model: the labor market is subject to matching frictions, and real wealth enters the utility function. These assumptions modify the two core equations of the standard New Keynesian model. With matching frictions, we can analyze equilibria in which inflation is fixed and not determined by a forward-looking Phillips curve. With wealth in the utility, the Euler equation is modified and we can obtain steady-state equilibria with a liquidity trap, positive inflation, and labor market slack. The model is simple enough to inspect the mechanisms behind cyclical fluctuations and to study the effects of conventional and unconventional monetary and fiscal policies. As a byproduct, the model provides microfoundations for the classical IS-LM model. Finally, we show how directed search can be combined with costly price adjustments to generate a forward-looking Phillips curve and recover some insights from the New Keynesian model.
    JEL: E12 E24 E32 E63
    Date: 2014–09
  6. By: Chuancun Yin; Dan Zhu
    Abstract: It is well known that a random vector with given marginal distributions is comonotonic if and only if it has the largest sum with respect to the convex order [ Kaas, Dhaene, Vyncke, Goovaerts, Denuit (2002), A simple geometric proof that comonotonic risks have the convex-largest sum, ASTIN Bulletin 32, 71-80. Cheung (2010), Characterizing a comonotonic random vector by the distribution of the sum of its components, Insurance: Mathematics and Economics 47(2), 130-136] and that a random vector with given marginal distributions is mutually exclusive if and only if it has the minimal convex sum [Cheung and Lo (2014), Characterizing mutual exclusivity as the strongest negative multivariate dependence structure, Insurance: Mathematics and Economics 55, 180-190]. In this note, we give a new proof of this two results using the theories of distortion risk measure and expected utility.
    Date: 2016–03
  7. By: Jose Apesteguia; Miguel Ángel Ballester
    Abstract: We propose a novel model of stochastic choice: the single-crossing random utility model (SCRUM). This is a random utility model in which the collection of utility functions satisfies the single-crossing property. We offer a characterization of SCRUMs based on three easy-to-check properties: Positivity, Monotonicity and Centrality. The identified collection of utility functions and associated probabilities is basically unique. We establish a stochastic monotone comparative result for the case of SCRUMs and study several generalizations of SCRUMs.
    Keywords: stochastic choice; single-crossing property; random utility models; monotone comparative statics
    JEL: D00
    Date: 2016–03
  8. By: Ahlheim, Michael; Neidhardt, Jan
    Abstract: This paper addresses a methodological problem of choice experiments, namely the problem that respondents sometimes avoid the intellectual effort of thoroughly considering the trade-offs between different alternatives that are the essence of every choice experiment, and tick instead the next best alternative without the necessary deliberation. This kind of behaviour which is called "nontrading" in the respective literature calls into question the validity of choice experiments. In this paper, which is based on an online choice experiment concerned with consumer's tastes for table grapes with 1,000 participants, we suggest possibilities to identify potential non-traders not only by their answering behaviour but also by some general characteristics we found to be typical of this kind of respondent.
    Keywords: Non-Trading Behaviour,Discrete Choice Experiment,Table Grapes
    Date: 2016
  9. By: Luiz Félix (VU University Amsterdam, the Netherlands); Roman Kräussl (University of Luxembourg, Luxemburg); Philip Stork (VU University Amsterdam, the Netherlands)
    Abstract: This paper investigates whether the overpricing of out-of-the money single stock calls can be explained by Tversky and Kahneman's (1992) cumulative prospect theory (CPT). We argue that these options are overpriced because investors' overweight small probability events and overpay for such positively skewed securities, i.e., characteristics of lottery tickets. We match a set of subjective density functions derived from risk-neutral densities, including the CPT with the empirical probability distribution of U.S. equity returns. We find that overweighting of small probabilities embedded in the CPT explains on average the richness of out-of-the money single stock calls better than other utility functions. The degree that agents overweight small probability events is, however, strongly time-varying and has a horizon effect, which implies that it is less pronounced in options of longer maturity. We also find that time-variation in overweighting of small probabilities is strongly explained by market sentiment, as in Baker and Wurgler (2007).
    Keywords: Cumulative prospect theory; Market sentimen; Risk-neutral densities; Call options
    JEL: G02 G12
    Date: 2016–04–01
  10. By: Neyse, Levent; Bosworth, Steven; Ring, Patrick; Schmidt, Ulrich
    Abstract: This paper contributes to a better understanding of the biological underpinnings of overconfidence by analyzing performance predictions in the Cognitive Reflection Test with and without monetary incentives. In line with the existing literature we find that the participants are too optimistic about their performance on average; incentives lead to higher performance; and males score higher than females on this particular task. The novelty of this paper is an analysis of the relation between participants’ performance prediction accuracy and their second to fourth digit ratio. It has been reported that the digit ratio is a negatively correlated bio-marker of prenatal testosterone exposure. In the unincentivized treatment, we find that males with low digit ratios, on average, are significantly more overconfident about their performance. In the incentivized treatment, however, we observe that males with low digit ratios, on average, are less overconfident about their performance. These effects are not observed in females. We discuss how these findings fit into the literature on testosterone and decision making and how they might help to explain seemingly opposing evidence.
    Keywords: Behavioural genetics,Personality,Sexual dimorphism
    Date: 2016
  11. By: Enzo Busseti; Ernest K. Ryu; Stephen Boyd
    Abstract: We consider the classic Kelly gambling problem with general distribution of outcomes, and an additional risk constraint that limits the probability of a drawdown of wealth to a given undesirable level. We develop a bound on the drawdown probability; using this bound instead of the original risk constraint yields a convex optimization problem that guarantees the drawdown risk constraint holds. Numerical experiments show that our bound on drawdown probability is reasonably close to the actual drawdown risk, as computed by Monte Carlo simulation. Our method is parametrized by a single parameter that has a natural interpretation as a risk-aversion parameter, allowing us to systematically trade off asymptotic growth rate and drawdown risk. Simulations show that this method yields bets that out perform fractional-Kelly bets for the same drawdown risk level or growth rate. Finally, we show that a natural quadratic approximation of our convex problem is closely connected to the classical mean-variance Markowitz portfolio selection problem.
    Date: 2016–03
  12. By: Nina Anchugina; Matthew Ryan; Arkadii Slinko
    Abstract: It is well-known that for a group of time-consistent decision makers their collective time preferences may become time-inconsistent. Jackson and Yariv (2014) demonstrated that the result of aggregation of exponential discount functions always exhibits present bias. We show that when preferences satisfy the axioms of Fishburn and Rubinstein (1982), present bias is equivalent to decreasing impatience (DI). Applying the notion of comparative DI introduced by Prelec (2004), we generalize the result of Jackson and Yariv (2014). We prove that the aggregation of distinct discount functions from comparable DI classes results in the collective discount function which is strictly more DI than the least DI of the functions being aggregated. We also prove an analogue of Weitzman's (1998) result, for hyperbolic rather than exponential discount functions. We show that if a decision maker is uncertain about her hyperbolic discount rate, then long-term costs and benefits will be discounted at a rate which is the probability-weighted harmonic mean of the possible hyperbolic discount rates.
    Date: 2016–04
  13. By: Kene Boun My; Nicolas Lampach
    Abstract: This note highlights in a very simple way the result gained from eliciting a subject’s aversion to inequity when this works to their own advantage, in a modified dictator game related to the domains of gains and losses. Our result demonstrates that individuals experience a stronger reaction to inequity in the domain of losses than in the domain of gains.
    Keywords: inequity aversion, modified dictator game, laboratory experiment.
    JEL: C70 C91 D63
    Date: 2016
  14. By: Carol Newman; John Rand; Finn Tarp; Neda Trifkovi.
    Keywords: poverty measurement, utility consistency, cost of basic needs
    Date: 2016
  15. By: Marc Germain (LEM-CNRS (UMR 9221), Université de Lille 3 and UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))
    Abstract: Dans le cadre d'un modèle de croissance à la Ramsey avec ressource naturelle et pollution et reposant sur certains postulats de l'économie écologique, ce papier étudie les effets de politiques de décroissance volontaire sur la production et le bien-être. L'instrument de ces politiques est une taxe prélevée sur la ressource naturelle. Ces politiques sont appliquées par les pouvoirs publics suite au retournement de la fonction d'utilité des ménages induit par l'augmentation de la pollution. Par rapport à la situation de laisser-faire, leur résultat est à la fois de réduire la production et la pollution d'une part, et d'accroître le bien-être d'autre part. Une réaction plus tardive des autorités publiques suite au retournement de la fonction d'utilité des ménages implique que la taxation de la ressource naturelle doit être plus élevée pendant les premières périodes. Si la préférence pour le futur des autorités est plus grande, alors les gains d'utilité dus à la politique de décroissance sont moindres pour les premières générations de la dynastie et supérieurs pour les suivantes. L'impact du progrès technique économisant la ressource ou améliorant le traitement de la pollution est également analysé. With the help of a growth model à la Ramsey with a natural resource and pollution and relying on postulates of ecological economics, this paper studies the impact of voluntary degrowth policies on production and welfare. The instrument of these policies is a tax levied on the natural resource. These policies are assumed to be applied by the public authorities after the downturn of the households'utility function due to the increase of pollution. With respect to the laisser-faire situation, their impact is to simultaneously decrease production and pollution on the one hand and increase welfare on the other. A delayed reaction of the public authorities after the turnover of the households'utility function implies a higher tax rate on the resource during the first periods. If the authorities'preference for the future is higher, then welfare gains from the degrowth policy are lower for the first generations of the dynasty and higher for the later. The impact of technical progress saving the resource or improving the pollution treatment is also analysed.
    Keywords: degrowth, steady state economics, pollution tax
    JEL: O44 O49 Q57
    Date: 2016–03–16

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