nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2016‒05‒08
seventeen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Expected Multi-Utility Representations by "Simplex" with Applications By Dino Borie
  2. A General Optimal Investment Model in the Presence of Background Risk By Alghalith, Moawia; Guo, Xu; Wong, Wing-Keung; Zhu, Lixing
  3. Binary Choice Probabilities on Mixture Sets By Matthew Ryan
  4. Crop Insurance Program Purchase Decision and Role of Risk Aversion: Evidence from Maize Production Areas in China By Lyu, Kaiyu; Barre, Thomas
  5. International Business Cycles and Risk Sharing with Uncertainty Shocks and Recursive Preferences By Robert Kollmann
  6. Preference Inconsistencies of a Rational Decision Maker By Kassas, Bachir; Palma, Marco; Zhang, Yvette
  7. Mentalism Versus Behaviourism in Economics: A Philosophy-of-Science Perspective By Franz Dietrich; Christian List
  8. Growth of income and welfare in the U.S, 1979-2011 By John Komlos
  9. Ambiguity about the chances of winning represents a key aspect in lotteries. By means of a controlled field experiment, we exogenously vary the degree of ambiguity about the winning chances of lotteries organized to incentivize the contribution for a publi By Julian Conrads; Rainer Rilke; Tommaso Reggiani
  10. In sickness but not in wealth: field evidence on patients’ risk preferences in the financial and health domain By Matteo M. Galizzi; Marisa Miraldo; Charitini Stavropoulou
  11. Measuring consumer heterogeneous preferences for pork traits under media reports: choice experiment in sixteen traceability pilot cities, China By Yan, Zhen; Zhou, Jie-hong
  12. The Impact of Taxes and Wasteful Government Spending on Giving By Roman M. Sheremeta; Neslihan Uler
  13. Bond Risk Premia in Consumption-based Models By Drew D. Creal; Jing Cynthia Wu
  14. Does Consumer’s Working Memory Matter? The Relationship between Working Memory and Selective Attention in Food Choice By Shen, Meng; Gao, Zhifeng
  15. Labor supply in the past, present, and future: a balanced-growth perspective By Boppart, Timo; Krusell, Per
  16. Can We Invest Based on Equity Risk Premia and Risk Factors from Multi-Factor Models? By Paweł Sakowski; Robert Ślepaczuk; Mateusz Wywiał
  17. Impact assessment of agricultural and fiscal policy in Greece on business-oriented arable farms By Stamatis Mantziaris; Stelios Rozakis

  1. By: Dino Borie (GREDEG CNRS; University of Nice Sophia Antipolis)
    Abstract: We give sufficient conditions to characterize the class of (possibly incomplete) preference relations over lotteries which can be represented by a Bauer simplex of (continuous) expected utility functions that preserve both indifferences and strict preferences. Our result is applied to a model of stochastic choice with the measurement of random expected utility functions and to a model of subjective expected utility with subjective states of the world.
    Keywords: Incomplete preferences, expected utility, random utility, random choice, subjective expected utility, states of the world
    JEL: D80
    Date: 2016–05
  2. By: Alghalith, Moawia; Guo, Xu; Wong, Wing-Keung; Zhu, Lixing
    Abstract: In this paper we present two dynamic models of background risk. We first present a stochastic factor model with an additive background risk. Thereafter, we present a dynamic model of simultaneous (correlated) multiplicative background risk and additive background risk. In so doing, we use a general utility function.
    Keywords: Stochastic factor model, utility function
    JEL: G11
    Date: 2016–04
  3. By: Matthew Ryan (Department of Economics, Faculty of Business and Law, Auckland University of Technology)
    Abstract: Experimental evidence suggests that choice behaviour has a stochastic element. Much of this evidence is based on studying choices between lotteries ñchoice under risk. Binary choice probabilities admit a strong utility representation (SUR) if there is a utility function such that the probability of choosing option A over option B is a strictly increasing function of the utility di§erence between A and B. Debreu (1958) obtained a simple set of su¢ cient conditions on binary choice probabilities for the existence of a SUR. More recently, Dagsvik (2008) considered binary choices between lotteries and provided axiomatic foundations for a SUR in which the underlying utility function is linear (i.e., conforms to expected utility). Our paper strengthens and generalises Dagsvikís result. We show that one of Dagsvikís axioms can be weakened, and we extend his analysis to encompass choices between uncertain prospects, as well as various non-linear speciÖcations of utility.
    Keywords: Strong utility representation, Choice probabilities
    Date: 2015–01
  4. By: Lyu, Kaiyu; Barre, Thomas
    Abstract: Risk aversion is a key determinate in risk management in the agricultural insurance market. Based on the unique datasets of risk preference experiment and maize producer survey in maize production areas in China, this paper explores the determinants of farmers’ CIP participation and scrutinizes the role of risk aversion in farmers’ CIP decision. Results show that risk aversion plays an important role in CIP decision, not only in the form of its’ direct effect, but also in the form of interaction term together with loss expected. We also find the purchase experience, CIP environment (village purchase ratio) and contract items (insured amount) are significant determinates in the CIP purchase decision. No significant evidence is found that serious adverse selection exists in the sampling areas.
    Keywords: Agricultural and Food Policy, Crop Production/Industries,
    Date: 2015
  5. By: Robert Kollmann
    Abstract: This paper analyzes the effects of output volatility shocks on the dynamics of consumption, trade flows and the real exchange rate, in a two-country, two-good 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 non-negligible 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: international business cycles; international risk sharing; external balance; exchange rate; volatility; consumption-real exchange rate anomaly
    JEL: F31 F32 F36 F41 F43
    Date: 2016–03
  6. By: Kassas, Bachir; Palma, Marco; Zhang, Yvette
    Abstract: The longstanding dispute over the accuracy of stated preference methods in eliciting the true valuations of individuals has stimulated interest in analyzing preference inconsistencies between revealed and stated preference mechanisms. This paper uses preference orderings to provide a more robust comparison between revealed and stated preferences and assess the validity of the latter. This is done by comparing an incentive compatible auction experiment (recoded as implied ranks) with a ranking procedure. Partial ranking models are constructed to examine consumer preferences under the two valuation mechanisms for the most preferred and the least preferred alternatives in order to provide a more detailed analysis. The stability and symmetry of parameters was tested and systematic differences between the models were analyzed in order to measure the extent of preference inconsistencies between the auction exercise and ranking procedure. Furthermore, the predictive power of the models was calculated to evaluate the relative reliability of each mechanism. The results provide robust evidence that individuals often employ different behavioral rules under the two elicitation mechanisms, especially when expressing mild feelings about certain alternatives. Compared to the more accurate auctions mechanism, the ranking exercise seems to perform fairly well only when eliciting preferences over the best ranked alternative.
    Keywords: auctions, choice-ranking, ordinal data, parameter stability, parameter symmetry, preference inconsistency, revealed preferences, stated preference, Consumer/Household Economics, Institutional and Behavioral Economics, D12,
    Date: 2015
  7. By: Franz Dietrich (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics, CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Christian List (LSE - London School of Economics)
    Abstract: Behaviourism is the view that preferences, beliefs, and other mental states in social-scientific theories are nothing but constructs re-describing people's behaviour. Mentalism is the view that they capture real phenomena, on a par with the unobservables in science, such as electrons and electromagnetic fields. While behaviourism has gone out of fashion in psychology, it remains influential in economics, especially in 'revealed preference' theory. We defend mentalism in economics, construed as a positive science, and show that it fits best scientific practice. We distinguish mentalism from, and reject, the radical neuroeconomic view that behaviour should be explained in terms of brain processes, as distinct from mental states.
    Keywords: decision theory,scientific realism,Mentalism,behaviourism,revealed preference
    Date: 2016–04–21
  8. By: John Komlos
    Abstract: We estimate growth rates of real incomes in the U.S. by quintiles using the Congressional Budget Office’s (CBO) post-tax, post-transfer data as basis for the period 1979-2011. We improve upon them by including only the present value of earnings that will accrue in retirement and excluding items included in the CBO income estimates such as “corporate taxes borne by labor” that do not increase either current purchasing power or utility. We estimate a high and a low growth rate using two price indexes, the CPI and the Personal Consumption Expenditure index. The major consistent findings include what in the colloquial is referred to as the “hollowing out” of the middle class. According to these estimates, the income of the middle class 2nd and 3rd quintiles increased at a rate of between 0.1% and 0.7% per annum, i.e., barely distinguishable from zero. Even that meager rate was achieved only through substantial transfer payments. In contrast, the income of the top 1% grew at an astronomical rate of between 3.4% and 3.9% per annum during the 32-year period, reaching an average annual value of $918,000, up from $281,000 in 1979 (in 2011 dollars). Hence, the post-tax, post-transfer income of the 1% relative to the 1st quintile increased from a factor of 21 in 1979 to a factor of 51 in 2011. However, income of no other group increased substantially relative to that of the lowest quintile. Oddly, the income of even those in the 96-99 percentiles increased only from a multiple of 8.1 to a multiple of 11.3. We next estimate growth in welfare assuming diminishing marginal utility of income. A logarithmic utility function yields a growth in welfare for the middle class of roughly 0.01% to 0.07% per annum, which is indistinguishable from zero. With interdependent utility functions only the welfare of the 5th quintile experienced meaningful growth while those of the first four quintiles tend to be either negligible or even negative.
    JEL: D30 D60 E0 I31 N12
    Date: 2016–04
  9. By: Julian Conrads; Rainer Rilke; Tommaso Reggiani
    Abstract: Ambiguity about the chances of winning represents a key aspect in lotteries. By means of a controlled field experiment, we exogenously vary the degree of ambiguity about the winning chances of lotteries organized to incentivize the contribution for a public good. In one treatment, people have been simply informed about the maximum number of potential participants (i.e. the number of lottery tickets released). In a second treatment, this information has been omitted as in all traditional lotteries. Our general finding shows that simply reducing the degree of ambiguity of the lottery leads to a sizable and significant increase (67%) in the participation rate. This result is robust to alternative prize configurations.
    Date: 2016
  10. By: Matteo M. Galizzi; Marisa Miraldo; Charitini Stavropoulou
    Abstract: We present results from a hypothetical framed field experiment assessing whether risk preferences significantly differ across the health and financial domains when they are elicited through the same multiple price list paired-lottery method. We consider a sample of 300 patients attending outpatient clinics in a university hospital in Athens, during the Greek financial crisis. Risk preferences in finance are elicited using paired-lottery questions with hypothetical payments. The questions are adapted to the health domain by framing the lotteries as risky treatments in hypothetical healthcare scenarios. Using Maximum Likelihood methods, we estimate the degree of risk aversion, allowing for the estimates to be dependent on domain and individual characteristics. The subjects in our sample, who were exposed to both health and financial distress, tend to be less risk averse in the financial than in the health domain.
    Keywords: Behavioral experiments in health; Field experiments; Risk aversion
    JEL: G32
    Date: 2016
  11. By: Yan, Zhen; Zhou, Jie-hong
    Abstract: An increasing number of recent media reports on pork safety problems at source have attracted great attention and thought to be a growing threat to risk perception amplification on pork safety, even leading to public panic. This paper was among the first to explore the impact of media report about potential benefits and risk of traceability on consumer utility valuation and preference heterogeneities for select pork traits. By capturing key issues from online media reports in last three years both on benefit and risk as information shock showed to interviewees, we investigate willingness to pay from 788 consumers across sixteen traceability pilot cities, China. The findings indicate that consumers value certification more than other pork traits, while only preference on farmerinfo labeling significantly imcreases in negative information group. Highly valued farmerinfo and free range labeling in same class from positive information shock, while consumer preference for free range in one class from negative group.
    Keywords: Food Consumption/Nutrition/Food Safety, Livestock Production/Industries,
    Date: 2015
  12. By: Roman M. Sheremeta (Weatherhead School of Management, Case Western Reserve University and Economic Science Institute, Chapman University); Neslihan Uler (Institute for Social Research, the University of Michigan)
    Abstract: We examine the impact of taxes and wasteful government spending on charitable giving. In our model, the government collects a flat-rate tax on income net of donations and wastes part of the tax revenue before redistribution. The model provides theoretical predictions which we test in a framed field experiment. The results of the experiment show that the tax rate has a weak and insignificant effect on giving. The degree of waste, however, has a large, negative and significant effect on giving, with the relationship moderated by the curvature in the utility function.
    Keywords: giving, charity donations, tax, waste, redistribution, experiments
    JEL: C90 D64 H41
    Date: 2016
  13. By: Drew D. Creal; Jing Cynthia Wu
    Abstract: Workhorse Gaussian affine term structure models (ATSMs) attribute time-varying bond risk premia entirely to changing prices of risk, while structural models with recursive preferences credit it completely to stochastic volatility. We reconcile these competing channels by introducing a novel form of external habit into an otherwise standard model with recursive preferences. The new model has an ATSM representation with analytical bond prices making it empirically tractable. We find that time variation in bond term premia is predominantly driven by the price of risk, especially, the price of expected inflation risk that co-moves with expected inflation itself.
    JEL: C11 E31 E43 E52 G12
    Date: 2016–04
  14. By: Shen, Meng; Gao, Zhifeng
    Abstract: The capacity to perform complex cognitive tasks depends on the ability to retain task-relevant information in an accessible state (working memory) and to selectively process information in the environment (selective attention). Due to working memory capacity limits, people usually filter out irrelevant information and instead focus on important information. Will consumer’s working memory capacity affect their attention and further their choice? Our study uses choice experiments (CE) to investigate the effect of working memory capacity on attention and choice. Evidence suggests that consumer’s working memory capacity will indeed affect their attention and choice.
    Keywords: Working Memory, Selective Attention, Choice Experiment, Consumer/Household Economics, Institutional and Behavioral Economics,
    Date: 2016
  15. By: Boppart, Timo; Krusell, Per
    Abstract: What explains how hard people work? Going back in time, a main fact to address is the steady reduction in hours worked. The long-run data, for the U.S. as well as for other countries, show a striking pattern whereby hours worked fall steadily by a little below a half of a percent per year, accumulating to about a halving of labor supply over 150 years. In this paper, we argue that a stable utility function defined over consumption and leisure can account for this fact, jointly with the movements in the other macroeconomic aggregates, thus allowing us to view falling hours as part of a macroeconomy displaying balanced growth. The key feature of the utility function is an income effect (of higher wages) that slightly outweighs the substitution effect on hours. We also show that our proposed preference class is the only one consistent with the stated facts. The class can be viewed as an enlargement of the well-known "balanced-growth preferences" that dominate the macroeconomic literature and that demand constant (as opposed to falling) hours in the long run. The postwar U.S. experience, over which hours have shown no net decrease and which is the main argument for the use of "balanced-growth preferences", is thus a striking exception more than a representative feature of modern economies.
    Keywords: balanced growth; hours worked; Kaldor facts; Labor Supply; preferences
    JEL: E21 J22 O11 O40
    Date: 2016–04
  16. By: Paweł Sakowski (Faculty of Economic Sciences, University of Warsaw); Robert Ślepaczuk (Faculty of Economic Sciences, University of Warsaw; Union Investment TFI S.A.); Mateusz Wywiał (Faculty of Economic Sciences, University of Warsaw; Quedex Derivatives Exchange)
    Abstract: We find that detailed analysis of multi-factor models makes it possible to propose investment strategies based on equity risk premium disequlibrium. We examine two investment algorithms built on weekly data of world equity indices for emerging and developed countries in the period of 2000-2015. We create seven risk factors using additional data about market capitalisation, book value, country GDP and betas of equity indices. The first strategy utilises theoretical value of equity risk premium from seven-factor Markov-switching model with variables common for all countries and variables specific to developed/emerging countries. We compare theoretical with realised equity risk premium for a given index to undertake the buy/sell decisions. The second algorithm works only on eight risk factors and applies them as input variables to Markowitz models with alternative optimisation criteria (target risk, target return, maximum Sharpe ratio, minimum variance and equally weighted assets). Finally, we notice that the impact of risk factors on final results of investment strategy is much more important than the selection of a particular econometric model in order to correctly evaluate equity risk premium.
    Keywords: investment algorithms, multi-factor models, Markov switching model, asset pricing models, equity risk premia, risk factors, Markowitz model
    JEL: C15 G11 F30 G12 G13 G14 G15
    Date: 2016
  17. By: Stamatis Mantziaris (Postgraduate Program MBA in Agribusiness, Agricultural University of Athens); Stelios Rozakis (Environmental Engineering Department, Technical University of Crete)
    Abstract: This paper examines the impacts of the national implementation of the CAP reform 2014-20 and the fiscal policy derived from the Third Memorandum on the crop-mix decisions and the viability of business oriented Greek arable farming. A mathematical programming model is specified maximizing farmers' utility subject to agronomic, institutional and resource constraints. According to CAP reform scenario, reduction for cotton and durum wheat and on the other hand increase mainly for set aside and secondary for alfalfa cultivation areas is observed. Similar crop-mix is cultivated for the combined scenario of CAP and fiscal reform. Although gross margin decreases in both scenarios, almost all farms remain viable because 64% of their gross revenue is derived from the market. Consequently, farms are not sensitive enough in reform concerning reduction of subsidies but the combination with tax measures decrease the levels of viability significantly.
    Keywords: Utility function, mathematical programming, policy analysis, arable farming, Thessaly
    JEL: C61 Q12 Q18
    Date: 2016

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