
on Utility Models and Prospect Theory 
By:  Yiqing Lin; Junjian Yang 
Abstract:  In this paper we study the utility maximization problem on the terminal wealth with proportional transaction costs and random endowment. Under the assumption of the existence of consistent price systems, which makes the duality approach possible, we consider the duality between the primal utility maximization problem and the dual one, which is set up on the domain of finitely additive measures. In particular, we prove duality results for utility functions supporting possibly negative values. Moreover, we construct the shadow market by the dual optimal process and exhibit the utility based pricing for the random endowment. 
Date:  2016–04 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1604.08224&r=upt 
By:  AJ A. Bostian; Christoph Heinzel 
Abstract:  Intertemporal choices simultaneously activate discounting, risk aversion, and intertemporal substitution. Future risk stimulates, more specially, higherorder aspects of preference. While a vast empirical literature has studied discounting, risk preferences, and basic consumption smoothing, empirical knowledge of higherorder preferences is still scarce. Based on a twoperiod consumption/saving model, we investigate the interaction of risk and time preferences in intertemporal decisions with future risk. We show that the main carriers of saving variation in intertemporal decisions under risk, according to the model, are intertemporal preferences. Risk preferences only play a minor role. The predictions under Expected Utility (EU) resemble those of the intertemporalsubstitution component of recursive utility, not the risk component. Our simulations also show that second and thirdderivative effects are the most essential features of preferences in the decisions in question. Effects already from the fourth order on have essentially no impact. While the risk effects under EU are stronger than under recursive preferences, the fewrelevance result regarding third and higherorder risk effects persists. For a deepened understanding of preferences underlying intertemporal choice, correctly identifying intertemporal preference seems to be the single most critical aspect. The quantitative differences in the predictions for EU and recursive preferences may allow to empirically discriminate between the preference concepts. 
JEL:  D91 C90 D81 
Date:  2016–05 
URL:  http://d.repec.org/n?u=RePEc:fsc:fspubl:44&r=upt 
By:  Christoph Heinzel 
Abstract:  The measurement of the strength of the precautionary saving motive under recursive utility (RU) has been conceptually restricted to reactions to the addition of a zeromean risk to safe future income. This paper provides characterizations of comparative precautionary saving under RU analogous to Ross' (1981) approach to comparative risk aversion for increases in risk, also of higher order, covering the two cases of income risk and a risky saving return. The characterizations involve a comparison based on precautionary premia. I also define preferenceintensity measures of the Rosstype and show how they can equivalently represent comparative precautionary saving. 
JEL:  D91 D81 
Date:  2016–05 
URL:  http://d.repec.org/n?u=RePEc:fsc:fspubl:43&r=upt 
By:  Dino Borie (GREDEG CNRS; University of Nice Sophia Antipolis) 
Abstract:  A simple mathematical result characterizing a partially ordered mean groupoid is proved and used to study the problem of additively separable preferences on preordered Cartesian product set. This means that most of the economic theory based on separable preferences  expected utility,rankdependent expected utility, qualitative probability, discounted utility  could be generalized to the multiutility approach. 
Keywords:  Additive utility, Separable utility, Completeness axiom, Incomplete preferences 
JEL:  D80 D90 
Date:  2016–05 
URL:  http://d.repec.org/n?u=RePEc:gre:wpaper:201611&r=upt 
By:  Stephen L. Cheung 
Abstract:  This methodological survey reviews recent developments in the design of experiments to elicit individuals' time preferences, with a focus on the measurement or control for potentially nonlinear utility. While the objective of a time preference experiment is usually to estimate parameters of a discount function, assumptions concerning the nature of utility may have an important influence upon these estimates. The survey classifies experiment designs on two dimensions: whether they assume an equivalence between utility under risk and over time, and whether they result in an estimate of the curvature of utility. 
Keywords:  time preference, discounted utility, instantaneous utility, choice list 
JEL:  C91 D03 D90 
Date:  2015–11–25 
URL:  http://d.repec.org/n?u=RePEc:qut:qubewp:wp034&r=upt 
By:  Glimcher, Paul W.; Tymula, Agnieszka A. 
Abstract:  We present a descriptive model of choice that incorporates neurobiological constraints, representational structures and costs into a traditional economic framework. An individual's behavior is fully described by two, in principle observable, primitives: an individual's neural/mental capacity and an endogenous rational expectation. The model captures the phenomena captured by Prospect Theory: reflection in risk attitudes and loss aversion, but unlike Prospect Theory accounts for individual heterogeneity in each and employs fewer parameters. Our theory provides an alternative explanation for endowment effect and makes a series of novel predictions amenable to future testing. 
Keywords:  Utility; decisionmaking; reference point; neuroeconomics 
Date:  2016–05 
URL:  http://d.repec.org/n?u=RePEc:syd:wpaper:201608&r=upt 
By:  Giuseppe Attanasi; Nikolaos Georgantzís; Valentina Rotondi; Daria Vigani 
Abstract:  In this paper we compare two mutually uncorrelated riskattitude elicitation tasks. In particular, we test for correlation of the elicited degrees of monetary risk aversion at a withinsubject level. We show that sufficiently similar incentivized mechanisms elicit correlated decisions in terms of monetary risk aversion only if other riskrelated attitudes are accounted for. Furthermore, we ask subjects to selfreport their general willingness to take risks. We find evidence of some external validity of the two tasks as predictors of selfreported risk attitudes in general human domains. 
Keywords:  Risk aversion, Elicitation method, Lottery choices. 
JEL:  D81 C91 
Date:  2016 
URL:  http://d.repec.org/n?u=RePEc:ulp:sbbeta:201624&r=upt 
By:  Rheinberger, Christoph; Treich, Nicolas 
Abstract:  In light of climate change and other global threats, policy commentators sometimes urge that society should be more concerned about catastrophes. This paper reflects on what society’s attitude toward lowprobability, highimpact events is, or should be. We first argue that catastrophe risk can be conceived of as a spread in the distribution of losses. Based on this conception, we review studies from decision sciences, psychology, and behavioral economics that elicit people’s attitudes toward various social risks. We find more evidence against than in favor of catastrophe aversion—the preference for a meanpreserving contraction of the loss distribution—and discuss a number of possible behavioral explanations. Next, we turn to social choice theory and examine how various social welfare functions handle catastrophe risk. We explain why catastrophe aversion may be in conflict with equity concerns and otherregarding preferences. Finally, we discuss current approaches to evaluate and regulate catastrophe risk. 
Date:  2016–03 
URL:  http://d.repec.org/n?u=RePEc:tse:wpaper:30373&r=upt 
By:  Victor Aguirregabiria; Erhao Xie 
Abstract:  This paper studies the identification of players' preferences and beliefs in empirical applications of discrete choice games using experimental data. The experiment comprises a set of games with similar features (e.g., twoplayer coordination games) where each game has different values for the players' monetary payoffs. Each game can be interpreted as an experimental treatment group. The researcher assigns randomly subjects to play these games and observes the outcome of the game as described by the vector of players' actions. Data from this experiment can be described in terms of the empirical distribution of players' actions conditional on the treatment group. The researcher is interested in the nonparametric identification of players' preferences (utility function of money) and players' beliefs about the expected behavior of other players, without imposing restrictions such as unbiased or rational beliefs or a particular functional form for the utility of money. We show that the hypothesis of unbiased/rational beliefs is testable and propose a test of this null hypothesis. We apply our method to two sets of experiments conducted by Goeree and Holt (2001) and Heinemann, Nagel and Ockenfels (2009). Our empirical results suggest that in the matching pennies game, a player is able to correctly predict other player's behavior. In the public good coordination game, our test can reject the null hypothesis of unbiased beliefs when the payoff of the noncooperative action is relatively low. 
Keywords:  Testing biased beliefs; Multiple equilibria; Strategic uncertainty; Coordination game 
JEL:  C57 C72 
Date:  2016–05–12 
URL:  http://d.repec.org/n?u=RePEc:tor:tecipa:tecipa560&r=upt 
By:  Mark Schneider (Economic Science Institute, Chapman University); Manuel Nunez (School of Business, University of Connecticut) 
Abstract:  A popular approach to modeling ambiguity aversion is to decompose preferences into the subjective expected utility of an act and an ambiguity index, or an adjustment factor, or a dispersion function. However, in these approaches the dispersion function (or ambiguity index, or adjustment factor) has very little structure imposed on it, leaving the selection of a specific dispersion function in applications to be rather arbitrary. In this note, working in the Anscombe Aumann (1963) framework, we provide a simpler axiomatic characterization of meandispersion preferences which uniquely identifies the dispersion function from the infinite class of possible alternatives. Given the representation, we also obtain unique identification of subjective probabilities. 
Keywords:  ambiguity aversion, translation invariance, dispersion, uncertainty, probabilistic sophistication 
JEL:  D81 
Date:  2016 
URL:  http://d.repec.org/n?u=RePEc:chu:wpaper:1610&r=upt 
By:  Anmol Bhandari; Jaroslav Borovička; Paul Ho 
Abstract:  We develop a framework to analyze economies with agents facing timevarying concerns for model misspecification. These concerns lead agents to interpret economic outcomes and make decisions through the lens of a pessimistically biased 'worstcase' model. We combine survey data and implied theoretical restrictions on the relative magnitudes and comovement of forecast biases across macroeconomic variables to identify ambiguity shocks as exogenous fluctuations in the worstcase model. Our solution method delivers tractable linear approximations that preserve the effects of timevarying ambiguity concerns and permit estimation using standard Bayesian techniques. Applying our framework to an estimated NewKeynesian business cycle model with frictional labor markets, we find that ambiguity shocks explain a substantial portion of the variation in labor market quantities. 
JEL:  C11 C63 D81 D84 E24 E32 
Date:  2016–05 
URL:  http://d.repec.org/n?u=RePEc:nbr:nberwo:22225&r=upt 
By:  Sheremeta, Roman; Uler, Neslihan 
Abstract:  We examine the impact of taxes and wasteful government spending on charitable giving. In our model, the government collects a flatrate 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:  2016–04–27 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:71001&r=upt 
By:  Fabrice Collard (Department of Economics  University of Bern); Sujoy Mukerji (Department of Economics and University College  University of Oxford); Kevin Sheppard (Department of Economics and OxfordMan Institute of Quantitative Finance  University of Oxford); JeanMarc Tallon (Paris School of Economics) 
Abstract:  This paper assesses the quantitative impact of ambiguity on historically observed financial asset returns and growth rates. The single agent, in a dynamic exchange economy, treats the conditional uncertainty about the consumption and dividends next period as ambiguous. We calibrate the agent's ambiguity aversion to match only the first moment of the riskfree rate in data and measure the uncertainty each period on the actual, observed history of (U.S.) macroeconomic growth outcomes. Ambiguity aversion accentuates the conditional uncertainty endogenously in a dynamic way, depending on the history; e.g., it increases during recessions. We show the model implied time series of asset returns substantially match the first and second conditional moments of observed return dynamics. In particular, we find the timeseries properties of our model generated equity premium, which may be regarded as an index measure of revealed uncertainty, relates closely to those of the macroeconomic uncertainty index recently developed in Jurado, Ludvigson, and Ng (2013) 
Keywords:  Equity premium, ambiguity. 
JEL:  G12 E21 D81 C63 
Date:  2011–05 
URL:  http://d.repec.org/n?u=RePEc:mse:cesdoc:11032rrr&r=upt 
By:  Yasufumi Gemma (Associate Director, Institute for Monetary and Economic Studies, Bank of Japan (Email: yasufumi.genma@boj.or.jp)) 
Abstract:  By means of an economic experiment, this paper examines the effects of money illusion on consumptionsaving decisionmaking. In the experiment, subjects make sequential consumptionsaving decisions in economic situations where nominal values of economic variables are displayed differently but there is no difference in their real values in that an optimal real consumption path is the same. Nevertheless, the experimental results show that a nominal difference arising from a higher positive rate of inflation causes subjects to consume more in early periods of the experiment and less in later periods. Moreover, given the utility function assumed in the experiment and the estimated relationship between the slope of the consumption path and the inflation rate, such money illusion results in a higher level of utility for a subject who confronts a higher positive rate of inflation if the level of the inflation rate is modest. In deflationary situations, a nominal difference stemming from a lower negative rate of inflation generates a similar effect to that from a higher positive rate in terms of the consumption path. These findings suggest that in making consumption saving decisions, subjects react to a rise of the inflation rate differently in inflationary situations and in deflationary situations, regardless of no change in the real interest rate. 
Keywords:  Consumptionsaving decisionmaking, Money illusion, Economic experiment 
JEL:  C90 D91 E21 E31 E40 
Date:  2016–04 
URL:  http://d.repec.org/n?u=RePEc:ime:imedps:16e06&r=upt 
By:  Cezar Toader; Cristian Anghel; Cristian Vele (Department of Economics and Physics, Technical University of Cluj Napoca) 
Abstract:  The paper presents optimum consumer issue, analyzed in two ways, when the consumer maximizes the usefulness and minimizes its costs that make them subject to the obtainment of a fixed utilities. The problem of optimal consumer is still very important in making the decision the consumer. Customer satisfaction was analyzed by a utility function. 
Keywords:  customer, optimum utility, costs, decision 
JEL:  C80 L11 M31 
Date:  2014–06 
URL:  http://d.repec.org/n?u=RePEc:clj:icmmae:1412&r=upt 
By:  Ceylan, Özcan 
Abstract:  This paper investigates marketwide risk aversion in an international setting. Particularly, this empirical study evaluates risk aversion spillover dynamics as an uncertainty transmission mechanism for the period 20002015 to reveal if there has been a significant change in these dynamics when markets are going through turbulent periods. As a plausible proxy for risk aversion, variance risk premium (VRP) is computed through the difference between expected variances under riskneutral and physical measures for seven markets studied: United States, United Kingdom, Germany, France, Netherlands, Switzerland and Japan. Effects of a shock to U.S. VRP on the other markets' VRPs are evaluated through Generalized Forecast Error Variance Decomposition. Results show that risk aversion spillovers from U.S. to other markets are stronger while the U.S. is going through turbulent periods confirming the intuition that investors are more focused on incidents in the turbulent market. Markets become more connected in terms of sentiments when a country is unexpectedly hit by a major crisis, limiting diversification opportunities. 
Keywords:  Investor sentiment, Risk aversion spillovers, Variance risk premium, Generalized forecast error variance decomposition, Investors' attention allocation, Financial crises. 
JEL:  D8 F36 G14 G15 
Date:  2016–05–09 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:71320&r=upt 
By:  Matthias Greiff; Kurt A. Ackermann; Ryan O. Murphy 
Abstract:  Different social contexts have been used when measuring distributional preferences. This could be problematic as contextual variance may inadvertently muddle the measurement process. We use a withinsubjects design and measure distributional preferences 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 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. 
Keywords:  Distributional preferences, social preferences, other regarding preferences, Social Value Orientation (SVO), measurement methods, individual differences 
JEL:  C91 D03 D64 
Date:  2016–04 
URL:  http://d.repec.org/n?u=RePEc:zur:econwp:224&r=upt 
By:  Robert Kollmann; Stefan Zeugner 
Abstract:  This note corrects Blanchard and Kahn’s (1980) solution for a linear dynamic rational expectations model with one state variable and one control variable. 
JEL:  C00 C60 E30 
Date:  2016–03 
URL:  http://d.repec.org/n?u=RePEc:eca:wpaper:2013/228886&r=upt 
By:  Hu, Xiaowen; Stowe, C. Jill 
Abstract:  This paper investigates the relationship between household income level and individual physical activity participation behavior. We investigate this issue through the lens of time preference. Our model considers income as a budget constraint of today as well as a component of future utility, and those with lower income discount future utility more heavily. Data from China Health and Nutrition Survey (CHNS) are tested utilizing a random effects method. The results show that both the likelihood to participate in physical activity and the time spent on physical activity are positively correlated with income. In general, these findings support the hypothesis that lowincome individuals are more likely to make poor choices with regard to future health, since they discount future utility relatively heavily. 
Keywords:  health choices, income, physical activity participation, time preference., Consumer/Household Economics, Food Consumption/Nutrition/Food Safety, Health Economics and Policy, Institutional and Behavioral Economics, 
Date:  2016 
URL:  http://d.repec.org/n?u=RePEc:ags:saea16:229984&r=upt 
By:  Balbás, Raquel; Balbás, Beatriz; Balbás, Alejandro 
Abstract:  Recent literature proved the existence of an unbounded market price of risk (MPR) or maximum generalized Sharpe ratio (GSR) if one combines the most important Brownianmotionlinked arbitrage free pricing models with a coherent and expectation bounded risk measure. Furthermore, explicit sequences of portfolios with a theoretical (risk, return) diverging to (1;+1) were constructed and their performance tested. The empirical evidence revealed that the divergence to (1;+1) is only theoretical (not real), but the MPR is much larger than the GSR of the most important international stock indices. The natural question is how to modify the available pricing models so as to prevent the caveat above. The theoretical MPR cannot equal inf nity but must be large enough (consistent with the empirical findings) and this will be the focus of this paper. It will be shown that every arbitrage free pricing model can be improved in such a manner that the new stochastic discount factor (SDF) satisfie the two requirements above, and the newMPR becomes bounded but large enough. This is important for several reasons; Firstly, if the existent models predict unrealistic price evolutions then these mistakes may imply important capital losses to practitioners and theoretical errors to researchers. Secondly, the lack of an unbounded MPR is much more coherent and consistent with equilibrium. Finally, the major discrepancies between the initial pricing model and the modifie one will affect the tails of their SDF, which seems to justify several empirical caveats of previous literature. For instance, it has been pointed out that it is not easy to explain the real quotes of many deeply OTM options with the existing pricing models. 
Keywords:  Discrepancy on tails; Coherent pricing; Market price of risk; Unbounded generalized Sharpe ratio; Risk measure 
JEL:  G13 G12 
Date:  2016–05–09 
URL:  http://d.repec.org/n?u=RePEc:cte:idrepe:22932&r=upt 
By:  Mackowiak, Bartosz Adam; Matejka, Filip; Wiederholt, Mirko 
Abstract:  Dynamic rational inattention problems used to be difficult to solve. This paper provides simple, analytical results for dynamic rational inattention problems. We start from the benchmark rational inattention problem. An agent tracks a variable of interest that follows a Gaussian process. The agent chooses how to pay attention to this variable. The agent aims to minimize, say, the mean squared error subject to a constraint on information flow, as in Sims (2003). We prove that if the variable of interest follows an ARMA(p,q) process, the optimal signal is about a linear combination of {X(t),...,X(tp+1)} and {e(t),... e(tq+1)}, where X(t) denotes the variable of interest and e(t) denotes its period t innovation. The optimal signal weights can be computed from a simple extension of the Kalman filter: the usual Kalman filter equations in combination with firstorder conditions for the optimal signal weights. We provide several analytical results regarding those signal weights. We also prove the equivalence of several different formulations of the information flow constraint. We conclude with general equilibrium applications from Macroeconomics. 
Keywords:  Kalman filter; Macroeconomics; rational inattention 
JEL:  C61 D83 E30 
Date:  2016–04 
URL:  http://d.repec.org/n?u=RePEc:cpr:ceprdp:11237&r=upt 
By:  Griffin, Jim; Liu, Jia; Maheu, John M 
Abstract:  Variance estimation is central to many questions in finance and economics. Until now expost variance estimation has been based on infill asymptotic assumptions that exploit highfrequency data. This paper offers a new exact finite sample approach to estimating expost variance using Bayesian nonparametric methods. In contrast to the classical counterpart, the proposed method exploits pooling over highfrequency observations with similar variances. Bayesian nonparametric variance estimators under no noise, heteroskedastic and serially correlated microstructure noise are introduced and discussed. Monte Carlo simulation results show that the proposed approach can increase the accuracy of variance estimation. Applications to equity data and comparison with realized variance and realized kernel estimators are included. 
Keywords:  pooling, microstructure noise, slice sampling 
JEL:  C11 C22 C58 G1 
Date:  2016–05–10 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:71220&r=upt 
By:  Matthew Polisson; Ludovic Renou 
Abstract:  Suppose that we have access to a finite set of expenditure data drawn from an individual consumer, i.e., how much of each good has been purchased and at what prices. Afriat (1967) was the first to establish necessary and sufficient conditions on such a data set for rationalizability by utility maximization. In this note, we provide a new and simple proof of Afriat's Theorem, the explicit steps of which help to more deeply understand the driving force behind one of the more curious features of the result itself, namely that a concave rationalization is without loss of generality in a classical finite data setting. Our proof stresses the importance of the nonuniqueness of a utility representation along with the finiteness of the data set in ensuring the existence of a concave utility function that rationalizes the data. 
Keywords:  Afriat's Theorem, concavity, revealed preference, utility maximization 
JEL:  C60 D11 
Date:  2016–04 
URL:  http://d.repec.org/n?u=RePEc:lec:leecon:16/09&r=upt 
By:  Jin Fan (School of Management, University of Science and Technology of China); Jun Li (School of Management, University of Science and Technology of China); Yanrui Wu (Business School, University of Western Australia); Shanyong Wang (School of Management, University of Science and Technology of China); Dingtao Zhao (School of Management, University of Science and Technology of China) 
Abstract:  Personal carbon trading (PCT) is a downstream capandtrade scheme which could be used to reduce carbon emissions from the household sector. To explore the effectiveness of this scheme, it is necessary to investigate how consumers respond to allowance price change.. In this paper, a general utility optimization (GUO) model and a constant elasticity of substitution (CES) utility function are proposed to examine the price, substitution and income effects of carbon allowance price changes. It is shown that higher income consumers are more sensitive to the allowance price changes than lower income consumers. Moreover, the shortrun adjustment in consumers’ consumption of electricity in response to a change in allowance price would be lower than the longrun value. According to the sensitivity analysis, downward (upward) adjustments in the elasticity of substitution result in a positive (negative) effect on price effect. The findings in this study are used to draw policy implications. Suggestions for future research are also provided. 
Date:  2016 
URL:  http://d.repec.org/n?u=RePEc:uwa:wpaper:1607&r=upt 