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on Utility Models and Prospect Theory |
| By: | Chaim Fershtman (Tel Aviv University); Uzi Segal (Boston College) |
| Abstract: | Interaction between decision makers may affect their preferences. We consider a setup in which each individual is characterized by two sets of preferences: his unchanged core preferences and his behavioral preferences. Each individual has a social influence function that determines his behavioral preferences given his core preferences and the behavioral preferences of other individuals in his group. Decisions are made according to behavioral preferences. The paper considers different properties of these social influence functions and their effect on equilibrium behavior. We illustrate the applicability of our model by considering decision making by a committee that has a deliberation stage prior to voting. |
| Keywords: | Risk aversion, social influence, behavioral preferences |
| JEL: | D81 |
| Date: | 2016–05–20 |
| URL: | http://d.repec.org/n?u=RePEc:boc:bocoec:912&r=upt |
| By: | Paul J. Healy (Department of Economics, Ohio State University); Yaron Azrieli (Department of Economics, Ohio State University); Christopher P. Chambers (Department of Economics, University of California, San Diego) |
| Abstract: | Experimental economists currently lack a convention for how to pay subjects in experiments with multiple tasks. We provide a theoretical framework for analyzing this question. Assuming monotonicity (dominated gambles are never chosen) and nothing else, we prove that paying for one randomly-chosen problem — the random problem selection (RPS) mechanism — is essentially the only incentive compatible mechanism. Paying for every period is similarly justified when we assume only a ‘no complementarities at the top’ (NCaT) condition. To help experimenters decide which is appropriate for their particular experiment, we also discuss empirical tests of these two assumptions. |
| Keywords: | Experimental design, decision theory, mechanism design |
| JEL: | C90 D01 D81 |
| Date: | 2016–01 |
| URL: | http://d.repec.org/n?u=RePEc:osu:osuewp:16-03&r=upt |
| By: | Shahzad Ahmad (State Bank of Pakistan); Farooq Pasha (State Bank of Pakistan); Muhammad Rehman (State Bank of Pakistan) |
| Abstract: | This paper theoretically evaluates the role of money and monetary policy in propagating business cycle fluctuations of Pakistan’s economy. We introduce the role of money via money in utility (MIU) and cash in advance constraint (CIA) in simple closed economy DSGE models and analyze monetary policy through a money growth rule as well as Taylor type interest rate rule. We establish the theoretical and empirical linkages between nominal and real variables of Pakistan’s economy for post financial liberalization era. We find that the cash base economy models under money growth rule matches the data relatively better compared to cashless economy with Taylor rule. |
| Keywords: | General Equilibrium Models, Modeling and Simulations, Monetary Policy |
| JEL: | D58 E27 E52 |
| Date: | 2016–04 |
| URL: | http://d.repec.org/n?u=RePEc:sbp:wpaper:74&r=upt |
| By: | Rossen Rozenov |
| Abstract: | The paper offers a non-probabilistic framework for representation of uncertainty in the context of a simple linear-quadratic model of fiscal adjustment. Instead of treating model disturbances as random variables with known probability distributions, it is only assumed that they belong to some pre-specified compact set. Such an approach is appropriate when the decision maker does not have enough information to form probabilistic beliefs or when considerations for robustness are important. Solution of the model in the minimax sense when disturbance sets are ellipsoids is obtained and the application of the method is illustrated using the example of Portugal. |
| Keywords: | Fiscal adjustment;Fiscal consolidation;Fiscal policy;Econometric models;Fiscal consolidation, decisions theory, uncertainty, minimax |
| Date: | 2016–03–17 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:16/69&r=upt |
| By: | Caroline J. Charpentier; Jan-Emmanuel De Neve; Jonathan P. Roiser; Tali Sharot |
| Abstract: | Intuitively, how we feel about potential outcomes will determine our decisions. Indeed, one of the most influential theories in psychology, Prospect Theory, implicitly assumes that feelings govern choice. Surprisingly, however, we know very little about the rules by which feelings are transformed into decisions. Here, we characterize a computational model that uses feelings to predict choice. We reveal that this model predicts choice better than existing value-based models, showing a unique contribution of feelings to decisions, over and above value. Similar to Prospect Theory value function, feelings showed diminished sensitivity to outcomes as value increased. However, loss aversion in choice was explained by an asymmetry in how feelings about losses and gains were weighed when making a decision, not by an asymmetry in the feelings themselves. The results provide new insights into how feelings are utilized to reach a decision. |
| Keywords: | decision-making; feelings; subjective well-being; value; utility; Prospect theory |
| JEL: | G32 |
| Date: | 2016–02 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:66420&r=upt |
| By: | Capéau, Bart; Decoster, André |
| Abstract: | This paper exploits the distinction between preference and opportunity factors in a Random Utility and Random Opportunity (RURO) model of job choice (Aaberge, Dagsvik and Strøm, 1995, and Aaberge, Colombino and Strøm, 1999). We estimate the model on Belgian data (SILC 2007). To investigate to what extent lower labour market participation of elderly is due to changing preferences (executing a job might become less enjoyable with age) or to differences in opportunities (elderly getting less, or less attractive job offers), we use the estimated model to simulate two counterfactuals. In the first, we remove partly the age heterogeneity in opportunities, in the second we remove age heterogeneity in preferences. A comparison of labour market behaviour in these two counterfactuals with the baseline shows that opportunities which decline with age are at least as an important factor in explaining low participation rates for the elderly, as is increasing preference for leisure. The effect of opportunities seems to work primarily through the extensive margin, whereas the effect of preferences is more outspoken in the intensive than in the extensive margin. |
| Date: | 2016–05–19 |
| URL: | http://d.repec.org/n?u=RePEc:ese:emodwp:em4-16&r=upt |
| By: | Santiago I. Sautua |
| Abstract: | Attitudes toward risk in?uence the decision to diversify among uncertain options. Yet, because in most situations the options are ambiguous, attitudes toward ambiguity may also play an important role. I conduct a laboratory experiment to investigate the effect of ambiguity on the decision to diversify. I fi?nd that diversi?cation is more prevalent and more persistent under ambiguity than under risk. Moreover, excess diversi?cation under ambiguity is driven by participants who stick with a status quo gamble when diversi?cation among gambles is not feasible. This behavioral pattern cannot be accommodated by major theories of choice under ambiguity |
| Keywords: | risk, ambiguity, inertia, diversi?cation, reference-dependent preferences, indecisiveness, ambiguity aversion |
| JEL: | C91 D01 D03 D81 |
| Date: | 2016–03–11 |
| URL: | http://d.repec.org/n?u=RePEc:col:000092:014588&r=upt |
| By: | Shaolin Ji; Xiaomin Shi |
| Abstract: | This paper concerns the recursive utility maximization problem under partial information. We first transform our problem under partial information into the one under full information. When the generator of the recursive utility is concave, we adopt the variational formulation of the recursive utility which leads to a stochastic game problem and a characterization of the saddle point of the game is obtained. Then, we study the K-ignorance case and explicit saddle points of several examples are obtained. At last, when the generator of the recursive utility is smooth, we employ the terminal perturbation method to characterize the optimal terminal wealth. |
| Date: | 2016–05 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1605.05802&r=upt |
| By: | Timo Boppart; Per Krusell |
| Abstract: | What explains how much 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. |
| JEL: | E21 J22 O11 O40 |
| Date: | 2016–05 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:22215&r=upt |
| By: | Christoph Heinzel |
| Abstract: | Previous research on the measurement of the strength of the precautionary saving motive has concentrated on reactions to an exogenous risk on future income. Complementing the work by Liu (2014), I derive a statement analogous to Ross' (1981)comparative risk aversion for precautionary saving under return-risk increases. The main theorem involves a comparison based on precautionary premia, whose definition deals explicitly with the immediate endogeneity of risk exposure under return risk. I also define preference-intensity measures and state conditions for a representation of the comparative strength of the precautionary-saving motive equivalent to the main theorem. All comparisons apply to a wide range of definitions of risk increases. |
| JEL: | D91 D81 |
| Date: | 2016–05 |
| URL: | http://d.repec.org/n?u=RePEc:fsc:fspubl:42&r=upt |
| By: | Xing, Ran (Tilburg University, School of Economics and Management) |
| Abstract: | This dissertation studies how mutual funds and hedge funds manage their liquidity and reduce trading costs, and the pricing of liquidity level and liquidity risk in financial markets. Chapter 1 documents the trading behavior of actively managed equity mutual funds from the perspective of their trading cost management. Chapter 2 analyzes what size for the liquidity risk premium can be justified theoretically. Here we calculate the liquidity risk premiums demanded by large investors by solving a dynamic portfolio choice problem with stochastic price impact of trading, CRRA utility and a time-varying investment opportunity set. Chapter 3 studies how hedge funds adjusted their holdings of liquid and illiquid stocks before, during and after the 2008 financial crisis. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:tiu:tiutis:1df96fc1-de24-4e94-a747-3a852fef4588&r=upt |
| By: | Julien Blasco; Graciela Chichilnisky |
| Abstract: | This article focuses on the work of O. Chanel and G. Chichilnisky (2013) on the flaws of expected utility theory while assessing the value of life. Expected utility is a fundamental tool in decision theory. However, it does not fit with the experimental results when it comes to catastrophic outcomes ---see, for example, Chichilnisky (2009) for more details. In the experiments conducted by Olivier Chanel in 1998 and 2009, several subjects are ask to imagine they are presented 1 billion identical pills. They are paid \$220,000 to take and swallow one, knowing that one out of 1 billion is deadly. The objective of this article is to show that risk aversion phenomenon cannot explain the experimental results found. This is an additional reason why a new kind of utility function is necessary: the axioms proposed by Graciela Chichilnisky will be briefly presented, and it will be shown that it better fits with experiments than any risk aversion utility function. |
| Date: | 2015–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1604.05672&r=upt |
| By: | Ferrer, Rosa; Perrone, Helena |
| Abstract: | This paper investigates how consumers react to product safety threats when there are no close substitutes for the unsafe product. Our main goal is to study the total costs of the crisis to consumers including the utility losses associated with substituting away from their favorite products, and to derive policy implications. Using data from an ideal setting related to mad cow disease, we estimate a full demand model for meat and identify the utility parameters that weight the importance of product safety relative to other product characteristics. We find that the consumers' response leads to utility losses and nutritional costs due to changes in the composition of the food basket. Counterfactual exercises isolate the different drivers of the consumers' reaction, measuring the contributions of these factors and identifying conditions that would have intensified the decline in demand. Based on our results, public intervention can play a stronger role in terms of complementing market incentives when the threat affects products for which consumers' response is costlier. |
| Keywords: | consumer welfare; Demand estimation; scanner data |
| JEL: | K13 L66 |
| Date: | 2016–05 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:11262&r=upt |
| By: | Luigi Mittone; Gian Paolo Jesi |
| Abstract: | The Allingham and Sandmo model is an adaptation of the standard expected utility maximization framework where the taxpayer is defined as a representative agent who is coping with a risky choice. The main limit of this model regards the assumption of perfect rationality from the agent’s side and the impossibility to study at the macro level a situation where many heterogeneous agents interact together. The aim of this work is to try to overcome, at least partially, some of the neoclassical standard approaches in this field. More precisely, we present a very simplified, agent- based, fiscal system with heterogeneous tax payers, interacting within a public good game framework. Heterogeneity has been introduced in our model by designing the agents like simple heuristics. The environment has been designed by a voluntary supply public good context reinforced through tax audits and fines. Looking for more realism, we also allowed agents to mutate their heuristics and we introduced two cross sectional types of agents: the “employees" and the “self-employees" allowing our agents to switch from one type to the other and vice-versa. Finally, the system is dynamic over time, since new agents can join over time to mimic the idea of having a growing population over time. We obtained a complex adaptive system (CAS) with heterogeneous agents, dynamically evolving, able to describe the adaptation of agent’s behaviour either concerning evading decision and the preferred kind of heuristic. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:trn:utwpce:1605&r=upt |
| By: | Hugo Cruz-Sanchez |
| Abstract: | We provide foundations for decisions in face of unlikely events by extending the standard framework of Savage to include preferences indexed by a family of events. We derive a subjective lexicographic expected utility representation which allows for infinitely many lexicographically ordered levels of events and for event-dependent attitudes toward risk. Our model thus provides foundations for models in finance that rely on different attitudes toward risk (e.g. Skiadas [9]) and for off-equilibrium reasonings in infinite dynamic games, thus extending and generalizing the analysis in Blume, Brandenburger and Dekel [3]. |
| Date: | 2016–05 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1605.07680&r=upt |
| By: | Wolfe, Elijah; Popp, Michael; Bazzani, Claudia; Nayga Jr, Rudolfo; Danforth, Diana; Popp, Jennie; Chen, Pengyin; Seo, Han-Seok |
| Keywords: | Edamame, non-hypothetical experimental auction, sensory test, willingness to pay, Agribusiness, Consumer/Household Economics, Food Consumption/Nutrition/Food Safety, Institutional and Behavioral Economics, Marketing, Q12, D12, |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:ags:saea16:230016&r=upt |
| By: | Rosato, Antonio; Tymula, Agnieszka A. |
| Abstract: | A key prediction of expectations-based reference-dependent preferences and loss aversion in second-price (Vickrey) auctions with private values is that the number of bidders should affect bids in auctions for real objects but not in auctions with induced monetary values. We develop an experiment with a within-subject design aimed at testing this distinctive comparative statics prediction. Our results are consistent with expectations-based reference-dependent preferences and loss aversion. In real-object auctions, we find that subjects' bids are affected by the number of competitors and, on average, they decline with the intensity of competition. In induced-value auctions, instead, bids are unaffected by the intensity of competition. We also successfully replicate an experiment from Sprenger (2015) aimed at distinguishing expectations-based loss aversion from models of Disappointment Aversion. This provides additional evidence that our findings in the auction experiments are due to expectations-based loss aversion. |
| Keywords: | Utility; decision-making; reference point; neuroeconomics |
| Date: | 2016–05 |
| URL: | http://d.repec.org/n?u=RePEc:syd:wpaper:2016-09&r=upt |