nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2016‒06‒14
fourteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Ellsberg Re-revisited: An Experiment Disentangling Model Uncertainty and Risk Aversion By Loic Berger; Valentina Bosetti
  2. Salience, Framing, and Decisions under Risk, Uncertainty, and Time By Jonathan W. Leland; Mark Schneider
  3. What is the Causal Impact of Knowledge on Preferences in Stated Preference Studies? By Nick Hanley; Mikolaj Czajkowski
  4. Unobserved Preference Heterogeneity in Demand Using Generalized Random Coefficients By Arthur Lewbel; Krishna Pendakur
  5. Diversification Benefits of Commodities: A Stochastic Dominance Efficiency Approach By Charoula Daskalaki; George Skiadopoulos; Nikolas Topaloglou
  6. State-dependent Preferences in Prediction Markets and Prices as Aggregate Statistic By Urmee Khan
  7. Savage's Theorem Under Changing Awareness By Dietrich, Franz
  8. Groups, Norms and Endogenous Membership: Towards a Socially Inclusive Economics By Raul V. Fabella
  9. Incentives in Experiments with Objective Lotteries By Paul J. Healy; Yaron Azrieli; Christopher P. Chambers
  10. Choice or information overload ? By Fabrice Le Lec; Marianne Lumeau; Benoît Tarroux
  11. Model of Behavior of the Consumer By Liliana Zima; Simona Sabou; Rita Toader; Cristian Anghel
  12. A Comparison of Stated and Revealed Risk Preferences using Safety-First By Sharma, Sankalp; Schoengold, Karina
  13. Currency demand stability in the presence of seasonality and endogenous financial innovation: Evidence from India By Singh, Sunny Kumar
  14. Consumer Willingness to Pay for Food Safety Interventions: The Role of Message Framing and Involvement By Britwum, Kofi; Yiannaka, Amalia

  1. By: Loic Berger (Fondazione Eni Enrico Mattei (FEEM)); Valentina Bosetti (Bocconi University and Fondazione Eni Enrico Mattei (FEEM))
    Abstract: The results of an experiment extending Ellsberg's setup demonstrate that attitudes towards ambiguity and compound uncertainty are closely related. However, this association is much stronger when the second layer of uncertainty is subjective than when it is objective. Provided that the compound probabilities are simple enough, we find that most subjects, consisting of both students and policy makers, (1) reduce compound objective probabilities, (2) do not reduce compound subjective probabilities, and (3) are ambiguity non-neutral. By decomposing ambiguity into risk and model uncertainty, and jointly eliciting the attitudes individuals manifest towards these two types of uncertainty, we characterize individuals' degree of ambiguity aversion. Our data provides evidence of decreasing absolute ambiguity aversion and constant relative ambiguity aversion.
    Keywords: Ambiguity Aversion, Model Uncertainty, Reduction of Compound Lotteries, Non-expected Utility, Subjective Probabilities, Decreasing Absolute Ambiguity Aversion
    JEL: D81
    Date: 2016–05
  2. By: Jonathan W. Leland (Division of Social and Economic Sciences, National Science Foundation); Mark Schneider (Economic Science Institute, Chapman University)
    Abstract: We propose a comparative model of decision making under risk, uncertainty, and time, in which large differences in payoffs and probabilities or dates of receipt are perceived as salient and overweighted in the evaluation process. The predictions of the model depend on what differences are compared across alternatives which, in turn, depends on how the choice is framed. We formalize a class of matrix-based frames which applies to decisions under risk, uncertainty, and time, and we specify two important types of frames within this class: minimal frames which provide the simplest representation of choice alternatives, and transparent frames which make the normative appeal of the classical rationality axioms more transparent. We also propose two simple and natural assumptions regarding the perceived salience of differences in numerical magnitudes. We show that the model predicts systematic framing effects in which people will exhibit major violations of rational choice theory (the Allais paradox, common ratio effect, Ellsberg paradox, present bias, and violations of stochastic dominance) when the options are represented in a minimal frame but will behave more consistently with the classical axioms when the same choices are presented in a transparent frame. The model employs the same salience-based decision algorithm across the domains of risk, uncertainty, and time, thus providing a unified approach to explaining choice anomalies as decision errors. Moreover, because it maintains the assumption that preferences obey expected and discounted utility, it facilitates traditional welfare analysis.
    Keywords: Salience Perception; Allais Paradox; Ellsberg Paradox; Present Bias; Diminishing Sensitivity
    JEL: D03 D81
    Date: 2016
  3. By: Nick Hanley (Department of Geography and Sustainable Development, University of St. Andrews); Mikolaj Czajkowski (University of Warsaw, Department of Economic Sciences, Poland)
    Abstract: This paper reports the results of a stated preference experiment designed to test for how information provided in a survey affects knowledge, and how knowledge affects preferences for a public good. A novel experimental design allows us to elicit subjects’ ex ante knowledge levels about a good’s attributes, exogenously vary how much new objective information about these attributes we provide to subjects, elicit subjects’ valuation for the good, and elicit posterior knowledge states about the same attributes. We find evidence of incomplete learning and fatigue: as subjects are told more information, their marginal learning rates decrease. We find there is no marginal impact of knowledge on the mean nor the variance of WTP for changes in the environmental good; but that ex ante knowledge does affect stated WTP. Our results are consistent with preference formation models of confirmation bias, costly search, or timing differences in learning and preference formation. Our results raise questions about the purpose and effects of providing information in stated preference studies
    Keywords: Learning, Information, Behavioral Economics, Decision Making Under Uncertainty
    JEL: D83 D81 Q51
    Date: 2016–04
  4. By: Arthur Lewbel (Boston College); Krishna Pendakur (Simon Fraser University)
    Abstract: We prove a new identification theorem showing nonparametric identification of the joint distribution of random coefficients in general nonlinear and additive models. This differs from existing random coefficients models by not imposing a linear index structure for the regressors. We then model unobserved preference heterogeneity in consumer demand as utility functions with random Barten scales. These Barten scales appear as random coefficients in nonlinear demand equations. Using Canadian data, we compare estimated energy demand functions with and without random Barten scales. We find that unobserved preference heterogeneity substantially affects the estimated consumer surplus costs of an energy tax.
    Keywords: unobserved heterogeneity, nonseparable errors, random utility parameters, random coefficients, equivalence scales, consumer surplus, welfare calculations
    JEL: C14 D12 D13 C21
    Date: 2015–11
  5. By: Charoula Daskalaki (University of Piraeus); George Skiadopoulos (Queen Mary University of London and University of Piraeus); Nikolas Topaloglou (Athens University of Economics and Business)
    Abstract: We revisit the question whether commodities should be included in investors' portfolios. We employ for the first time a stochastic dominance efficiency (SDE) approach to construct optimal portfolios with and without commodities and we evaluate their comparative performance. SDE circumvents the necessity to posit a specific utility function to describe investor's preferences and it does not impose distributional assumptions on asset returns. We find that commodities provide diversification benefits both in- and out- of-sample. This evidence is stronger when commodity indices which mimic dynamic commodity trading strategies are used. We explain our results by documenting that commodity markets are segmented from the equity and bond markets.
    Keywords: Alternative investments, Commodity indices, Market integration, Portfolio choice, Stochastic dominance
    JEL: C1 C4 C6 G10 G11
    Date: 2016–05
  6. By: Urmee Khan (Department of Economics, University of California Riverside)
    Abstract: If traders in prediction markets have state-dependent preferences so that marginal utility of money varies across states, prices in a Rational Expectation equilibrium are quantile statistics of distributions that de- rive from both the distribution of realized signals, and the distribution of state-dependence parameters. As a result, even with a common prior and regardless of whether prices reveal realized signals fully or not, the interpretation of prices as posterior probabilities remains problematic.
    Keywords: Prediction markets, information aggregation, state-dependent preferences
    Date: 2016–04
  7. By: Dietrich, Franz
    Abstract: This paper proposes a simple unified framework of changing awareness, addressing both outcome and (nature) state awareness, and both how fine and how exhaustive the awareness is. Six axioms characterize an (essentially unique) expected-utility representation of preferences, in which utilities and probabilities are revised systematically under changes in awareness. Revision is governed by three well-defined rules: (R1) certain utilities are transformed affinely, (R2) certain probabilities are transformed proportionally, and (R3) certain (`objective') probabilities are preserved. Rule R2 parallels Karni and Viero's (2013) 'reverse Bayesianism' and Ahn and Ergin's (2010) 'partition-dependence'. Savage's (1954) theorem emerges in the special case of fixed awareness. The theorem draws mathematically on Kopylov (2007), Niiniluoto (1972) and Wakker (1981).
    Keywords: Decision under uncertainty, outcome unawareness versus state unawareness, non-refinement versus non-exhaustiveness, utility revision versus probability revision
    JEL: D80 D81
    Date: 2016
  8. By: Raul V. Fabella (School of Economics, University of the Philippines Diliman; National Academy of Science and Technology)
    Abstract: In Part I, we argue that Economics must outgrow the narrow confines of Neo-Classical Economics to embrace ‘sociality’ first championed by Herbert Simon in the mid-1950s and now by a growing number of economists under the banner of Social Economics. We contend here that Neo-Classical Economics is incomplete, rather than wrong. Firstly any alternative model must subsume the Neo-Classical model as a special case even as it embraces conceptual promontories from other social science disciplines, viz., groups, norms and sanctions. Secondly, it must be couched in a language familiar to the economics profession? maintain optimizing behavior and equilibrium analysis. In Part II, we construct a formal model where the agent is at once a private entity and a member of a social group; his utility is inclusive combining the agent’s private utility over goods (the Neo-Classical utility) and the utility the he derives from being a member, viz., access to group’s collective good. As a member, he commits to support the procurement of the group’s collective good and submits to a system of norms and to the corresponding self-organized sanctions regime punishing violation of group norms. The agent solves a sequence of optimization problems: the first determines his optimal consumption basket given his budget constraint (net of group contribution), prices in the market location of the group; this gives his inclusive indirect utility; the second determines his optimal market hours by maximizing his indirect inclusive utility subject to time constraint and the market wage rate; this gives his doubly indirect inclusive utility; thirdly, he maximizes his inclusive doubly indirect utility with respect to the monetary contribution of the group given the sanctions for norm violation. The choice of social group follows from a rank order of groups by greatest inclusive utility an agent can attain in each competing social group. Finally, we show how the agent’s relative weighting of his private and group commitment may wax and wane depending upon the stakes of the inter-group competition.
    Keywords: Sociality, groups, norms, choice of groups, compliance with norms, inter-group competition
    JEL: D01 D11
    Date: 2016–05
  9. 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: When subjects in an experiment are given multiple decisions, their choices in one decision may be distorted by the choices made in others. An experiment’s payment mechanism is incentive compatible if no such distortions occur. Azrieli et al. (2014) provide two characterizations of incentive compatible mechanisms in a general decision-theoretic framework in subjects’ choices are represented as Savage-style acts. In particular, paying for one randomly-chosen problem — the Random Problem Selection (RPS) mechanism — is incentive compatible when we assume preferences satisfy event-wise monotonicity, and nothing else. Here, we consider the case where subjects view gambles as objective lotteries. Using completely different proof techniques, we show that the set of incentive compatible mechanisms under the monotonicity assumption is strictly larger than in the acts case. We discuss these new incentive compatible mechanisms in detail.
    Keywords: Experimental design, decision theory, mechanism design
    JEL: D81 D84
    Date: 2016–05
  10. By: Fabrice Le Lec (CES, Université de Paris 1, France); Marianne Lumeau (CEPN, Université de Paris 13, LABEX ICCA, France); Benoît Tarroux (CREM, UMR CNRS 6211, Faculté des Sciences Économiques, Université de Rennes 1, France)
    Abstract: This paper aims to test how the profusion of choice and information affects individuals' decisions. In particular, we investigate whether the possible choice overload effects are due to the mere presence of many alternatives or the difficulty in processing abundance of information that comes with the proliferation of options. To do so, we use the frequency with which familiar alternatives are preferred to unfamiliar ones as a behavioural measure of overload. We first propose an individual decision model, in which uncertainty about values of alternatives leads consumer to prefer familiar goods. We use this theoretical approach to devise an experiment where the level of information and the number of alternatives systematically vary. Our results show that individuals are prone to overload in the presence of larger choice sets, but that information has a small impact, if any.
    Keywords: Choice overload; Information overload; Bounded rationality; Familiarity; Experimental Economics
    JEL: C91 D03 D83
    Date: 2016–04
  11. By: Liliana Zima; Simona Sabou; Rita Toader; Cristian Anghel (Department of Economics and Physics, Technical University of Cluj Napoca)
    Abstract: The paper presents analysis of factors that influence consumer behavior, pattern of behavior of the consumer using Lagrange multiplier, the function of utility to the consumer preferences and elasticity Analysis application on the basis of income and price.
    Keywords: consumer behavior, factors, analysis, model, Lagrange multiplier
    JEL: C80 L11 M31
    Date: 2014–06
  12. By: Sharma, Sankalp; Schoengold, Karina
    Abstract: Our dataset is confidential and the resulting analysis cannot be shared without the permission of USDA-NASS. We are awaiting the completion of their internal review of our work and then the results will be shared.
    Keywords: Risk analysis, risk aversion, farm decision-making, Crop Production/Industries, Farm Management, Institutional and Behavioral Economics, Production Economics, Risk and Uncertainty, Q10, Q12, Q18,
    Date: 2016
  13. By: Singh, Sunny Kumar
    Abstract: Based on the money-in-the-utility function, this paper intends to examine the stability of the currency demand function for India with real private consumption expenditure, tax-GDP ratio and deposit rate as explanatory variables by applying the seasonal cointegration technique developed by EGHL (1993) and HEGY (1990) for the period 1996:1 to 2014:4. The empirical findings show that there is absence of long-run cointegrationg relationship among the variables at the zero and annual frequency, however, there is evidence of a relationship among the variables at the biannual frequency. Moreover, the time-varying coefficient of deposit rate elasticity, used to test the Gurley-Shaw hypothesis, suggests that innovations in financial markets, especially improvements in the payment technology, raises the deposit rate elasticity, beginning from 2010 onward.
    Keywords: Currency demand; Seasonal cointegration; Seasonal error correction; Financial innovation; State-space Modeling
    JEL: E51 O3
    Date: 2016–01–01
  14. By: Britwum, Kofi; Yiannaka, Amalia
    Abstract: Research on recent pre-slaughter interventions in the beef industry, particularly vaccinations and direct-fed microbials, have proven their effectiveness in reducing E. coli contamination in beef. In spite of such evidences, adoption of these technologies have been minimal. This study determined consumer response and willingness to pay (WTP) for beef products from cattle vaccinated against E. coli and given direct-fed microbials, and evaluated multiple message frames and their persuasive impacts on WTP for the technologies. Respondents were grouped into six information treatments, and were exposed to gain-framed and loss-framed messages, a media food safety story, and combinations of the media story and the gain-framed and loss-framed messages. A survey which included a choice experiment targeted a representative, random sample of 1,879 residents across the U.S in July and August 2015. A random parameters logit model found that consumers preferred animal vaccines over direct-fed microbials, and preferred either intervention to none at all. Corroborating prospect theory’s loss aversion, the loss-framed message, and the combined loss-framed message with the media story were the most persuasive, inducing the highest WTP. These findings altogether present an optimistic outlook about consumers’ openness to these technologies, and are of interest to agents in the beef sector who influence the variety and presentation of consumption choices available to consumers.
    Keywords: direct-fed microbials, message framing, vaccines, willingness to pay., Consumer/Household Economics, Food Consumption/Nutrition/Food Safety, Institutional and Behavioral Economics, D11 D12 Q13,
    Date: 2016–05–25

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