nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2016‒08‒21
thirteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Random Expected Utility and Certainty Equivalents: Mimicry of Probability Weighting Functions By Wilcox, Nathaniel
  2. Gender Wage Gaps and Risky vs. Secure Employment: An Experimental Analysis By Jung, Seeun; Choe, Chung; Oaxaca, Ronald L.
  3. Ambiguity and Time-Varying Risk Aversion in Sovereign Debt Markets By Christoph Große Steffen; Maximilian Podstawski
  4. Do People Anticipate Loss Aversion By Alex Imas; Anya Samek; Sally Sadoff
  5. Early resolution of uncertainty and asset prices By Richard Kihlstrom; Christian Gollier
  6. Estimating household neediness from disaggregate expenditures By Ligon, Ethan
  7. Completing incomplete preferences By Qiu, Jianying
  8. Global variance term premia and intermediary risk appetite By Van Tassel, Peter; Vogt, Erik
  9. Rational allocation of attention in decision-making By Schmitt, Stefanie Yvonne
  10. An Experimental Study of Decision Process with Interactive Technology By Anya Samek; Inkyoung Hur; Ji Soo Yi; Sung-Hee Kim
  11. The Impact of Self-Control on Investment Decisions By Lucks, Konstantin
  12. Duality theory for portfolio optimisation under transaction costs By Christoph Czichowsky; Walter Schachermayer
  13. Remittances and Asset Accumulation of Household in Pakistan By Fatima, Kiran; Qayyum, Abdul

  1. By: Wilcox, Nathaniel
    Abstract: For simple prospects of the kind routinely used for certainty equivalent elicitation, random expected utility preferences imply a conditional expectation function that can mimic deterministic rank dependent preferences. That is, an agent with random expected utility preferences can have mean certainty equivalents that look exactly like rank dependent probability weighting functions of the inverse-s shape discussed by Quiggin (1982) and later advocated by Tversky and Kahneman (1992) and other scholars. It seems that certainty equivalents cannot nonparametrically identify preferences, at least not in every relevant sense, since their conditional expectation depends on assumptions concerning the source and nature of their variability.
    Keywords: "Random Expected Utility", "Certainty Equivalents", "Money Equivalents", "Probability Weighting", "Probability Weighting Function", "Weighting Function"
    JEL: C13 C91 D81
    Date: 2016–08–11
  2. By: Jung, Seeun (Inha University); Choe, Chung (Hanyang University); Oaxaca, Ronald L. (University of Arizona)
    Abstract: In addition to discrimination, market power, and human capital, gender differences in risk preferences might also contribute to observed gender wage gaps. We conduct laboratory experiments in which subjects choose between a risky (in terms of exposure to unemployment) and a secure job after being assigned in early rounds to both types of jobs. Both jobs involve the same typing task. The risky job adds the element of a known probability that the typing opportunity will not be available in any given period. Subjects were informed of the exogenous risk premium being offered for the risky job. Women were more likely than men to select the secure job, and these job choices accounted for between 40% and 77% of the gender wage gap in the experiments. That women were more risk averse than men was also manifest in the Pratt-Arrow Constant Absolute Risk Aversion parameters estimated from a random utility model adaptation of the mean-variance portfolio model.
    Keywords: occupational choice, gender wage differentials, risk aversion, lab experiment
    JEL: J16 J24 J31 C91 D81
    Date: 2016–08
  3. By: Christoph Große Steffen; Maximilian Podstawski
    Abstract: This paper introduces changes in the level of ambiguity as a complementary source of time-varying risk aversion. We show in a consumption-based asset pricing model with simultaneously risky and ambiguous assets that a rise in the level of ambiguity raises investors' risk aversion. The effect is quantified in an application to European sovereign debt markets using a structural VAR to achieve identification in the data. We proxy for ambiguity using a measure of macroeconomic uncertainty and decompose empirically credit default swaps (CDS) for Spain and Italy into three shocks: fundamental default risk, risk aversion, and uncertainty. We find that shocks to uncertainty significantly increase international investors' risk aversion, accounting for about one fifth of its variation at a five week horizon, and have a significant and economically relevant impact on sovereign financing premia
    Keywords: Time-varying risk aversion, Ambiguity, Uncertainty, Sovereign debt, Identification via heteroscedasticity, Maxmin
    JEL: C32 D80 E43 G01 H63
    Date: 2016
  4. By: Alex Imas; Anya Samek; Sally Sadoff
    Abstract: There is growing interest in the use of loss contracts that offer performance incentives as upfront payments that employees can lose. Standard behavioral models predict a tradeoff in the use of loss contracts: employees will work harder under loss contracts than under gain contracts; but, anticipating loss aversion, they will prefer gain contracts to loss contracts. In a series of experiments, we test these predictions by measuring performance and preferences for payoff-equivalent gain and loss contracts. We find that people indeed work harder under loss than gain contracts, as the theory predicts. Surprisingly, rather than a preference for the gain contract, we find that people actually prefer loss contracts. In exploring mechanisms for our results, we find suggestive evidence that people do anticipate loss aversion but select into loss contracts as a commitment device to improve performance.
    Date: 2015
  5. By: Richard Kihlstrom (University of Pennsylvania); Christian Gollier (University of Toulouse)
    Abstract: We characterize the properties of the term structures of the risk-free interest rates and of the equity premia when the representative agent has Epstein-Zin-Weil preferences. We consider a simple 3-date model with various forms of predictability of consumption growth. When risk aversion is larger than the aversion to consumption fluctuations, the persistency of the first-period shock on consumption reduces the short interest rate but raises the long interest rate. It raises the short equity premium, but it reduces the long equity premium.
    Date: 2016
  6. By: Ligon, Ethan
    Abstract: Understanding how marginal utilities of expenditure evolve over time is key to the specification, the estimation, and the testing of dynamic consumer behavior. But in existing dynamic models researchers often (perhaps implicitly) assume that Engel curves are linear. This allows one to specify marginal utilities as a function of nothing more than real expenditures, but is sharply at odds with strong empirical evidence against linearity, including Engel's Law. Here we show how one can use data on disaggregate expenditures to estimate demand systems that may feature highly non-linear Engel curves; this same estimation procedure yields summary measures of household welfare within the period which we call "neediness". Our neediness measure is of interest in its own right, and can also be used to construct measures of inequality and poverty which match conventional measures given prevailing prices, but which also describe how inequality and poverty would be different were prices different. Beyond this, it is intimately related to the marginal utilities of expenditure that are critical in dynamic models. We illustrate the use of these methods using data from Uganda to estimate an incomplete demand system, and to estimate household neediness in different periods. This offers measures of the distribution of welfare and how this distribution changes over time. Our measure of household neediness can also be regarded as an index of the marginal utility of expenditures, which plays a central role in models involving dynamics and risk. We use our estimates to look for evidence of either borrowing or savings constraints, and find no such evidence; separately, we find strong evidence of heterogeneity in relative risk aversion.
    Keywords: Social and Behavioral Sciences, Neediness, Frisch demands, Marginal Utility of Expenditures, Relative Risk Aversion, Uganda
    Date: 2016–08–17
  7. By: Qiu, Jianying
    Abstract: We propose a model for individuals who have incomplete preferences and attempt to complete them. We show that two empirical puzzles ‑ the willingness-to-pay and willingness-to-ask (WTP-WTA) gap as well as the present bias ‑ arise naturally in the process of completing incomplete preferences. Based on the model, an incentive-compatible mechanism to measure the incompleteness in preferences is developed. An experimental implementation of the measurement mechanism provides results consistent with our model.
    Keywords: incomplete preferences, incentive-compatible measurement mechanism, experiments, the incompleteness in preferences
    JEL: B40 C91 D81
    Date: 2015–03–08
  8. By: Van Tassel, Peter (Federal Reserve Bank of New York); Vogt, Erik (Federal Reserve Bank of New York)
    Abstract: Sellers of variance swaps earn time-varying risk premia for their exposure to realized variance, the level of variance swap rates, and the slope of the variance swap curve. To measure risk premia, we estimate a dynamic term structure model that decomposes variance swap rates into expected variances and term premia. Empirically, we document a strong global factor structure in variance term premia across the U.S., U.K., Europe, and Japan. We further show that variance term premia are negatively correlated with the risk appetite of hedge funds, broker-dealers, and mutual funds. Our results support the hypothesis that financial intermediaries are marginal investors in the variance swap market.
    Keywords: variance swap; variance risk premium; term structure; empirical asset pricing; volatility; financial intermediaries
    JEL: C58 G12 G13
    Date: 2016–08–12
  9. By: Schmitt, Stefanie Yvonne
    Abstract: This paper proposes a model of attention allocation in decision-making. Attention has various definitions across the literature. Here, I understand attention as selecting information for costly processing. The paper investigates how an agent rationally allocates attention. The resulting attention allocation is context-dependent and influences choice quality. Next to inattention, two strategies of allocating attention prevail. These strategies share similarities with bottom-up and top-down attention - concepts reported in the psychological literature. Exploring firms' strategic considerations reveals an incentive for firms to produce high quality and highlight quality, if consumers expect low quality, and to exploit consumers by producing low quality and shrouding quality, if agents expect high quality.
    Keywords: rational attention,information-processing,decision-making,shrouding
    JEL: D10 D03 D81 D83 L15
    Date: 2016
  10. By: Anya Samek; Inkyoung Hur; Ji Soo Yi; Sung-Hee Kim
    Abstract: We investigate the effect of different interactive technologies on the decision-making process in an information search laboratory experiment. In our experiment, the participant makes a selection from a list of differently-valued objects with multiple attributes. We compare presenting information in static form to two methods of interactive presentation. In the first, the participant can manually sort objects by attribute, a capability similar to that found in spreadsheet software. In the second, we present an interactive visual tool that (1) automatically sorts all objects by attribute and (2) uses visual cues for comparisons. Manual sorting capability does not cause an improvement in decisions in this context. On the other hand, the visual tool increases the value of the objects selected by the participant and decreases time spent deliberating. We also find that our interactive presentations affect the decision-making process of participants by changing the number of intermediate options considered. Our results highlight the importance of investigating the effect of technology on information search, and suggest that appropriate interactive visual displays may improve search in practice.
    Date: 2015
  11. By: Lucks, Konstantin
    Abstract: This paper explores how reduced self-control affects individual investment behavior in two laboratory tasks. For this purpose, I exogenously reduce subjects’ self-control using a well-established psychological treatment. In each task, I find no significant main treatment effect, but secondary effects consistent with findings on self-control from other studies and self-control’s potential relevance in financial markets. In experiment 1, I find no significant change in the disposition effect following the manipulation. However, treated participants trade fewer different shares per round. In experiment 2, I look at the effect of self-control on myopic loss aversion by implementing a 2×2 design by varying investment horizon and self-control in a repeated lottery environment. Average behavior suggests that reduced self-control increases framing effects, but I cannot reject the null hypothesis of equal investment levels between the self-control treatments within each investment frame. Analyzing the dynamics of decision making in more detail, self-control depleted participants in the narrow frame reduce their investment levels on average over time which seems to be driven by more intense reactions to investment experiences.
    Keywords: Self-control, loss aversion, disposition effect, trade clustering, myopic loss aversion
    JEL: D53 D81 G02 G11
    Date: 2016–07–19
  12. By: Christoph Czichowsky; Walter Schachermayer
    Abstract: We consider the problem of portfolio optimisation with general càdlàg price processes in the presence of proportional transaction costs. In this context, we develop a general duality theory. In particular, we prove the existence of a dual optimiser as well as a shadow price process in an appropriate generalised sense. This shadow price is defined by means of a "sandwiched" process consisting of a predictable and an optional strong supermartingale, and pertains to all strategies that remain solvent under transaction costs. We provide examples showing that, in the general setting we study, the shadow price processes have to be of such a generalised form.
    Keywords: utility maximisation; proportional transaction costs; convex duality; shadow prices; supermartingale deflators; optional strong supermartingales; predictable strong supermartingales; logarithmic utility
    JEL: C61 G11
    Date: 2016–06
  13. By: Fatima, Kiran; Qayyum, Abdul
    Abstract: Assets accumulated by household is important topic, it is investment by household to maximise their utility for present time and for future. It is stock investment which help the household to use these assets in tough time. How income receive to household from three sources i.e. labour income, internal remittances, and external remittances effect assets accumulation of household is the topic for investigation in this paper. This paper analyses the effect of remittances on aggregate household’s assets of Pakistan by using Probit model estimated through maximum likelihood method. Finding of this paper shows that external remittances positively and significantly affect assets accumulation of aggregate household of Pakistan. Results of the paper are closest to theoretical idea that remittances have significantly affect the asset accumulation of household.
    Keywords: Assets Accumulation, Utility, Internal Remittances, External Remittances, Households, Pakistan, Probit Model
    JEL: C25 D10 F22 F24 R20
    Date: 2016

This nep-upt issue is ©2016 by Alexander Harin. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.