nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2016‒11‒06
eighteen papers chosen by

  1. Risk Taking, Intertemporal Choice, and Loss Aversion By William Morrison, Robert Oxoby
  2. Optimal retirement income tontines By Moshe A. Milevsky; Thomas S. Salisbury
  3. Alternative Resolution to the Mehra?Prescott Puzzle: Verification by the Original Data By Hideaki Tamura; Yoichi Matsuabayashi
  4. Equilibrium of a production economy with unbounded attainable allocations set By Senda Ounaies; Jean-Marc Bonnisseau; Souhail Chebbi
  5. Expectation-Based Loss Aversion and Strategic Interaction By Simon Dato; Andreas Grunewald; Daniel Müller
  6. The Marriage Market, Labor Supply and Education Choice By Monica Costa-Dias
  7. Robust Utility Maximization in Discrete-Time Markets with Friction By Ariel Neufeld; Mario Sikic
  8. Inducing stability in hedonic games By Dinko Dimitrov; Emiliya A. Lazarova; Shao-Chin Sung
  9. 'When the Going Gets Tough: Durable Consumption and the Equity Premium' By Myroslav Pidkuyko
  10. Sovereign Debt - Election Concerns and the Democratic Disadvantage By Amrita Dhillon; Andrew Pickering; Tomas Sjöström
  11. The Interaction between Consumption and Health in Retirement By John Karl Scholz; Ananth Seshadri
  12. Belief updating: Does the 'good-news, bad-news' asymmetry extend to purely financial domains? By Barron, Kai
  13. Lifecycle Consumption Under Different Income Profiles: Experimental Evidence By John Duffy; Yue Li
  14. Dividing Goods and Bads Under Additive Utilities By Anna Bogomolnaia; Herve Moulin; Fedor Sandomirskiy; Elena Yanovskaya
  15. Deciding fast and slow By D. Pennesi
  16. A degree-distance-based connections model with negative and positive externalities By Philipp Moehlmeier; Agnieszka Rusinowska; Emily Tanimura
  17. Can a concern for status reconcile diverse social welfare programs? By Stark, Oded; Jakubek, Marcin

  1. By: William Morrison, Robert Oxoby (Wilfrid Laurier University)
    Abstract: We report on two laboratory experiments testing for the presence of loss aversion, separate from risk aversion, in decisions involving risk and intertemporal choice. Both experiments utilize an asset legitimacy protocol to control for ‘house money’ effects. In our first experiment, we augment the Holt-Laury risk preference elicitation protocol to address the effects of loss aversion. In our second experiment, we explore loss aversion using a discount rate elicitation protocol that controls for risk preferences. Our results show that loss aversion can be separated from risk preferences and has a profound effect in decision-making.
    JEL: C91 D91
    Date: 2016–07–01
  2. By: Moshe A. Milevsky; Thomas S. Salisbury
    Abstract: Tontines were once a popular type of mortality-linked investment pool. They promised enormous rewards to the last survivors at the expense of those died early. And, while this design appealed to the gambling instinc}, it is a suboptimal way to generate retirement income. Indeed, actuarially-fair life annuities making constant payments -- where the insurance company is exposed to longevity risk -- induce greater lifetime utility. However, tontines do not have to be structured the historical way, i.e. with a constant cash flow shared amongst a shrinking group of survivors. Moreover, insurance companies do not sell actuarially-fair life annuities, in part due to aggregate longevity risk. We derive the tontine structure that maximizes lifetime utility. Technically speaking we solve the Euler-Lagrange equation and examine its sensitivity to (i.) the size of the tontine pool $n$, and (ii.) individual longevity risk aversion $\gamma$. We examine how the optimal tontine varies with $\gamma$ and $n$, and prove some qualitative theorems about the optimal payout. Interestingly, Lorenzo de Tonti's original structure is optimal in the limit as longevity risk aversion $\gamma \to \infty$. We define the natural tontine as the function for which the payout declines in exact proportion to the survival probabilities, which we show is near-optimal for all $\gamma$ and $n$. We conclude by comparing the utility of optimal tontines to the utility of loaded life annuities under reasonable demographic and economic conditions and find that the life annuity's advantage over the optimal tontine is minimal. In sum, this paper's contribution is to (i.) rekindle a discussion about a retirement income product that has been long neglected, and (ii.) leverage economic theory as well as tools from mathematical finance to design the next generation of tontine annuities.
    Date: 2016–10
  3. By: Hideaki Tamura (Graduate School of Economics, Kobe University); Yoichi Matsuabayashi (Graduate School of Economics, Kobe University)
    Abstract: Many extensive debates followed Mehra and Prescott fs (1985) sensational empirical results concerning the equity premium embodied in household equity portfolios. The problem of the equity premium?the Mehra?Prescott puzzle?arises because researchers overlook the factor of uncertainty in household consumption behaviour, thereby failing to account for the offsetting effect in the intertemporal substitution of consumption. Although many US empirical studies reject the consumption-based capital asset pricing model under a time-separable constant relative risk aversiontype utility function, we resolve this problem by formulating an expandedEuler equation that accommodates uncertainty using Mehra?Prescott fs original data.
    Keywords: Intertemporal consumption, Precautionary saving, Uncertainty, Offsetting effect, Euler equation, Equity premium puzzle
    JEL: C51 D81 D91 E21 G12
    Date: 2016–10
  4. By: Senda Ounaies (Centre d'Economie de la Sorbonne & Department of Mathematics - University El Manar Tunis); Jean-Marc Bonnisseau (Centre d'Economie de la Sorbonne - Paris School of Economics); Souhail Chebbi (Department of Mathematics - King Saud University)
    Abstract: In this paper, we consider a production economy with an unbounded attainable set where the consumers may have non-complete non-transitive preferences. To get the existence of an equilibrium, we provide an asymptotic property on preferences for the attainable consumptions. We show that this condition holds true if the set of attainable allocations is compact or, when preferences are representable by utility functions, if the set of attainable individually rational utility levels is compact. So we extend the previous existence results with unbounded attainable sets in two ways by adding a production sector and considering general preferences
    Keywords: production economy; unbounded attainable allocations; quasi-equilibrium; non complete non transitive preferences
    JEL: C62 D11 D51
    Date: 2016–08
  5. By: Simon Dato; Andreas Grunewald; Daniel Müller
    Abstract: This paper provides a comprehensive analysis regarding strategic interaction under expectation-based loss-aversion. First, we develop a coherent framework for the analysis by extending the equilibrium concepts of Koszegi and Rabin (2006, 2007) to strategic interaction and demonstrate how to derive equilibria. Second, we delineate how expectation-based loss-averse players differ in their strategic behavior from their counterparts with standard expected-utility preferences. Third, we analyze equilibrium play under expectation-based loss aversion and comment on the existence of equilibria.
    Keywords: Non-Cooperative Games, Expectation-Based Loss Aversion, Reference-Dependent Preferences, Mixed Strategies
    JEL: C72 D01 D03 D81
    Date: 2016–02
  6. By: Monica Costa-Dias (Institute for Fiscal Studies)
    Abstract: We develop an equilibrium life-cycle model of education, marriage and labor supply and consumption in a transferable utility context. Individuals start by choosing their investments in education anticipating returns in the marriage market and the labor market. They then match based on the economic value of marriage and on preferences. Equilibrium in the marriage market determines intra-household allocation of resources. Following marriage households (married or single) save, supply labor and consume private and public under uncertainty. Marriage thus has the dual role of providing public goods and offering risk sharing. The model is estimated using the British Household Panel Survey.
    Date: 2016
  7. By: Ariel Neufeld; Mario Sikic
    Abstract: We study a robust stochastic optimization problem in the quasi-sure setting in discrete-time. We show that under a lineality-type condition the problem admits a maximizer. This condition is implied by the no-arbitrage condition in models of financial markets. As a corollary, we obtain existence of an utility maximizer in the frictionless market model, markets with proportional transaction costs and also more general convex costs, like in the case of market impact.
    Date: 2016–10
  8. By: Dinko Dimitrov (Saarland University); Emiliya A. Lazarova (University of East Anglia); Shao-Chin Sung (Aoyama Gakuin University)
    Abstract: In many applications of coalition formation games, a key issue is that some desirable coalition structures are not elements of the core of these games. In these cases, it would be useful for an authority which aims to implement a certain outcome to know how far from the original game is the nearest game where the desirable outcome is part of the core. This question is at the center of this study. Focusing on hedonic games, we uncover previously unexplored links between such games and transferrable utility games, and develop a tailor-made so- lution concept for the transferrable utility game, the implementation core, to provide an answer to our question.
    Keywords: hedonic game, implementation core, Kemeny distance, stability
    JEL: C71 D71
    Date: 2016–09–29
  9. By: Myroslav Pidkuyko
    Abstract: I present an endowment economy where a representative agent has recursive preferences over the consumption of non-durable and durable goods, and uncertainty about the underlying endowments. Using parameter calibration consistent with real business cycle literature (risk aversion coefficient of 2.1 and elasticity of intertemporal substitution of 1.09), the model generates a high level of equity premium and a low and stable risk-free rate. The model is also able to explain up to 60% of the equity volatility. The volatile expenditure on durable consumption goods generates a high and volatile equity premium; endogenous time-varying uncertainty produces a counter-cyclical equity premium.
    Date: 2016
  10. By: Amrita Dhillon; Andrew Pickering; Tomas Sjöström
    Abstract: We examine default decisions under different political systems. If democratically elected politicians are unable to make credible commitments to repay externally held debt, default rates are inefficiently high because politicians internalize voter utility loss from repayment. Politicians who are motivated by electoral concerns are more likely to default in order to avoid voter utility losses, and, since lenders recognize this, interest rates and risk premiarise. Therefore, democracy potentially confers a credit market disadvantage. However, farsighted institutions that take into account how interest rates respond to default risk can ameliorate the disadvantage. Using a numerical measure of institutional farsightedness obtained from the Government Insight Business Risk and Conditions database, we …find that the observed relationship between credit-ratings and democratic status is indeed strongly conditional on farsightedness. With myopic institutions, democracy is estimated to cost on average about 2.5 investment grades. With farsighte institutions there is, if anything, a democratic advantage.
    Keywords: Sovereign debt, Default, Risk premia, Autocracy, Democracy, Institutions
    JEL: H63 F55 D72 D82 H75 O43 C72
    Date: 2016–11
  11. By: John Karl Scholz (University of Wisconsin-Madison); Ananth Seshadri (University of Wisconsin-Madison)
    Abstract: We study the interaction between consumption and health in retirement. Our main contribution is the estimation of a consumption Euler equation taking health into consideration. The Euler equation is derived from a model of consumption in retirement with three important building blocks of health: health shocks, health as an investment and health as a provider of utility. We estimate the Euler equation using data from the Health and Retirement Study (HRS) and Consumption and Activities Mail Survey (CAMS). The estimates suggest that health is an important determinant of utility. We use the estimated model to study the empirical significance of the three building blocks of health. We find that health shocks play an important role in slowing down the decline of consumption with age in retirement. We also find that including health into the utility function could help explain the heterogeneous consumption-age profiles related to health. Finally, we find that health investments, such as physical exercise, have a significant effect on the evolutions of both health and consumption in retirement.
    Date: 2016–09
  12. By: Barron, Kai
    Abstract: Bayes' statistical rule remains the status quo for modeling belief updating in both normative and descriptive models of behavior under uncertainty. Recent research has questioned the use of Bayes' rule in descriptive models of behavior, presenting evidence that people overweight 'good news' relative to 'bad news' when updating ego-relevant beliefs. In this paper, we present experimental evidence testing whether this 'good-news, bad-news' effect extends to belief updating in the domain of financial decision making, i.e. the domain of most applied economic decision making. We find no evidence of asymmetric updating in this domain. In contrast, the average participant in our experiment is strikingly close to Bayesian in her belief updating. However, we show that this average behavior masks the existence of three distinct types of updating behavior - each of which is distinct from Bayesian, but none of which displays the 'good-news, bad-news' effect.
    Keywords: economic experiments,Bayes' rule,asymmetric belief updating,belief measurement,proper scoring rules,subjective probability,motivated beliefs
    JEL: C11 C91 D83
    Date: 2016
  13. By: John Duffy (Department of Economics, University of California-Irvine); Yue Li (SUNY-Albany)
    Abstract: We report on a series of economic decision-making experiments exploring how individuals make lifecycle consumption and saving plans when they face different income profiles. We find that for every income profile we consider, subjects on average over- consume in the early periods of life and under-consume in later periods of life relative to the conditional optimum and any sudden drop in income reduces their lifetime utility. We conduct a specification search for a model to explain our data and find that a two-type model with one type consuming the conditional optimum and the other type consuming endowments best fits our data.
    Keywords: Bond markets; Lifecycle model; Consumption and savings; Retirement planning; Behavioral and experimental economics
    JEL: C92 C91 D91 E21 H55
    Date: 2016–10
  14. By: Anna Bogomolnaia (National Research University Higher School of Economics); Herve Moulin (National Research University Higher School of Economics); Fedor Sandomirskiy (National Research University Higher School of Economics); Elena Yanovskaya (National Research University Higher School of Economics)
    Abstract: When utilities are additive, we uncovered in our previous paper (Bogomolnaia et al. "Dividing Goods or Bads under Additive Utilities") many similarities but also surprising differences in the behavior of the familiar Competitive rule (with equal incomes), when we divide (private) goods or bads. The rule picks in both cases the critical points of the product of utilities (or disutilities) on the efficiency frontier, but there is only one such point if we share goods, while there can be exponentially many in the case of bads. We extend this analysis to the fair division of mixed items: each item can be viewed by some participants as a good and by others as a bad, with corresponding positive or negative marginal utilities. We find that the division of mixed items boils down, normatively as well as computationally, to a variant of an all goods problem, or of an all bads problem: in particular the task of dividing the non disposable items must be either good news for everyone, or bad news for everyone. If at least one feasible utility profile is positive, the Competitive rule picks the unique maximum of the product of (positive) utilities. If no feasible utility profile is positive, this rule picks all critical points of the product of disutilities on the efficient frontier
    Keywords: fair division of goods and bads, competitive equilibrium with equal incomes, Nash product, envy-freeness
    JEL: D61 D63 D82
    Date: 2016
  15. By: D. Pennesi
    Abstract: Empirical evidence suggests that choices are affected by the amount of time available to the decision maker. Time pressure or a cooling-off period (mandatory delay of choice) changes how choices are determined. Yet, few models are able to account for the role of available time on decisions. This paper proposes a dual-self model in which a fast and a slow self bargain to decide: the longer is the decision process, the higher is the bargaining power of the slow self when deciding. A large variety of behaviors observed under time pressure or cooling-off can be explained by our model. Quantitative predictions concerning the effect of nudging through time manipulation are also provided. We characterize the model imposing testable conditions on revealed preferences combined with non-choice data.
    JEL: D01 D03 D11 D81
    Date: 2016–10
  16. By: Philipp Moehlmeier (Bielefeld University); Agnieszka Rusinowska (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics); Emily Tanimura (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)
    Abstract: We develop a modification of the connections model by Jackson and Wolinsky (1996) that takes into account negative externalities arising from the connectivity of direct and indirect neighbors, thus combining aspects of the connections model and the co-author model. We consider a general functional form for agents' utility that incorporates both the effects of distance and of neighbors' degree. Consequently, we introduce a framework that can be seen as a degree-distance-based connections model with both negative and positive externalities. Our analysis shows how the introduction of negative externalities modifies certain results about stability and efficiency compared to the original connections model. In particular, we see the emergence of new stable structures, such as a star with links between peripheral nodes. We also identify structures, for example, certain disconnected networks, that are efficient in our model but which could not be efficient in the original connections model. While our results are proved for the general utility function, some of them are illustrated by using a specific functional form of the degree-distance-based utility.
    Keywords: network, externality, degree, distance, connections model
    Date: 2016
  17. By: Stark, Oded; Jakubek, Marcin
    Abstract: Let there be two individuals: "rich," and "poor." Due to inefficiency of the income redistribution policy, if a social planner were to tax the rich in order to transfer to the poor, only a fraction of the taxed income would be given to the poor. Under such inefficiency and a standard utility specification, a Rawlsian social planner who seeks to maximize the utility of the worst-off individual will select a different allocation of incomes than a utilitarian social planner who seeks to maximize the sum of the individuals' utilities. However, when individuals prefer not only to have more income but also not to have low status conceptualized as low relative income, and when this distaste is incorporated in the individuals' utility functions with a weight that is greater than a specified critical level, then a utilitarian social planner will select the very same income distribution as a Rawlsian social planner.
    Keywords: Maximization of social welfare,Rawlsian social welfare function,Utilitarian social welfare function,Inefficient policy of income redistribution,Distaste for low status
    JEL: D31 D60 H21 I38
    Date: 2016
  18. By: SEMIN KIM (Yonsei University)
    Abstract: We consider the performance and incentive compatibility of voting rules in a Bayesian environment: agents have independent private values, there are at least three alternatives, and monetary transfers are prohibited. First, we show that in a neutral environment, meaning alternatives are symmetric ex-ante, essentially any ex-post Pareto efficient ordinal rule is incentive compatible. Importantly, however, we can improve upon ordinal rules. We show that we can design an incentive compatible cardinal rule which achieves higher utilitarian social welfare than any ordinal rule. Finally, we provide numerical findings about incentive compatible cardinal rules that maximize utilitarian social welfare.
    Keywords: Ordinal rule, Pareto efficiency, Incentive compatibility, Bayesian mechanism design.
    JEL: C72 D01 D02 D72 D82
    Date: 2016–11

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