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on Utility Models and Prospect Theory |
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Issue of 2016‒11‒13
seventeen papers chosen by |
| By: | Chen, Daniel L.; Schonger, Martin |
| Abstract: | The study of the normative and positive theory of choice under uncertainty has made major advances through thought experiments often referred to as paradoxes: the St. Petersburg paradox, the Allais paradox, the Ellsberg paradox, and the Rabin paradox. Machina proposes a new thought experiment which posits a choice between two acts that have three outcomes. As in the Ellsberg paradox there are three events, but while the Ellsberg paradox has two (monetary) outcomes in Machina there are three. Machina shows that four prominent theories of ambiguity aversion predict indifference between the acts. Introspection, however, suggests that many people might very well strictly prefer one act over the other. This paper makes four contributions: first, to our knowledge, it is the first to experimentally implement the Machina thought experiment. Second, we employ a novel method to simultaneously elicit the certainty equivalent of an embedded lottery. Third, our results—across three experiments—indicate non-indifference, which rejects earlier theories of ambiguity aversion, but is consistent with a newer one, which we apply to explain our results. Fourth, we show that independence is a sufficient condition for indifference in the Machina paradox, and thereby explains why so many models predict indifference. |
| Keywords: | Ellsberg paradox, Machina paradox, uncertainty aversion, independence axiom |
| JEL: | D81 |
| Date: | 2016–10 |
| URL: | http://d.repec.org/n?u=RePEc:tse:iastwp:31142&r=upt |
| By: | Chen, Daniel L. |
| Abstract: | This paper proposes a reference-point dependent model of social behavior where individuals maximize a three-term utility function: a consumption utility term and two “social” terms. One social term captures a preference for desert (i.e., others getting what we think they deserve) and the other term a preference for the satisfaction of other’s expectations, or to placate them (i.e., them getting what we think they think they deserve). After motivating the modeling assumptions with findings from empirical moral philosophy and evolutionary psychology, I introduce the model and generate some simple comparative statics results, which I then test with experiments. I discuss how the model explains several paradoxes of empirical moral philosophy that are less explicable by current economic models of social preference focusing on outcomes and intentions. |
| Keywords: | Reference points, social preferences, just desert |
| JEL: | D6 K2 |
| Date: | 2016–10 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:31132&r=upt |
| By: | Kent D. Daniel; Robert B. Litterman; Gernot Wagner |
| Abstract: | Pricing greenhouse gas emissions is a risk management problem. It involves making trade-offs between consumption today and unknown and potentially catastrophic damages in the (distant) future. The optimal carbon price is based on society’s willingness to substitute consumption across time and across uncertain states of nature. A large body of work in macroeconomics and finance has attempted to infer societal preferences using the observed behavior of asset prices, and has concluded that the standard preference specifications are inconsistent with observed asset valuations. This literature has developed a richer set of preferences that are more consistent with asset price behavior. In this paper, we explore the implications of these richer preference specifications for the Social Cost of Carbon (SCC), the expected discounted damage of each marginal ton of carbon emissions at an optimal emissions reductions pathway. We develop a simple discrete-time model in which the representative agent has an Epstein-Zin preference specification, and in which uncertainty about the effect of carbon emissions on global temperature and on eventual damages is gradually resolved over time. In our model the SCC is equal to the value of the carbon emissions price at any given point in time that maximizes the utility of the representative agent at that time. We embed a number of features including tail risk, the potential for technological change, and backstop technologies. When coupled with the potential for low-probability, high-impact outcomes, our calibration allows us to decompose the SCC into the expected damages and the risk-premium. In contrast to most modeled carbon price paths, our calibration suggests a high SCC today that is expected to decline over time. It also points to the importance of backstop technologies and, in contrast to standard specifications, to potentially very large deadweight costs of delay. We find, for example, that with damage distributions calibrated to an SCC of $40, a value associated with only a small risk premium, the deadweight loss in utility associated with delaying the implementation of optimal pricing by 15 years is equivalent to a 6% loss of consumption. |
| JEL: | G0 G12 Q51 Q54 |
| Date: | 2016–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:22795&r=upt |
| By: | Thai Ha-Huy (EPEE - Université d'Evry); Cuong Le Van (Centre d'Economie de la Sorbonne - Paris School of Economics, IPAG Business School); Nguyen Manh-Hung (Toulouse School of Economics - INRA) |
| Abstract: | We consider a model with an infinite number of states of nature, von Neumann - Morgenstern utilities, where agents have different probability beliefs and where short sells are allowed. We show that no-arbitrage conditions, defined for finite dimensional asset markets models, are not sufficient to ensure existence of equilibrium in presence of an infinite number of states of nature. However, if the individually rational utility set U is compact, we obtain an equilibrium. We give conditions which imply the compactness of U. We give examples of non-existence of equilibrium when these conditions do not hold |
| Keywords: | asset market equilibrium; individually rational attainable allocations; individually rational utility set; no-arbitrage prices; no-arbitrage condition |
| JEL: | C62 D50 D81 D84 G1 |
| Date: | 2016–10 |
| URL: | http://d.repec.org/n?u=RePEc:mse:cesdoc:16062&r=upt |
| By: | Enrico G. De Giorgi; Ola Mahmoud |
| Abstract: | A widely applied diversification paradigm is the naive diversification choice heuristic. It stipulates that an economic agent allocates equal decision weights to given choice alternatives independent of their individual characteristics. This article provides mathematically and economically sound choice theoretic foundations for the naive approach to diversification. We axiomatize naive diversification by defining it as a preference for equality over inequality and derive its relationship to the classical diversification paradigm. In particular, we show that (i) the notion of permutation invariance lies at the core of naive diversification and that an economic agent is a naive diversifier if and only if his preferences are convex and permutation invariant; (ii) Schur-concave utility functions capture the idea of being inequality averse on top of being risk averse; and (iii) the transformations, which rebalance unequal decision weights to equality, are characterized in terms of their implied turnover. |
| Date: | 2016–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1611.01285&r=upt |
| By: | John C. Whitehead; Daniel K. Lew |
| Abstract: | We develop econometric models to jointly estimate revealed preference (RP) and stated preference (SP) models of recreational fishing behavior and preferences using survey data from the 2007 Alaska Saltwater Sportfishing Economic Survey. The RP data are from site choice survey questions, and the SP data are from a discrete choice experiment. Random utility models using only the RP data may be more likely to estimate the effect of cost on site selection well, but catch per day estimates may not reflect the benefits of the trip as perceived by anglers. The SP models may be more likely to estimate the effects of trip characteristics well, but less attention may be paid to the cost variable due to the hypothetical nature of the SP questions. The combination and joint estimation of RP and SP data seeks to exploit the contrasting strengths of both. We find that there are significant gains in econometric efficiency, and differences between RP and SP willingness to pay estimates are mitigated by joint estimation. We compare a number of models that have appeared in the environmental economics literature with the generalized multinomial logit model. The nested logit “trick” model fails to account for the panel nature of the data and is less preferred to the mixed logit error components model that accounts for panel data and scale differences. Naïve (1) scaled, (2) mixed logit, and (3) generalized multinomial logit models produced similar results to a generalized multinomial logit model that accounts for scale differences in RP and SP data. Willingness to pay estimates do not differ across these models but are greater than those in the mixed logit error components model. Key Words: discrete choice experiment, generalized multinomial logit model, hypothetical bias, revealed preference, stated preference, travel cost method |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:apl:wpaper:16-22&r=upt |
| By: | Bryan, Mark L.; Geraci, Andrea |
| Abstract: | We compare two alternative ways of measuring workers’ marginal willingness to pay (MWP) for four non-standard working arrangements: flexitime, part-time, night work, and rotating shifts. The first method is based on job-to-job transitions within a job search framework, while the second is based on estimating the determinants of subjective well-being. Using BHPS panel data from 1991-2008, we relate differences in the results to conceptual differences between utility and subjective wellbeing proposed recently in the happiness literature. We conclude that there is not a single representation of MWP: utility trade-offs (revealed by choices) need not be the same as wellbeing trade-offs; and we find evidence that subjective wellbeing is traded off against other goods that provide utility. Overall, we find that workers care particularly about their number of weekly hours. |
| Date: | 2016–10–20 |
| URL: | http://d.repec.org/n?u=RePEc:ese:iserwp:2016-12&r=upt |
| By: | Chen, Daniel L.; Schonger, Martin |
| Abstract: | Most papers that employ the strategy method (SM) use many observations per subject to study responses to rare or off-equilibrium behavior that cannot be observed using direct elicitation (DE), but ignore that the strategic equivalence between SM and DE holds for the monetary payoff game but not the game participants actually play, which is in terms of utilities. To illustrate the severity of this issue, we formalize the mapping from the monetary payoff game to this actual game. A theorem provides necessary and sufficient conditions for strategic equivalence to apply. When the domain of preferences includes commonlymodeled motivations, such as intentions or disappointment aversion, or less-common ones, such as self-image or duty, strategic equivalence fails and thus the invariance to the method of elicitation does not apply. We use results from the past literature and our own experiments to investigate how well this theorem explains when results with SM and DE differ. We manipulate the salience of off-equilibrium considerations in our own experiments to demonstrate that SM and DE are not strategically equivalent, contrary to conventional wisdom. Three results emerge. First, not accounting for the bias in the estimation when decisions at one information set can influence the utility at another information set can render significant differences in decision-making. Second, the bias can be large and equivalent to some of the other causal effects being measured. Third, subtle interventions on salience can magnify these differences by a similar amount. |
| Keywords: | Theory of experiments, strategy method, social preferences, intentions, deontological motivations |
| JEL: | A13 C90 D03 D64 |
| Date: | 2016–10 |
| URL: | http://d.repec.org/n?u=RePEc:tse:iastwp:31135&r=upt |
| By: | Calford, Evan |
| Abstract: | In normal form games, when agents exhibit ambiguity aversion the exclusion of mixed strategies from agents' choice sets can enlarge the set of equilibria. While it is possible, in a game theoretic experiment, to enforce pure strategy reporting it is not possible to prevent subjects from mixing before reporting a pure strategy. This short paper establishes conditions under which the set of equilibrium in a game with ambiguity averse agents and pure strategy reporting is invariant to the existence of pre-play mixing devices. This result is crucial for the interpretation of recent experimental work on the role of ambiguity aversion in normal form games. |
| Keywords: | Ambiguity Aversion, Mixed Strategies, Game Theory, Experimental Economics |
| JEL: | C72 C92 D03 D81 |
| Date: | 2016–10–31 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:74909&r=upt |
| By: | Dan Anderberg (Department of Economics, Royal Holloway University of London); Claudia Cerrone (Max Planck Institute for Research on Collective Goods) |
| Abstract: | This paper develops a model of risky investment in education under disappointment aversion, modelled as loss aversion around one's endogenous expectation. The model shows that disappointment aversion reduces the optimal investment in education for lower ability people and increases it for higher ability people, thereby magnifying the investment gap between them generated by the riskiness of education. Policies aimed at influencing students' expectations can reduce early dropout. |
| Keywords: | education, risk, disappointment aversion, endogeneous reference points |
| JEL: | D03 D81 I21 |
| Date: | 2016–11 |
| URL: | http://d.repec.org/n?u=RePEc:mpg:wpaper:2016_16&r=upt |
| By: | Morone, Andrea; Temerario, Tiziana |
| Abstract: | In this paper, we first replicated Harrison et al. (2012). Then, we studied if the group’s size has an impact on group’s risk aversion. In line with Harrison et al. (2012), our results confirm that no significant differences occur between individuals and groups risk aversion in three-person group. We also found that group size does not affect the level of risk aversion. |
| Keywords: | Preferences; Risk attitude; Laboratory; Majority Rule; |
| JEL: | C91 C92 D01 |
| Date: | 2016–11 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:74949&r=upt |
| By: | Morone, Andrea; Temerario, Tiziana |
| Abstract: | In this paper, we first replicated Harrison et al. (2012). Then, we studied if the group’s size has an impact on group’s risk aversion. In line with Harrison et al. (2012), our results confirm that no significant differences occur between individuals and groups risk aversion in three-person group. We also found that group size does not affect the level of risk aversion. |
| Keywords: | Risk attitude,Preferences |
| JEL: | C91 C92 D01 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:esprep:147413&r=upt |
| By: | Bocher, Temesgen; Sindi, Kirimi; Nshimiyimana, Jean Claude; Low, Jan |
| Abstract: | Identifying consumer preferences and willingness to pay for Orange Fleshed Sweet potato (OFSP) juice were the objectives of the study. This study is based on a structured survey and taste tests administered to 980 randomly approached and verbally agreed participants (384 female and 562 male) selected from seven different markets representing different income groups in Rwanda. Four juices types were tested: two popular brands of 100% pineapple juice, one 100%-OFSP juice, and one 80% OFSP-20% pineapple juice blend. During the taste testing, there was no information provided as to what the type or brand of the juice was. The consumers ranked different juice attributes such as aroma, taste, color, “right” amount of sugar, and aftertaste by rating using a Likert scale (1 to 5, with five being the most preferred). Heckman two-stage probit model is used to analyze willingness-to-pay and a multinomial logit model to analyze the determinants of juice choice. It is indicated that both consumer characteristics and juice attributes influence willingness-to-pay and preference: sex of the consumer, juice buying frequency, aroma, right amount of sugar, taste of the juice, and vitamin A knowledge were positively associated with willingness-to-pay and juice choice. Without nutritional information on OFSP juice, the willingness-to-pay for the standard juices compared to OFSP-based juices were statistically higher; but with nutritional information the willingness-to-pay and juice choice for OFSP juice was significantly improved. It is concluded that nutritional information, particularly about the role that vitamin A plays in health is important in determining the juice preferences and willingness to pay. |
| Keywords: | Consumer/Household Economics, Demand and Price Analysis, Food Consumption/Nutrition/Food Safety, |
| Date: | 2016–09 |
| URL: | http://d.repec.org/n?u=RePEc:ags:aaae16:249314&r=upt |
| By: | Salvatore Piccolo (Università Cattolica del Sacro Cuore (Milano), and CSEF); Aldo Pignataro (Università Cattolica del Sacro Cuore (Milano)) |
| Abstract: | Two firms supplying experience goods compete to attract loss averse consumers that are uncertain about how well these goods fit their needs. To resolve valuation uncertainty, firms can allow perspective customers to test (experiment) their products before purchase. We investigate firms' dynamic incentives to allow experimentation and analyze the resulting effects on the profitability and the stability of horizontal price fixing. The analysis shows that, depending on the regulatory regime in place | i.e., whether experimentation is forbidden, mandated or simply allowed but not imposed (laissez-faire) | the degree of consumer loss aversion has ambiguous effects both on the profits that firms can achieve through implicit collusion and on the extent to which these agreements can be sustained. Moreover, we also show that while in static environments consumer welfare is always maximized by a policy that forbids experimentation, the opposite might happen in a dynamic environment. |
| Keywords: | Collusion, Loss Aversion, Product Experimentation, Vertical Differentiation |
| JEL: | L12 L15 L44 M30 |
| Date: | 2016–11–07 |
| URL: | http://d.repec.org/n?u=RePEc:sef:csefwp:457&r=upt |
| By: | Chen, Daniel L.; Schonger, Martin |
| Abstract: | Recent advances in economic theory, largely motivated by experimental findings, have led to the adoption of models of human behavior where a decision-maker not only takes into consideration her own payoff but also others’ payoffs and any potential consequences of these payoffs. Investigations of deontological motivations, where a decision-maker makes her choice not only based on the consequences of a decision but also the decision per se have been rare. We propose an experimental method that can detect an individual’s deontological motivations by varying the probability of the decision-maker’s decision having consequences. It uses two states of the world, one where the decision has consequences and one where it has none. We show that a purely consequentialist decision-maker whose preferences satisfy first-order stochastic dominance will choose the decision that leads to the best consequences regardless of the probability of the consequential state. A purely deontological decision-maker is also invariant to the probability. However, a mixed consequentialist-deontological decision-maker’s choice changes with the probability. The direction of change gives insight into the location of the optimand for one’s duty. We provide a formal interpretation of major moral philosophies and a revealed preference method to detect deontological motivations and discuss the relevance of the theory and method for economics and law. |
| Keywords: | Consequentialism, deontological motivations, normative commitments, social preferences, revealed preference, decision theory, first order stochastic dominance, random lottery incentive method |
| JEL: | D6 K2 |
| Date: | 2016–10 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:31113&r=upt |
| By: | Taras Bodnar; Yarema Okhrin; Nestor Parolya |
| Abstract: | In this paper we estimate the mean-variance (MV) portfolio in the high-dimensional case using the recent results from the theory of random matrices. We construct a linear shrinkage estimator which is distribution-free and is optimal in the sense of maximizing with probability $1$ the asymptotic out-of-sample expected utility, i.e., mean-variance objective function. Its asymptotic properties are investigated when the number of assets $p$ together with the sample size $n$ tend to infinity such that $p/n \rightarrow c\in (0,+\infty)$. The results are obtained under weak assumptions imposed on the distribution of the asset returns, namely the existence of the fourth moments. Thereafter we perform numerical and empirical studies where the small- and large-sample behavior of the derived estimator are investigated. The resulting estimator shows significant improvements over the naive diversification and it is robust to the deviations from normality. |
| Date: | 2016–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1611.01958&r=upt |
| By: | Shelegia, Sandro; Wilson, Chris |
| Abstract: | To provide a more flexible workhorse model of temporary price reductions or `sales', this paper presents a substantially generalized `clearinghouse' sales framework. Our framework permits multiple dimensions of firm heterogeneity, and views firms as competing directly in utility rather than prices. The paper i) reproduces and extends many equilibria from the existing literature, ii) offers a range of new results on how firm heterogeneity affects market outcomes, iii) provides original insights into the number and type of firms that use sales, and iv) extends a `cleaning' procedure that is commonly used in empirical studies of sales and price dispersion. |
| Keywords: | Sales,Price Dispersion,Advertising,Clearinghouse,Heterogeneity |
| JEL: | L13 D43 M3 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:esprep:147411&r=upt |