nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2017‒01‒01
fourteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. A Proposal to Extend Expected Utility in a Quantum Probabilistic Framework By Diederik Aerts; Emmanuel Haven; Sandro Sozzo
  2. Learning and dynamic choices under uncertainty: from weighted regret and rejoice to expected utility By F. Zagonari
  3. Ensemble Prospectism By Kim Kaleva Kaivanto
  4. A Solution to the Missing Globalization Puzzle by Non-CES Preferences By Hakan Yilmazkuday
  5. Assessing small-scale raspberry producers' risk and ambiguity preferences: Evidence from field-experiment data in rural Chile By Cárcamo, Jorge; Cramon-Taubadel, Stephan von
  6. A new approach of stochastic dominance for ranking transformations on the discrete random variable By Gao, Jianwei; Zhao, Feng
  7. Model Uncertainty in Risk Analysis and Decision Theory: A Preliminary Investigation By Emanuele Borgonovo; Veronica Cappelli; Fabio Maccheroni; Massimo Marinacci
  8. Slutsky, Let Me Introduce You to Arrow-Pratt: Competitive Price Effects with Uncertain Production By Hurley, Terrance M.
  9. An Empirical Exploration of the Near-Term and Persistent Effects of Conflict on Risk Preferences By Marc Rockmore; Christopher B. Barrett; Jeannie Annan
  10. Cooperation under risk and ambiguity By Björk, Lisa; Kocher, Martin; Martinsson, Peter; Nam Khanh, Pham
  11. Preferences for Intrinsically Risky Attributes By Zack Dorner; Daniel A. Brent; Anke Leroux
  12. Dual Moments and Risk Attitudes By Louis R. Eeckhoudt; Roger J. A. Laeven
  13. Putting Your Money Where Your Mouth Is By Daniel A. Brent; Lata Gangadharan; Anke Leroux; Paul A. Raschky
  14. Early Childhood Environment, Breastfeeding and the Formation of Preferences By Armin Falk; Fabian Kosse

  1. By: Diederik Aerts; Emmanuel Haven; Sandro Sozzo
    Abstract: Expected utility theory (EUT) is widely used in economic theory. However, its subjective probability formulation, first elaborated by Savage, is linked to Ellsberg-like paradoxes and ambiguity aversion. This has led various scholars to work out non-Bayesian extensions of EUT which cope with its paradoxes and incorporate attitudes toward ambiguity. A variant of the Ellsberg paradox, recently proposed by Mark Machina and confirmed experimentally, challenges existing non-Bayesian models of decision-making under uncertainty. Relying on a decade of research which has successfully applied the formalism of quantum theory to model cognitive entities and fallacies of human reasoning, we put forward a non-Bayesian extension of EUT in which subjective probabilities are represented by quantum probabilities, while the preference relation between acts depends on the state of the situation that is the object of the decision. We show that the benefits of using the quantum theoretical framework enables the modeling of the Ellsberg and Machina paradoxes, as the representation of ambiguity and behavioral attitudes toward it. The theoretical framework presented here is a first step toward the development of a `state-dependent non-Bayesian extension of EUT' and it has potential applications in economic modeling.
    Date: 2016–12
  2. By: F. Zagonari
    Abstract: This paper identifies the globally stable conditions under which an individual facing the same choice in many subsequent times learns to behave as prescribed by the expected-utility model. To do so, the analysis moves from the relevant behavioural models suggested by psychology (i.e., weighted probabilities applied to regret and rejoice theory), and by updating probability estimations and outcome preferences according to the learning models suggested by neuroscience (i.e., adaptive learning aimed at reducing surprises), and analogous to Bayesian updating. The search context is derived from experimental economics, whereas the learning framework is borrowed from theoretical economics. Analytical results show that obstinate and lucky individuals are better off in the short-run (i.e., a low density of events in the reference period), but they do not learn, and this is true to a greater extent in a simple context; in contrast, reactive and unlucky individuals are worse off in the short-run, but they learn and are better off in the long-run (i.e., all individuals are equally lucky or unlucky), and this is true to a greater extent in a complex context. The expected-utility model explains real behaviours in the long-run whenever unlucky events are more likely than lucky events.
    JEL: D83
    Date: 2016–12
  3. By: Kim Kaleva Kaivanto
    Abstract: Incomplete preferences displaying ‘mildly sweetened’ structure are common, yet theoretically problematic. This paper examines the properties of the rankings induced by the set of all coherent completions of the mildly sweetened partial preference structure. Building on these properties, I propose an ensemble-based refinement of Hare’s (Analysis 70:237–247, 2010) prospectism criterion for rational choice when preferences are incomplete. Importantly, this ensemble-based refinement is immune to Peterson’s (Theory & Decision 78:451–456, 2015) weak money pump argument. Hence, ensemble prospectism ensures outcome rationality. Furthermore, by recognizing the structural isomorphism between mildly sweetened preference structures and Cover’s splitting rule in Blackwell’s Pick the Largest Number problem (Ann Math Stat 22:393–399, 1951), ensemble prospectism can be shown to yield better-than-even odds of selecting the expost higher-utility option – despite the absence of all-things-considered preferences ex ante.
    Keywords: Prospectism, Refinement, Money pump, Outcome rationality, Ensemble method, Voting rules, Incomplete preferences, Mildly sweetened preferences, Cover rule, Hare, Peterson
    JEL: D81
    Date: 2016
  4. By: Hakan Yilmazkuday (Department of Economics, Florida International University)
    Abstract: One channel of welfare-improving globalization is through the increasing integration of trade. Although this is attributed to decreasing effects of distance across countries, the workhorse models of gravity fail to capture it, the so-called the missing globalization or the distance puzzle. This paper shows that this puzzle may be due to the restricting assumption of constant elasticity of substitution (CES) preferences working behind the gravity models. We test the validity of this assumption for different trade intervals and show that it is violated due to the distance elasticity of trade decreasing with the amount of trade. Accordingly, we consider a type of non-CES utility function, namely constant absolute risk version (CARA), and analytically show that the negative relation between trade and distance elasticity of trade is captured by CARA preferences. We estimate the gravity equation implied by CARA preferences, empirically confirm the endogenous relation between trade and distance elasticity of trade, and show that the distance puzzle is solved under CARA preferences. According to the data set used, CARA preferences are also econometrically selected over CES preferences based on their goodness of fit.
    Keywords: Distance Puzzle, Non-CES Preferences, CARA Preferences
    JEL: F12 F13 F14
    Date: 2016–12
  5. By: Cárcamo, Jorge; Cramon-Taubadel, Stephan von
    Abstract: Most researchers who analyze producers' preferences under uncertainty report that producers are averse towards risk and ambiguity scenarios. This aversion has an influence on producers' decision-making processes; hence the relevance of determining and analyzing these preferences as a key factor to design agricultural policies that help producers to cope with production uncertainty. In this study we elicit small-scale raspberry producers' preferences through field experiments in rural Maule (Chile). In addition, we identify producers' socioeconomic and farm characteristics that influence these preferences. Finally, we compare the two standard methods in the current literature to estimate producers' risk preferences from field experiments, and analyze if the estimation method influences these preferences. Our results show an asymmetry in producers' risk preferences; producers are twice as sensitive to losses as to gains. Additionally, we find that producers get smaller lottery utilities in scenarios where ambiguity is present, which implies ambiguity aversion. We also show that the method used to estimate risk preferences can influence the results, with obvious implications for policy design.
    Keywords: Risk Preferences,Ambiguity Preferences,Small-scale Producers,Raspberry Producers,Producers' Preferences Elicitation
    Date: 2016
  6. By: Gao, Jianwei; Zhao, Feng
    Abstract: This paper develops some new stochastic dominance (SD) rules for ranking transformations on a random variable, which is the first time to study ranking approach for transformations on the discrete framework. By using the expected utility theory, the authors first present a sufficient condition for general transformations by first degree SD (FSD), and further develop it into the necessary and sufficient condition for the monotonic transformations. For the second degree SD (SSD) case, the authors divide the monotonic transformations into increasing and decreasing ones, and respectively derive the necessary and sufficient conditions for the two situations. For two different discrete random variables with the same possible states, they obtain the sufficient and necessary condition for FSD and SSD, respectively. The feature of the new SD rules is that each FSD condition is represented by the transformation functions and each SSD condition is characterized by the transformation functions and the probability distributions of the random variable. This is different from the existing SD approach where they are described by cumulative distribution functions. In this way, the authors construct a new theoretical paradigm for transformations on the discrete random variable. Finally, a numerical example is provided to show the effectiveness of the new SD rules.
    Keywords: stochastic dominance,transformation,utility theory,insurance
    JEL: C51 D81 G1
    Date: 2016
  7. By: Emanuele Borgonovo; Veronica Cappelli; Fabio Maccheroni; Massimo Marinacci
    Abstract: The purpose of this note is to discuss the relation between model uncertainty in risk analysis and decision theory.
    Date: 2016
  8. By: Hurley, Terrance M.
    Abstract: The purpose of this article is to characterize the effect of a competitive price change on a producer’s commodity transactions under uncertainty and impatience. The novelty comes from a methodological approach inspired by both Slutsky and Arrow-Pratt. Combining and generalizing these methodological frameworks illuminates natural analogues between production and consumption with and without uncertainty, while facilitating the analysis of certain, risky, and uncertain choice within a consistent framework. Contributions include (i) the introduction of the immediate profit function — a generalization of cost function to an economic environment with uncertainty and impatience, (ii) a generalization of Arrow-Pratt risk aversion to characterize preferences over time as well as over uncertainty, (ii) a generalization of Arrow-Pratt risk aversion to characterize technological and market uncertainty, (iv) the decomposition of price effects on commodity choices with uncertainty and impatience using Slutsky substitution and income effects, and the generalized Arrow-Pratt characterizations of uncertainty aversion, patience aversion, technological uncertainty and market uncertainty; and (v) a reexamination of Sandmo’s seminal comparative static analysis of a producer facing price risk in the context of price uncertainty and impatience.
    Keywords: state-contingent, production, risk, uncertainty, comparative static, Production Economics, Research Methods/ Statistical Methods, Risk and Uncertainty, D21, D8,
    Date: 2016–12
  9. By: Marc Rockmore (Clark University); Christopher B. Barrett (Charles H. Dyson School of Applied Economics and Management and Cornell University); Jeannie Annan (International Rescue Committee, New York, and Harvard T H Chan School of Public Health, Boston)
    Abstract: A burgeoning empirical literature on the effects of conflict on various economic behavioral parameters exhibits mixed results, with respect to both the magnitude and the direction of the effects. By estimating the distribution of estimated effects of violence on risk preferences, rather than just the average effect, we reconcile the discordant results of the prior literature. The distribution also reveals substantial and previously overlooked variation in the effects of exposure. This raises questions about the widespread use of aggregated measures of exposure to violence in conflict literature. We use panel data from northern Uganda, the latest round collected seven years after the violence ended, to explore the heterogeneous effects of different experiences of violence – personal suffering, perpetration, witness, or indirect experience through family members’ suffering – on different measures of ambiguity and risk aversion, correcting for many of the methodological shortcomings of previous studies. We find that violence has an adverse near-term effect on mental health, but with heterogeneous effects on risk aversion depending on the nature of one’s experience of violence. We also find that the risk preference effects persist even after a recovery in mental health.
    Date: 2016–10
  10. By: Björk, Lisa (Department of Economics, School of Business, Economics and Law, Göteborg University); Kocher, Martin (Department of Economics, LMU Munich); Martinsson, Peter (Department of Economics, School of Business, Economics and Law, Göteborg University); Nam Khanh, Pham (School of Economics, Ho Chi Minh City University of Economics)
    Abstract: The return from investments in public goods is almost always uncertain, in contrast to the most common setup in the existing empirical literature. We study the impact of natural uncertainty on cooperation in a social dilemma by conducting a public goods experiment in the laboratory in which the marginal return to contributions is either deterministic, risky (known probabilities) or ambiguous (unknown probabilities). Our design allows us to make inferences on dierences in cooperative attitudes, beliefs, and one-shot as well as repeated contributions to the public good under the three regimes. Interestingly, we do not find that natural uncertainty has a significant impact on the inclination to cooperate, neither on the beliefs of others nor on actual contribution decisions. Our results support the generalizability of previous experimental results based on deterministic settings. From a behavioural point of view, it appears that strategic uncertainty overshadows natural uncertainty in social dilemmas.
    Keywords: Public good; conditional cooperation; experiment; uncertainty; risk; ambiguity
    JEL: C91 D64 D81 H41
    Date: 2016–12
  11. By: Zack Dorner; Daniel A. Brent; Anke Leroux
    Abstract: Riskiness is an important attribute of goods, whereby the utility derived from that attribute is determined by one’s attitude to risk. We develop a novel approach to leverage data on risk attitudes from a fully incentivized risk elicitation task to model intrinsic riskiness of alternatives in a choice experiment. In a door-to-door survey, 981 respondents participated in a discrete choice experiment to elicit preferences over alternative sources of municipal water, conditional on water price and quality. Additional source attributes, such as the risk associated with vulnerability to drought or technological risks are treated as intrinsic since they cannot be plausibly disassociated from the water supply source. A risk task estimates participants’ coefficient of constant relative risk aversion (CRRA), which is incorporated into the preference estimation to test the hypotheses that supply risk and new technology risk are important intrinsic attributes for new water sources. Participants are not given information about supply or technological risks of the sources to avoid framing effects driving the results. Controlling for water quality and cost, we find that supply risk – and not technology risk – is an important determinant of participants’ choices.
    Date: 2016–11
  12. By: Louis R. Eeckhoudt; Roger J. A. Laeven
    Abstract: In the economics of risk, the primal moments of mean and variance play a central role to define the local index of absolute risk aversion. In this note, we show that in canonical non-EU models dual moments have to be used instead of, or on par with, their primal counterparts to obtain an equivalent index of absolute risk aversion.
    Date: 2016–12
  13. By: Daniel A. Brent; Lata Gangadharan; Anke Leroux; Paul A. Raschky
    Abstract: We present a novel approach to address differences between stated and paid choices by incentivizing stated choices in a randomized field experiment. The treatment increases the incentives in the field by making each decision financially relevant. Our results show that the treatment increases estimates of the marginal utility of income, with the effect being economically and statistically significant in aggregate. We develop a stylized model that formalizes the extent of hypothetical bias implied by our empirical results by allowing for alternative treatment-induced channels. Under a range of plausible parameter values our results indicate hypothetical bias in approximately 95% of the parameter space with a mean hypothetical bias of 60%. Heterogeneous treatment effects indicate that low income respondents are more susceptible to hypothetical bias.
    Keywords: field experiment, quasi-public goods, non-market goods, stated preference, hypothetical bias
    JEL: Q51 C93
    Date: 2016–11
  14. By: Armin Falk; Fabian Kosse
    Abstract: This study provides insights on the role of early childhood family environment within the process of preference formation. We start by presenting evidence showing that breastfeeding duration is a valid measure of the quality of early childhood environment. In the main analysis, we then investigate how early childhood environment affects the formation of fundamental economic preferences such as time, risk, and social preferences. In a sample of preschool children we find that longer breastfeeding duration is associated with higher levels of patience and altruism as well as a lower willingness to take risk. Repeating the analysis on a sample of young adults indicates that the observed pattern is replicable and persists into adulthood. Importantly, in both data sets our findings are robust when controlling for cognitive ability and parental socio-economic status. We can further rule out that the results are purely driven by nutritional effects of breastfeeding. Altogether, our findings strongly suggest that early childhood environment as measured by breastfeeding duration systematically and persistently affects preference formation.
    Keywords: Time preferences, risk preferences, altruism, experiments with children, origins of preferences, childhood environment, breastfeeding
    JEL: C91 D64 D90 D81 J13
    Date: 2016

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