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on Utility Models and Prospect Theory |
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Issue of 2017‒03‒05
twenty papers chosen by |
| By: | Fosgerau, Mogens; Ranjan, Abhishek |
| Abstract: | This note establishes a new identification result for additive random utility discrete choice models (ARUM). A decision-maker associates a random utility U_{j}+m_{j} to each alternative in a finite set j∈{1,...,J}, where U={U₁,...,U_{J}} is unobserved by the researcher and random with an unknown joint distribution, while the perturbation m=(m₁,...,m_{J}) is observed. The decision-maker chooses the alternative that yields the maximum random utility, which leads to a choice probability system m→(Pr(1|m),...,Pr(J|m)). Previous research has shown that the choice probability system is identified from the observation of the relationship m→Pr(1|m). We show that the complete choice probability system is identified from observation of a relationship m→∑_{j=1}^{s}Pr(j|m), for any s |
| Keywords: | ARUM; random utility discrete choice; identification |
| JEL: | C25 D11 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:76800&r=upt |
| By: | Stark, Oded; Falniowski, Fryderyk; Jakubek, Marcin |
| Abstract: | In determining the optimal redistribution of a given population's income, we ask which factor is more important: the social planner's aversion to inequality, embedded in an isoelastic social welfare function indexed by a parameter alpha, or the individuals' concern at having a low relative income, indexed by a parameter beta in a utility function that is a convex combination of (absolute) income and low relative income. Assuming that the redistribution comes at a cost (because only a fraction of a taxed income can be transferred), we find that there exists a critical level of beta below which different isoelastic social planners choose different optimal allocations of incomes. However, if beta is above that critical level, all isoelastic social planners choose the same allocation of incomes because they then find that an equal distribution of incomes maximizes social welfare regardless of the magnitude of alpha. |
| Keywords: | Maximization of social welfare,Isoelastic social welfare functions,Deadweight loss of tax and transfer,Concern at having a low relative income,Social planners' aversion to inequality |
| JEL: | D31 D60 D63 H21 I38 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:tuewef:96&r=upt |
| By: | Giorgia Callegaro; Luciano Campi; Valeria Giusto; Tiziano Vargiolu |
| Abstract: | In this paper we study the pricing and hedging of structured products in energy markets, such as swing and virtual gas storage, using the exponential utility indifference pricing approach in a general incomplete multivariate market model driven by finitely many stochastic factors. The buyer of such contracts is allowed to trade in the forward market in order to hedge the risk of his position. We fully characterize the buyer’s utility indifference price of a given product in terms of continuous viscosity solutions of suitable nonlinear PDEs. This gives a way to identify reasonable candidates for the optimal exercise strategy for the structured product as well as for the corresponding hedging strategy. Moreover, in a model with two correlated assets, one traded and one nontraded, we obtain a representation of the price as the value function of an auxiliary simpler optimization problem under a risk neutral probability, that can be viewed as a perturbation of the minimal entropy martingale measure. Finally, numerical results are provided. |
| JEL: | C1 |
| Date: | 2017–02–04 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:68953&r=upt |
| By: | Qi Liu; Lei Lu; Bo Sun |
| Abstract: | This paper studies a principal-agent model in which the information on future firm performance is ambiguous and the agent is averse to ambiguity. We show that if firm risk is ambiguous, while stocks always induce the agent to perceive a high risk, options can induce him to perceive a low risk. As a result, options can be less costly in incentivizing the agent than stocks in the presence of ambiguity. In addition, we show that providing the agent with more incentives would induce the agent to perceive a higher risk, and there is a discontinuous jump in the compensation cost as incentives increase, which makes the principal reluctant to reset contracts frequently when underlying fundamentals change. Thus, compensation contracts exhibit an inertia property. Lastly, the model sheds some light on the use of relative performance evaluation, and provides a rationale for the puzzle of pay-for-luck in the presence of ambiguity. |
| Keywords: | Ambiguity ; Executive compensation ; Options ; Relative performance evaluation |
| JEL: | G30 J33 |
| Date: | 2017–02 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:1195&r=upt |
| By: | Tetsuya Ishikawa; Scott Robertson |
| Abstract: | We consider the optimal investment problem when the traded asset may default, causing a jump in its price. For an investor with constant absolute risk aversion, we compute indifference prices for defaultable bonds, as well as a price for dynamic protection against default. For the latter problem, our work complements Sircar & Zariphopoulou (2007), where it is implicitly assumed the investor is protected against default. We consider a factor model where the asset's instantaneous return, variance, correlation and default intensity are driven by a time-homogenous diffusion X taking values in an arbitrary region E. We identify the certainty equivalent with a semi-linear degenerate elliptic partial differential equation with quadratic growth in both function and gradient. Under a minimal integrability assumption on the market price of risk, we show the certainty equivalent is a classical solution. In particular, our results cover when X is a one-dimensional affine diffusion and when returns, variances and default intensities are also affine. Numerical examples highlight the relationship between the factor process and both the indifference price and default insurance. Lastly, we show the insurance protection price is not the default intensity under the dual optimal measure. |
| Date: | 2017–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1703.00062&r=upt |
| By: | Greiff, Matthias; Ackermann, Kurt; Murphy, Ryan O. |
| Abstract: | Different social contexts have been used when measuring distributional preferences. This could be problematic as contextual variance may inadvertently muddle the measurement process. We use a within-subjects design and measure distributional preferences in resource allocation tasks with role certainty, role uncertainty, decomposed games, and matrix games. Results show that, at the aggregate level, role uncertainty and decomposed games lead to higher degrees of prosociality when compared to role certainty. At the individual level, we observe considerable differences in behavior across the social contexts, indicating that the majority of people are sensitive to these different social settings but respond in different ways. |
| JEL: | C91 D03 D64 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:vfsc16:145529&r=upt |
| By: | BONAN Jacopo; LEMAY-BOUCHER Philippe; SCOTT Douglas; TENIKUE Michel |
| Abstract: | This paper estimates time preference parameters using commonly-applied methodologies, with the aim of investigating the link between these measures and actual economic behaviour. An experiment was conducted in the city of Thies, in Senegal, using the unique reference numbers of banknotes as a means of determining an individual?s willingness to save money. The findings of this experiment provide an innovative comparison between real choices, and choices made in the presence of hypothetical rewards. Our research indicates that individuals display a far greater degree of patience, when the possibility of genuine financial gain is made available to them. Our results show that hypothetical time preferences parameters are poor predictors of actual behaviour, prompting questions over the validity of commonly used measurements. |
| Keywords: | Time-Preferences; Randomized-experiment; Senegal |
| Date: | 2017–02 |
| URL: | http://d.repec.org/n?u=RePEc:irs:cepswp:2017-03&r=upt |
| By: | César Calvo (Universidad de Piura) |
| Abstract: | Two competing strands exist within the theoretical literature on vulnerability to poverty, each with its own policy implications. Vulnerability may be seen as low expected utility and thus stress the danger of self-perpetuating poverty, as the poor shy away from risky, yet necessary decisions to escape their hardship. Alternatively, vulnerability is often construed as expected poverty and provides policy-makers with a forward-looking viewpoint that both sheds light and raises new questions on how best to formulate the targeting of social spending. This paper provides an overview of the theoretical work underpinning each of these competing views. |
| Keywords: | Poverty, Vulnerability, Risk Aversion |
| JEL: | I3 |
| Date: | 2016–07 |
| URL: | http://d.repec.org/n?u=RePEc:ima:wpaper:2016-003&r=upt |
| By: | Mengxing Wei; Ali al-Nowaihi; Sanjit Dhami |
| Abstract: | We report the results of an experiment we performed to test the matching probabilities for the Ellsberg paradox predicted by the quantum decision model of al-Nowaihi and Dhami (2016). We find that the theoretical predictions of that model are in conformity with our experimental results. This supports the thesis that violations of classical (Kolmogorov) probability theory may not be due to irrational behaviour but, rather, due to inadequacy of classical probability theory for the description of human behaviour. |
| Keywords: | Quantum probability; the Ellsberg paradox; the law of total probability; the law of reciprocity; the Feynman rules; cognitive limitations. |
| JEL: | D03 |
| Date: | 2017–02 |
| URL: | http://d.repec.org/n?u=RePEc:lec:leecon:17/07&r=upt |
| By: | Francesco Cerigioni |
| Abstract: | Evidence from nancial markets suggests that asset prices can be consistently far from their funda- mental value. Prices seem to underreact to news in the short-run and overreact in the long-run. In this paper, we use Dual Process Theory to describe traders behavior. In particular, a part of traders holds wrong beliefs anytime the market environment does not change suciently. The proportion of traders with wrong beliefs will depend on how similar past market environments are with the present one. We show that such model not only can be seen as a way of endogenizing noise trading, but also provides a justi cation for noise traders' beliefs and it shows that underreaction and overreaction naturally arise in such framework. Finally, we discuss how the model might help understanding the emergence of the equity-premium puzzle and its variation through time. |
| Keywords: | Asset Pricing, Dual Processes, Noise Trading, Underreaction, Overreaction, Equity-Premium Puzzle |
| JEL: | G02 G11 G12 |
| Date: | 2016–09 |
| URL: | http://d.repec.org/n?u=RePEc:upf:upfgen:1553&r=upt |
| By: | Stark, Oded |
| Abstract: | This paper adds three dimensions to the received literature: it models migration when the individuals’ preferences regarding their relative income are ordinal, it works out the resulting spatial steady state distribution of the individuals, and it shows that the aggregate of the individuals’ migration choices in the spatial steady state distribution sums up to the social optimum. This finding does not apply when the individuals’ preferences regarding their relative income are cardinal. We highlight the importance of the assumption about the nature of the individuals’ social preferences (whether ordinal or cardinal) to studying and predicting their migration behavior, and to elucidating the consequences of that behavior for social welfare. |
| Keywords: | Ordinal preferences, Distaste for low relative income, An ordinal measure of income relative deprivation, Interregional migration, Steady state spatial distribution, Social Welfare, Labor and Human Capital, C61, C62, D50, D60, D62, I31, R13, R23, Z13, |
| Date: | 2017–02 |
| URL: | http://d.repec.org/n?u=RePEc:ags:ubzefd:253373&r=upt |
| By: | Fugger, Nicolas; Rasch, Alexander; Zeppenfeld, Christopher |
| Abstract: | We examine bidding behavior in first-price sealed-bid and Dutch auctions, which are strategically equivalent under standard preferences. We investigate whether the empirical breakdown of this equivalence is due to (non-standard) preferences or due to the different complexity of the two formats, i.e., a different level of mathematical or individual sophistication. First, we elicit measures of individual preferences and secondly manipulate the degree of complexity by offering various levels of decision support. Our results show that the equivalence of the two auction formats only breaks down in the absence of decision support. This indicates that the empirical breakdown is caused by differing complexity between the two formats rather than non-standard preferences. |
| JEL: | D44 D81 D47 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:vfsc16:145849&r=upt |
| By: | Bart Smeulders; Clintin Davis-Stober; Michel Regenwetter; Frits Spieksma |
| Abstract: | In so-called random preference models of probabilistic choice, a decision maker chooses according to an unspecified probability distribution over preference states. The most prominent case arises when preference states are linear orders or weak orders of the choice alternatives. The literature has documented that actually evaluating whether decision makers' observed choices are consistent with such a probabilistic model of choice poses computational difficulties. This severely limits the possible scale of empirical work in behavioral economics and related disciplines. We propose a family of column generation based algorithms for performing such tests. We evaluate our algorithms on various sets of instances. We observe substantial improvements in computation time and conclude that we can efficiently test substantially larger data sets than previously possible. |
| Date: | 2017–02 |
| URL: | http://d.repec.org/n?u=RePEc:ete:kbiper:572504&r=upt |
| By: | Lucas F. Husted; John H. Rogers; Bo Sun |
| Abstract: | In this paper we provide strong evidence that heightened uncertainty in the U.S. real economy or financial markets significantly raises excess returns to the currency carry trade. We posit that this works through the influence of uncertainty on global investors' risk preferences. Macro and financial uncertainty also lower foreign exchange risk reversals, an effect that is particularly strong for high interest rate portfolios. Our results are consistent with the idea that an increase in uncertainty regarding the U.S. economy or financial markets increases investors' risk aversion, which in turn drives up the expected returns and the cost of protection against crash risk in the FX market. |
| Keywords: | Exchange rates ; Uncovered interest parity ; Uncertainty |
| JEL: | F41 |
| Date: | 2017–02 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:1196&r=upt |
| By: | Tabea Herrmann; Olaf Hübler; Lukas Menkhoff; Ulrich Schmidt |
| Abstract: | This paper complements evidence on the Allais paradox from advanced countries and educated people by a novel investigation in a poor rural area. The share of Allais-type behavior is indeed high and related to characteristics of “lacking ability”, such as poor education, unemployment, and little financial sophistication. Based on prospective reference theory, we extend these characteristics by biased processing of probabilistic information. Finally, we reveal that Allais-type behavior is linked to risk-related characteristics, such as risk tolerance and optimism. This indicates a potential problem as exactly the more dynamic among the poor tend to make inconsistent decisions under uncertainty. |
| Keywords: | Field experiments, Allais paradox, socio-demographic characteristics, prospective reference theory, first order stochastic dominance, risk attitude, optimism |
| JEL: | D81 D3 O10 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:diw:diwwpp:dp1645&r=upt |
| By: | Meinhardt, Holger Ingmar |
| Abstract: | (Nguyen 2016) claimed that he has developed a simplifying set of the Kohlberg criteria that involves checking the balancedness of at most (n-1) sets of coalitions. This claim is not true. Analogous to Nguyen and Thomas (2016), he has incorrectly applied the indirect proof. He established in his purported proofs of the main results that a truth implies a falsehood. This is a wrong statement and such a hypotheses must be rejected (cf. Meinhardt (2015,2016a,2016b)). Executing a logical correct interpretation ought immediately lead him to the conclusion that his proposed algorithms are deficient. In particular, he had to detect that the imposed balancedness requirement on the test condition within his proposed methods cannot be appropriate. As a consequence, either a nucleolus with a weakly balanced set will be dismissed by the implemented algorithms or a solution which is not a nucleolus will be selected as a nucleolus. Hence, one cannot expect that one of these algorithms makes a correct selection. The supposed algorithms are wrongly designed and cannot be set in any relation with Kohlberg. |
| Keywords: | Transferable Utility Game, Nucleolus, Balancedness, Kohlberg Criteria; Convexity; Affine Hull; Propositional Logic; Circular Reasoning (circulus in probando); Indirect Proof; Proof by Contradiction |
| JEL: | C71 |
| Date: | 2017–02–26 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:77143&r=upt |
| By: | Konon, Alexander |
| Abstract: | Contemporary theoretical literature on occupational choice consists mostly of models that treat choice outcomes as either deterministic or risky. This paper proposes taking a slightly more realistic perspective by constructing a general occupational choice model on the basis of the assumption that outcomes are partially uncertain such that some reward distributions are unknown. The change in perspective yields some major advantages: Learning and career trajectories, which in general cannot be generated by models with deterministic or risky rewards, become a natural feature of the dynamic solution of sequential occupational choice problems. Furthermore, earnings-puzzle-like observations can be explained by sufficiently high uncertainty aversion, as uncertainty aversion has a significant impact on learning. In addition, central model predictions are consistent with data on relative choice frequencies and enterprise death rates. |
| JEL: | D81 D83 L26 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:vfsc16:145583&r=upt |
| By: | Daniel A. Brent; Michael Ward |
| Abstract: | Recent attention has focused on the role of financial literacy as an explanation for anomalies in consumer choice in a range of settings, such savings, retirement investment, and debt. We contribute to this literature on this by analyzing the link between financial literacy and consumer durables in the context of energy efficiency. Energy efficiency is a compelling setting to assess the role of financial literacy on consumer behavior because purchasing energy durables is a complicated dynamic decision, and there is an extensive literature claiming that consumer investments in energy efficiency are sub-optimal. We augment a standard choice experiment for the purchase of a new hot water system by eliciting data on financial literacy. Financial literacy is an economically important and statistically significant determinant of investment in energy efficiency. A one standard deviation increase in our metric of financial literacy increases the willingness to pay for reduced operating costs by 9%. This result is robust to incorporating incentivized experimentally-elicited individual discount rates and risk aversion, as well as standard controls such as income and education, indicating that financial literacy is not merely a proxy for standard demographic characteristics. We show that financial literacy also makes choices more consistent with standard consumer preferences and increases the probability that respondents select the investments with the lowest lifetime discounted costs. The results establish low financial literacy as a specific mechanism driving low investment in energy efficiency. |
| URL: | http://d.repec.org/n?u=RePEc:lsu:lsuwpp:2017-04&r=upt |
| By: | Aurélie Pierre (IRDES Institut de recherche et documentation en économie de la santé, Université Paris Descartes); Florence Jusot (Université Paris-Dauphine Leda-Legos) |
| Keywords: | Complementary Health Insurance, Inequality, Risk aversion, Time preference, National Interprofessional Agreement, Simulation. |
| JEL: | I13 D63 |
| Date: | 2017–02 |
| URL: | http://d.repec.org/n?u=RePEc:irh:wpaper:dt67bis&r=upt |
| By: | Jonathan E. Alevy (Department of Economics, University of Alaska Anchorage); Julianna Butler (Department of Economics, University of Delaware); Michael Price (Department of Economics, Georgia State University) |
| Abstract: | Economic theory has shown that bidder’s choice auctions result in higher revenues than traditional good-by-good auctions, if bidders are risk-averse. Most theoretical and experimental work focuses on bidder’s choice auctions where bidders value only one of the available goods. We report results from lab and field experiments that examine multi-good demand, which is common in bidder’s choice auctions used in field settings. We also implement treatments that vary revelation of price. Information. We find that while price revelation does not have a significant effect on revenue, multi-good demand mutes the theoretical revenue superiority the bidder’s choice mechanism. This is consistent with the notion that the perceived risk of losing one’s most preferred good is softened when there is a chance to win other goods. This result implies that bidder’s choice auctions should be used in settings where each bidder is likely to strongly prefer one good over the others, though this need not be the same good for every bidder. Further, this work demonstrates the complementarities of the field and laboratory settings to answer questions which are not clearly resolved using only one setting. |
| Keywords: | experimental economics, field experiment, lab experiment, auction, bidder's choice |
| JEL: | D70 H41 D81 |
| Date: | 2016–09 |
| URL: | http://d.repec.org/n?u=RePEc:ala:wpaper:2016-01&r=upt |