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on Utility Models and Prospect Theory |
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Issue of 2017‒03‒26
seventeen papers chosen by |
| By: | Daniel Danau (University of Caen Normandy, CREM-CAEN, UMR CNRS 6211, France) |
| Abstract: | Under the expected utility paradigm, prudence (u''' > 0) is usually associated with the amount of risk premium an individual requires in order to renounce to a certain current outcome in favour of an uncertain future outcome. A prudent individual requires a higher premium the lower her initial wealth. However, when the individual has to make a costly investment before obtaining the outcome, she may prefer to delay that investment. This translates into a preference for latter, not earlier outcome. Consequently, prudence cannot be associated with a risk premium. In this paper we show that, for an individual who prefers to delay the investment, prudence is actually associated with the economic bene t granted by that delay. Speci cally, a lower expected unit cost of acquiring the good is associated with a greater bene t of the investment delay if and only if u''' is high, and, with a uniform distribution, u''' > 0. We also show that the preference for facing a lower expected unit cost and/or a wider support of the unit cost increases with u'''. We describe two applications of this result, namely, sequential learning in the delegation of a task and timing of investment decisions under multiperiod uncertainty. |
| Keywords: | Prudence; Risk aversion; Sequential screening; Real Options |
| JEL: | D81 |
| Date: | 2017–03 |
| URL: | http://d.repec.org/n?u=RePEc:tut:cremwp:2017-05&r=upt |
| By: | Franz, Markus |
| Abstract: | This dissertation contributes to the research on three core elements of decision support systems for managers and consumers: data management, model management and user interface. With respect to data management this dissertation proposes an approach for reducing unobserved product heterogeneity in online transaction data sets. The example of an online auction data set is used to investigate the approach’s ability to improve data quality. In the area of model management this dissertation contributes an approach to elicit consumer product preferences for exponential (beside linear) utility functions aiming at predicting consumers’ utilities and willingness-to-pay for individual products. The question which utility function (linear or exponential) is better suited for predicting product utilities and the willingness to pay is evaluated using a laboratory experiment. Further, in the area of user interfaces this dissertation deals with information visualization. Focusing on coordinate systems, a laboratory experiment is used to investigate which visualization format (two or three dimensional) is better suited for supporting simple vs. complex decision making scenarios and which criteria matter when choosing a visualization format for a particular level of decision making complexity. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:dar:wpaper:85651&r=upt |
| By: | Robert Kollmann |
| Abstract: | The business cycles of advanced economies are synchronized. Standard macro models fail to explain that fact. This paper presents a simple model of a two-country, two-traded-good, complete-financial-markets world in which country-specific productivity shocks generate business cycles that are highly correlated internationally. The model assumes recursive intertemporal preferences (Epstein-Zin-Weil), and a muted response of labor hours to household wealth changes (due to Greenwood-Hercowitz-Huffman period utility and demand-determined employment under rigid wages). Recursive intertemporal preferences magnify the terms of trade response to country-specific shocks. Hence, a productivity (and GDP) increase in a given country triggers a strong improvement of the foreign country’s terms of trade, which raises foreign labor demand. With a muted labor wealth effect, foreign labor and GDP rise, i.e. domestic and foreign real activity commove positively. |
| Keywords: | international business cycle synchronization, recursive preferences, terms of trade, real exchange rate, wealth effect on labor supply |
| JEL: | F31 F32 F36 F41 F43 |
| Date: | 2017–03 |
| URL: | http://d.repec.org/n?u=RePEc:een:camaaa:2017-21&r=upt |
| By: | Robert Kollmann |
| Abstract: | The business cycles of advanced economies are synchronized. Standard macro models fail to explain that fact. This paper presents a simple model of a two-country, two-tradedgood, complete-financial-markets world in which country-specific productivity shocks generate business cycles that are highly correlated internationally. The model assumes recursive intertemporal preferences (Epstein-Zin-Weil), and a muted response of labor hours to household wealth changes (due to Greenwood-Hercowitz-Huffman period utility and demand-determined employment under rigid wages). Recursive intertemporal preferences magnify the terms of trade response to country-specific shocks. Hence, a productivity (and GDP) increase in a given country triggers a strong improvement of the foreign country’s terms of trade, which raises foreign labor demand. With a muted labor wealth effect, foreign labor and GDP rise, i.e. domestic and foreign real activity comove positively. |
| Keywords: | international business cycle synchronization; recursive preferences; trade; real exchange; wealth effect on labor supply |
| JEL: | F31 F32 F36 F41 F43 |
| Date: | 2017–03 |
| URL: | http://d.repec.org/n?u=RePEc:eca:wpaper:2013/248464&r=upt |
| By: | Jean-Pierre Fouque; Ruimeng Hu |
| Abstract: | Rough stochastic volatility models have attracted a lot of attentions recently, in particular for the linear option pricing problem. In this paper, starting with power utilities, we propose to use a martingale distortion representation of the optimal value function for the nonlinear asset allocation problem in a (non-Markovian) fractional stochastic environment (for all Hurst index $H \in (0,1)$). We rigorously establish a first order approximation of the optimal value, where the return and volatility of the underlying asset are functions of a stationary slowly varying fractional Ornstein-Uhlenbeck process. We prove that this approximation can be also generated by a fixed zeroth order trading strategy providing an explicit strategy which is asymptotically optimal in all admissible controls. Furthermore, we extend the discussion to general utility functions, and obtain the asymptotic optimality of this fixed strategy in a specific family of admissible strategies. |
| Date: | 2017–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1703.06969&r=upt |
| By: | Tristan Le Cotty (CIRED - Centre International de Recherche sur l'Environnement et le Développement - CIRAD - Centre de Coopération Internationale en Recherche Agronomique pour le Développement - EHESS - École des hautes études en sciences sociales - AgroParisTech - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique); Elodie Maitre d'Hotel (UMR MOISA - Marchés, Organisations, Institutions et Stratégies d'Acteurs - CIRAD - Centre de Coopération Internationale en Recherche Agronomique pour le Développement - Montpellier SupAgro - Centre international d'études supérieures en sciences agronomiques - INRA Montpellier - Institut national de la recherche agronomique [Montpellier] - CIHEAM - Centre International des Hautes Études Agronomiques Méditerranéennes, CIRAD - Centre de Coopération Internationale en Recherche Agronomique pour le Développement); Raphael Soubeyran (LAMETA - Laboratoire Montpelliérain d'Économie Théorique et Appliquée - UM3 - Université Paul-Valéry - Montpellier 3 - Montpellier SupAgro - Centre international d'études supérieures en sciences agronomiques - INRA Montpellier - Institut national de la recherche agronomique [Montpellier] - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique); Julie Subervie (LAMETA - Laboratoire Montpelliérain d'Économie Théorique et Appliquée - UM3 - Université Paul-Valéry - Montpellier 3 - Montpellier SupAgro - Centre international d'études supérieures en sciences agronomiques - INRA Montpellier - Institut national de la recherche agronomique [Montpellier] - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique) |
| Abstract: | This paper investigates whether Burkinabe maize farmers’ fertilizer-use decisionsare correlated with their risk and time preferences. We conducted a survey and a se-ries of hypothetical experiments on a sample of 1,500 farmers. We find that morepatient farmers do use more fertilizer, but it is only because they plant more maize (afertilizer-intensive crop) rather than because they use more fertilizer per hectare ofmaize planted. Conversely, we find no statistically significant link between risk aver-sion and fertilizer use. We use a simple two-period model, which suggests that riskaversion may indeed have an ambiguous effect on fertilizer use. |
| Keywords: | agriculture,risk aversion,time preferences,agricultural price,western africa,fertilizer,aversion au risque,prix agricole,burkina faso,afrique occidentale,engrais |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:hal:ciredw:hal-01429099&r=upt |
| By: | Anthony Newell; Lionel Page |
| Abstract: | We design an asset market experiment in which participants are primed in a boom or bust market condition before trading. We find that pricing bubbles are significantly reduced in the markets in the bust priming condition and that mispricing of assets is larger in the boom condition. We also find that participants exhibit weaker predictive ability in the boom priming condition compared to the bust priming condition. These findings lend weight to the idea that traders’ risk attitude are time varying and that market dynamics may affect these risk attitudes, creating the possibility of feedback loops on market conditions themselves. |
| Keywords: | Behavioural finance, countercyclical risk aversion, time-varying risk aversion, feedback loops, financial bubbles. |
| JEL: | C91 C92 D81 G10 G12 |
| Date: | 2017–03–17 |
| URL: | http://d.repec.org/n?u=RePEc:qut:qubewp:wp050&r=upt |
| By: | Michel Beine; Marco Delogu; Lionel Ragot |
| Abstract: | This working paper studies the determinants of international students’ mobility at the university level, focusing specifically on the role of tuition fees. We derive a gravity model based on a Random Utility Maximization model of location choice for international students in the presence of capacity constraints of the hosting institutions. The last layer of the model is estimated using new data on student migration flows at the university level for Italy and the United Kingdom. The particular institutional setting of the two destination countries allows us to control for the potential endogeneity of tuition fees. We obtain evidence for a clear and negative effect of fees on international student mobility and confirm the positive impact of the quality of the education. The estimations also support the important role of additional destination-specific variables such as host capacity, the expected return of education and the cost of living in the vicinity of the university. |
| Keywords: | Foreign Students;Tuition Fees;Location Choice;University Quality |
| JEL: | F22 H52 I23 O15 |
| Date: | 2017–03 |
| URL: | http://d.repec.org/n?u=RePEc:cii:cepidt:2017-04&r=upt |
| By: | Loïc Berger (IESEG School of Management and Fondazione Eni Enrico Mattei (FEEM)); Johannes Emmerling (Fondazione Eni Enrico Mattei (FEEM) and Centro Euro-Mediterraneo sui Cambiamenti Climatici (CMCC)) |
| Abstract: | Inequity plays a fundamental role in the evaluation of social welfare in many dimensions. We revisit the concept of inequity, whether across states of world (uncertainty), across individuals (inequality) and across generations (intergenerational equity), using a common framework generalizing the discounted expected utilitarianism approach. We propose a general measure of welfare as equity equivalents and develop the corresponding inequity index. We then allow for different degrees of inequity aversion across the three dimensions to span a simplex of possible inequity preferences and relate it to the recent literature on this topic. We show that the ordering of aggregation across the different dimensions matters for welfare evaluations and that many welfare-theoretical approaches developed in the literature may be seen as special cases of this general framework. |
| Keywords: | Utilitarianism, Inequality, Inequity Aversion, Risk Aversion, Intertemporal Welfare, Discounting |
| JEL: | D60 D63 D30 |
| Date: | 2017–03 |
| URL: | http://d.repec.org/n?u=RePEc:fem:femwpa:2017.14&r=upt |
| By: | Kausik Gangopadhyay (Indian Institute of Management, Kozhikode); Kousik Guhathakurta (Indian Institute of Management, Kozhikode) |
| Abstract: | The housing asset bubble and mortgage crisis of 2007-08 in the US market poses a challenge to understanding of market and hypotheses related to market efficiency. The contribution of our paper is bifold. First, we present a survey of the existing literature which explains the housing asset bubble. We have emphasized on agent based modeling approaches in this context. The second part of the paper frames an economic model to demonstrate the power of irrational “exuberance hypothesis”, a term coined by Robert J Shiller. Using a felicity function based framework, this shows that the power of irrational expectation in bringing about an artificial and unintended boost in demand for investment of housing asset. |
| URL: | http://d.repec.org/n?u=RePEc:iik:wpaper:129&r=upt |
| By: | Jason Delaney (Georgia Gwinnett College); Sarah Jacobson (Williams College); Thorsten Moenig (Temple University) |
| Abstract: | We develop an axiomatic theory that integrates the discovered preference hypothesis into neoclassical microeconomic choice theory, making predictions amenable to empirical tests. Several regularities in economic literatures could be explained by a theory in which preferences must be discovered through experience. These include: choice reversals as seen in various contexts, instability as seen in risky choice, and errors that decline with repetition as seen in contingent valuation. With reasonable assumptions, we show that choices may appear unstable while preferences are being learned, and that unlearned preferences are associated with welfare loss. We also show that even after choices appear to stabilize, agents face the potential for continued welfare loss due to persistent mis-ranking because of selection bias in the feedback and learning process. The transitory welfare loss that occurs during the learning process decreases over time, with more common goods, and with more income. For large discrete items purchased a small number of times (like houses), this transitory welfare loss may continue the agent’s whole life. The long-run welfare loss caused by persistent mis-ranking is primarily determined by initial misperceptions of goods. In extensions, we demonstrate that imperfect memory of learned tastes and stochasticity in the consumption experiences may make preference learning harder, and that learning spillovers across goods and sophisticated agents who know they need to learn their preferences may or may not alleviate welfare loss. |
| Keywords: | discovered preferences, preference stability, learning, risk preferences |
| JEL: | D81 D83 D01 D03 |
| Date: | 2017–03 |
| URL: | http://d.repec.org/n?u=RePEc:wil:wileco:2017-02&r=upt |
| By: | Pierani, P.; Tiezzi, S.; |
| Abstract: | This paper deals with one of the main empirical problems associated with the rational addiction model, namely that the demand equation derived from the rational addiction theory is not empirically distinguishable from models with forward looking behavior, but with time inconsistent preferences. The implication is that, even when forward†looking behavior is supported by data, the standard rational addiction equation cannot identify time consistency in preferences. In fact, we show that the possibility of testing for exponential versus non-exponential time discounting is nestled within the general rational addiction model. We propose a test that uses only the information obtained from the general specification and the price effects. We use a panel of Italian individuals to estimate a rational addiction model for tobacco. GMM estimators deal with errors in variables and unobserved heterogeneity. The results conform to the theoretical predictions. We find evidence that tobacco consumers are forward looking. Our test of time consistency does not reject the hypothesis that smokers in our sample actually discount exponentially. |
| Keywords: | rational addiction; general versus standard empirical specification; time consistency; GMM; |
| JEL: | C23 D03 D12 |
| Date: | 2017–03 |
| URL: | http://d.repec.org/n?u=RePEc:yor:hectdg:17/05&r=upt |
| By: | Daniel Lacker; Thaleia Zariphopoulou |
| Abstract: | We analyze a family of portfolio management problems under relative performance criteria, for fund managers having CARA or CRRA utilities and trading in a common time horizon in log-normal markets. We construct explicit time-independent equilibrium strategies for both the finite population games and the corresponding mean field games, which we show are unique in the class of time-independent equilibria. In the CARA case, competition drives agents to invest more in the risky asset than they would otherwise, while in the CRRA case competitive agents may over- or under-invest, depending on their levels of risk tolerance. |
| Date: | 2017–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1703.07685&r=upt |
| By: | Carlos Sáenz-Royo (LEE and Department of Economics, Universitat Jaume I, Castellón, Spain) |
| Abstract: | This study meditates about mental heuristic rules as a representation of bounded rationality in individual decision making. The heuristic process presented here represents simultaneously limited computational capacity, the capacity to determine relevant information in complex contexts around beliefs, and time as an endogenous part of decision. The mathematical model of this heuristic rule correlates to the fallibility of the agent depending on the relative outcome of the alternatives in exogenous terms; the availability of only part of the information regarding the alternatives concert by beliefs; and the amount of time the decision maker is willing to spend on a decision based on previous experience and knowing that there is a tradeoff between time and fallibility. The resulting mathematical model can be applied to many disciplines like such as opinion models, game theory, the comparison of systems of distribution of authority, and fields that utilize the technique of agent-based models (ABM) that use individual behavior to study the macroscopic results of interactions. |
| Keywords: | Bounded rationality, individual decisions making, heuristic, fallibility, modelling decisions, ABM. |
| JEL: | A14 C00 D03 Z13 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:jau:wpaper:2017/04&r=upt |
| By: | Jansen, Anika (federal institute for vocational education and training (bibb), bonn); Pfeifer, Harald (federal institute for vocational education and training (bibb), bonn); Raecke, Julia (federal institute for vocational education and training (bibb), bonn) |
| JEL: | J24 J31 |
| URL: | http://d.repec.org/n?u=RePEc:unm:umagsb:2017004&r=upt |
| By: | V. Shikhman |
| Abstract: | We consider an economy with consumers maximizing Cobb-Douglas utilities from the algorithmic perspective. It is known that in this case nding equilibrium prices reduces to the eigenvalue problem for a particularly structured stochastic matrix. We show that the power method for solving this eigenvalue problem can be naturally interpreted as a t^atonnement executed by an auctioneer. Its linear rate of convergence is established under the reasonable assumption of pairwise connectivity w.r.t. commodities within submarkets. We show that the pairwise connectivity remains valid under suciently small perturbations of consumers' tastes and endowments. Moreover, the property of pairwise connectivity holds for almost all Cobb-Douglas economies. |
| Keywords: | exchange economy; Cobb-Douglas utility; tâtonnement; power method; regular economy; stochastic matrix |
| Date: | 2017–03 |
| URL: | http://d.repec.org/n?u=RePEc:eca:wpaper:2013/248466&r=upt |
| By: | Benoît Campagne; Aurélien Poissonnier |
| Abstract: | The evaluation of fiscal and structural reforms has become not only a standard but indispensable exercise in the DSGE literature and in the policy-making publications and reports. Institutions such as the IMF, the European Commission, the OECD, the ECB, and many central banks have now developed and refined their own tools and are capable of conducting such analyses in different contexts. The effects of structural reforms have been documented by D'Auria et al. (2009) for EU member states and for Italy by Annicchiarico et al. (2013) both in the R&D version of the Quest III model. The IMF or the OECD have also conducted their own evaluations for Europe (Bayoumi et al., 2004; Everaert and Schule, 2006,2008; Cacciatore et al., 2012). Fiscal reforms or consolidation have also been assessed through DSGE models. In the European context some work were conducted on the Quest III model (Vogel, 2012). Coenen et al. (2008) investigate labor tax reforms in the New Area Wide Model (NAWM). Clinton et al. (2011) provide similar insights in the case of an international model (GIMF). Coenen et al. (2012) give an extensive review of the size of fiscal multipliers in the main institutional models. The recurrence and the systematic use of DSGEs today therefore raises the question of their actual capabilities. Whereas their qualitative behaviours have largely improved and now properly describe economic data, their quantitative accuracy is still debated among economists (see for instance Schorfheide (2011) for a summary of current DSGE weaknesses). We use the two country DSGE model of the Euro area MELEZE developed at Insee to shed a new light on two standard exercises: structural and fiscal reforms evaluations. The main features of the model compare with standard tools developed in international institutions and central banks: nominal and wage rigidities, capital adjustment cost, and both Ricardian and non-Ricardian consumers. We study the dependency of fiscal and structural simulations' results to various specifications in our DSGE model. Within a range of feasible calibrations for the elasticities in the utility function, the share of non Ricardian consumers, and among other sensitivity tests, the analysis focuses on short and long term multipliers of both fiscal and structural reforms. We also rank policy schemes based on welfare analyses along the transitional paths. The model MELEZE used in this paper features the standard modeling choices of the two country monetary union literature. The core of the model for each country is inspired by Christiano et al. (2005) and Smets and Wouter (2003, 2005, 2007): firms and consumers maximize their objective (utility or profit) by interacting on the goods, labor and capital markets with both prices and wages rigidities introducing neo-Keynesian features in the model à la Erceg et al. (2000). The model also integrates risk free assets to ensure an intertemporal trade-off and real rigidities on the capital market. In addition, our model builds on academic works studying monetary and fiscal policies in monetary unions Gali and Monacelli (2008), Benigno (2004) by introducing capital markets. We also introduce non Ricardian households as advocated by Mankiw (2000), a feature which is crucial for the reaction of private consumption to public spending (Gali et al. 2007), and therefore a priori crucial to the size of fiscal multipliers. We compare this mechanism with Edgeworth complementarity as advocated by Fève and Sahuc (2013). Moreover, we introduce in our model public and private debts exchanged on a union wide financial market both at steady state and out of equilibrium. Holding debt or asset is motivated by agents' preferences for the present and comes at a financial intermediation cost embodied through a debt elastic premium. We explicit and micro-found this financial intermediation service by introducing a financial intermediation sector. Beyond public debt, the government uses public spending to stimulate and monitor economic activity. It can also exogenously modify its fiscal policy along different axes: lump-sum transfers and taxes on consumption, labor, capital income or dividends. As detailed below, we depart from traditional budget rules behaviors used in the literature, and derive a forward-looking optimizing behavior for the government. All these modeling elements are generally embedded in large scale models developed in central banks and international institutions among which are GEM at the IMF (Bayoumi et al., 2004), NAWM at the ECB (Coenen et al., 2008) or in open economy EAGLE (Gomes et al., 2012), QUEST III at the European Commission (Ratto et al., 2009) and its R&D version (Roeger et al., 2008). Whereas these models sometimes also consider both tradable and non-tradable goods, heterogeneous agents on the labor market, or endogenous growth, we choose to simplify our model and do not consider these additions. The outcome is a model tractable enough to be fully linearized by hand. We are also able to solve for the steady state for the real variables in levels and carefully account for all the steady state restrictions imposed on the parameters of the model. We replicate three different settings: France against the rest of the Eurozone, Italy against the rest of the Eurozone, and a symmetric calibration for the Euro area as a closed economy. In a first section, we study the long-term impact of mark-up reforms in both the labor and goods markets. Even in the absence of entry costs, wage bargaining and an endogenous determination of the number of firms as in Blanchard and Giavazzi (2003), our results compare with stylized facts obtained in their model. Moreover and numerically, reforms simulation as conducted in Everaert and Schule (2006) indicates that the absence of additional rigidities and of a distinction between tradable and non-tradable goods may overestimate the long-term gains from pro-competitive reforms. More importantly, even though the stylized facts behind such reforms are robust, they increase output level at steady state, their quantification is uncertain. Within a range of feasible calibrations for the elasticities in the utility function, the effect of a structural reform can be magnified threefold. Similarly, the introduction of non Ricardian agents amplifies the gains from deregulation up to a doubling factor. In a second section, we study the effect of temporary or permanent fiscal reforms. We simulate increases in public spending, transfers or decreases in various tax rates calibrated to 1% of pre-stimulus output. The resulting fiscal multipliers are compared to the main existing DSGE models based on the results provided in Coenen et al. (2012), and to the French macroeconometric model Mésange developed at Insee (Klein and Simon, 2010). We find that our model gives comparable multipliers for temporary shocks but highlight that these measures of the fiscal multipliers crucially depend on their timing and the way both fiscal and monetary authorities commit or react to the stimulus. In particular, the modeling of government spending, usually introduced through an ad hoc spending rule, can imply fiscal multipliers larger or smaller than one. We compare these results with an alternative modeling of governments' behavior. Actually, we depart from ad hoc fiscal or budget rules traditionally introduced in quantitative models to endogenise public spending and tax rates to ensure governments' solvency (Bayoumi et al., 2004; Coenen et al., 2008; Ratto et al. 2009 ; Corsetti et al., 2009). We consider governments that maximize their stream of spending in a forward-looking way, closely equivalent to a Euler equation for households. In the end, public spending fiscal multipliers can range from 0.7 to 1.3 depending on the specification of the governments' spending rule and of the monetary environment. Cuts on distorting tax rates provides lower multipliers, that turn out to be even negative in the absence of government commitment for cuts in corporate income taxes and labor income taxes. Coordination across countries leads to increased fiscal multipliers. In response to permanent spending shocks financed though lump-sum transfers, our model provides weaker long-term multipliers yet comparable to Coenen et al. (2012) results. This weaker response stems from the negative wealth effect implied by the necessary financing fall in transfers. In all, our results raise questions on the ability for current quantitative DSGE models to provide accurate quantitative estimates for economic policies. In the conduct of policy analysis, one should therefore be very cautious to properly assess the dependency of the results to the specification of the model, and provide detailed sensitivity tests. Ongoing developments to be included in this paper include: a. Studying the transitional dynamic of structural reforms b. Ranking policy schemes based on welfare analyses along the transitional paths c. Stronger justification of the government’s behavior by the introduction of government spending in households’ utility function. |
| Keywords: | Euro Area, France, Italy, General equilibrium modeling, Impact and scenario analysis |
| Date: | 2015–07–01 |
| URL: | http://d.repec.org/n?u=RePEc:ekd:008007:8482&r=upt |