nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2017‒05‒07
twelve papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Dynamically consistent preferences under imprecise probabilistic information By Riedel, Frank; Tallon, Jean-Marc; Vergopoulos, Vassili
  2. Risk aversion and prudence in contests By Sahm, Marco
  3. About the minimal magnitudes of measurement’s forbidden zones. Version 1 By Harin, Alexander
  4. Existence value, biodiversity, and the utilitarian dilemma By Bartkowski, Bartosz
  5. Semiparametric Estimation of the Random Utility Model with Rank-Ordered Choice Data By Jin Yan; Hong Il Yoo
  6. Optimal excess-of-loss reinsurance and investment problem for an insurer with default risk under a stochastic volatility model By Nian Yao; Zhiming Yang
  7. Revealed preferences over risk and uncertainty By Matthew Polisson; John K.-H. Quah; Ludovic Renou
  8. Exchange rate volatility and exports: Estimation of firms risk preferences By Broll, Udo; Mukherjee, Soumyatanu; Sensarma, Rudra
  9. Economic preferences 2.0: Connecting competition, cooperation and inter-temporal preferences By Antonio M. Espin; Angel Sanchez; Benedikt Herrmann
  10. An Empirical Theory of Pure Exchange:Individual Demand and Equilibrium By Dominique, C-Rene
  11. Pairs Trading under Drift Uncertainty and Risk Penalization By S\"uhan Altay; Katia Colaneri; Zehra Eksi
  12. Geographical Dispersion of Consumer Search Behavior By Hakan Yilmazkuday

  1. By: Riedel, Frank (Center for Mathematical Economics, Bielefeld University); Tallon, Jean-Marc (Center for Mathematical Economics, Bielefeld University); Vergopoulos, Vassili (Center for Mathematical Economics, Bielefeld University)
    Abstract: This paper extends decision theory under imprecise probabilistic information to dynamic settings. We explore the relationship between the given objective probabilistic information, an agent's subjective multiple priors, and updating. Dynamic consistency implies rectangular sets of priors at the subjective level. As the objective probabilistic information need not be consistent with rectangularity at the subjective level, agents might select priors outside the objective probabilistic information while respecting the support of the given set of priors. Under suitable additional axioms, the subjective set of priors belongs to the rectangular hull of the objective probabilistic information.
    Keywords: Imprecise information, imprecision aversion, multiple priors, dynamic consistency
    Date: 2017–04–27
  2. By: Sahm, Marco
    Abstract: I examine the impact of risk preferences on efforts and winning probabilities in generalised Tullock contests between two players. The theoretical analysis yields two main results. First, I specify a sufficient condition on the agents' comparative prudence under which a higher common level of risk aversion leads to lower aggregate effort in symmetric contests. Second, I show that for a certain range of parameters in asymmetric contests, higher risk-aversion will be a disadvantage if the agent is comparatively prudent.
    Keywords: Tullock Contest,Risk Aversion,Prudence
    JEL: C72 D72
    Date: 2017
  3. By: Harin, Alexander
    Abstract: Suppose a random variable takes on values in an interval. The minimal distance from the expectation of the variable to the nearest boundary of the interval is considered here. One of the aims of the present article is also an analysis of the question when this minimal distance can be neglected with respect to the standard deviation. This minimal distance can determine the minimal magnitudes of forbidden zones caused by noise for results of measurements near the boundaries of the intervals. The most observed influence and problems of these forbidden zones are suffered in behavioral economics and decision sciences.
    Keywords: utility theory; prospect theory; behavioral economics; decision sciences; probability; dispersion; variance; expectation; noise;
    JEL: C02 C1 C9 C91 C93 D8 D81
    Date: 2017–04–25
  4. By: Bartkowski, Bartosz
    Abstract: Existence value has been argued to be a significant part of the total economic value of some ecosystems. However, its compatibility with the welfare economic foundations of economic valuation is very limited - it is difficult to logically conceive of changes in existence. Moreover, when applied to biodiversity, the concept of existence value gives rise to an instance of a more fundamental problem of economic valuation, termed here the utilitarian dilemma: it can be argued conceptually that biodiversity cannot have existence value; yet the results of empirical studies suggest that people in stated preference studies can be expected to assign existence value to it. The utilitarian dilemma arises as the analysing economist must deal somehow with 'erroneous' preferences. There seems to be no simple solution to the dilemma, but deliberative monetary valuation has the potential to alleviate it.
    Keywords: axiology,biodiversity,economic valuation,existence value,utilitarianism
    Date: 2017
  5. By: Jin Yan (The Chinese University of Hong Kong.); Hong Il Yoo (Durham Business School)
    Abstract: We propose two semiparametric methods for estimating the random utility model using rank-ordered choice data. The framework is “semiparametric” in that the utility index includes finite dimensional preference parameters but the error term follows an unspecified distribution. Our methods allow for a flexible form of heteroskedasticity across individuals. With complete preference rankings, our methods also allow for heteroskedastic and correlated errors across alternatives, as well as a variety of random coefficients distributions. The baseline method we develop is the generalized maximum score (GMS) estimator, which is strongly consistent but follows a non-standard asymptotic distribution. To facilitate statistical inferences, we make extra regularity assumptions and develop the smoothed GMS estimator, which is asymptotically normal. Monte Carlo experiments show that our estimators perform favorably against popular parametric estimators under a variety of stochastic specifications
    Keywords: Rank-ordered; Random utility; Semiparametric estimation; Smoothing
    JEL: C14 C35
    Date: 2017–04
  6. By: Nian Yao; Zhiming Yang
    Abstract: In this paper, we study an optimal excess-of-loss reinsurance and investment problem for an insurer in defaultable market. The insurer can buy reinsurance and invest in the following securities: a bank account, a risky asset with stochastic volatility and a defaultable corporate bond. We discuss the optimal investment strategy into two subproblems: a pre-default case and a post-default case. We show the existence of a classical solution to a pre-default case via super-sub solution techniques and give an explicit characterization of the optimal reinsurance and investment policies that maximize the expected CARA utility of the terminal wealth. We prove a verification theorem establishing the uniqueness of the solution. Numerical results are presented in the case of the Scott model and we discuss economic insights obtained from these results.
    Date: 2017–04
  7. By: Matthew Polisson (University of St Andrews); John K.-H. Quah (Johns Hopkins University); Ludovic Renou (Queen Mary University of London)
    Abstract: We develop a nonparametric procedure, called the lattice method, for testing the consistency of contingent consumption data with a broad class of models of choice under risk and under uncertainty. Our method allows for risk loving and elation seeking behavior and can be used to calculate, via Afriat's efficiency index, the magnitude of violations from a particular model of choice. We evaluate the performance of different models (including expected utility, disappointment aversion, rank dependent utility, mean-variance utility, and stochastically monotone utility) in the data collected by Choi et al. (2007), in terms of pass rates, power, and predictive success.
    Keywords: expected utility, rank dependent utility, disappointment aversion, Bronars power, predictive success, generalized axiom of revealed preference, first order stochastic dominance, mean-variance utility
    JEL: C14 C60 D11 D12 D81
  8. By: Broll, Udo; Mukherjee, Soumyatanu; Sensarma, Rudra
    Abstract: In this companion paper to Broll and Mukherjee (2017), we empirically analyse how exchange rate volatilities affect firms optimal production and exporting decisions. The firms elasticity of risk aversion determines the direction of the impact of exchange rate risk on exports. Based on a flexible utility function that incorporates all possible risk preferences, a unique structurally estimable equation is used to estimate the risk aversion elasticities for a panel of Indian service sector (non-financial) firms over 2004-2015, using the quantile regression method.
    Keywords: exports,exchange rate volatility,risk aversion
    JEL: D21 D81 F10 F31
    Date: 2017
  9. By: Antonio M. Espin (Department of Economics, Middlesex University Business School; and Granada Lab of Behavioral Economics (GLoBE)); Angel Sanchez (Grupo Interdisciplinar de Sistemas Complejos (GISC), Departamento de Matematicas, Universidad Carlos III de Madrid; and Instituto de Biocomputacion y Fisica de Sistemas Complejos (BIFI), Universidad de Zaragoza; and Institute UC3M-BS for Financial Big Data, Universidad Carlos III de Madrid); Benedikt Herrmann (Centre for Decision Research and Experimental Economics, School of Economics, University of Nottingham)
    Abstract: This paper presents a “second generation†theory on the nature of social preferences. Incorporating an inter-temporal ingredient, we generate an outcome-based model which focuses on the conflict between cooperation towards social efficiency and competition for the individual relative standing. We build on the argument that cooperative (competitive) patterns are more likely to arise when the future is perceived as secure and predictable (unsecure and unpredictable). In order to accommodate this argument with recent experimental results showing a relationship between individuals’ inter-temporal preferences and social behavior in one-shot games, social efficiency is assumed to trigger long-run satisfaction whereas relative standing is linked to short-run satisfaction. In so doing, we add a dynamic component to social preferences. This feature of the model implies that more patient individuals are more willing to get involved in cooperative affairs while more impatient individuals are more likely to display competitive patterns. Yet, an individual’s inter-temporal preferences interact with contextual factors (cues of future (un)predictability) to determine her course of action. The theory is then tested to shed new light on individuals’ decisions in different games used in experimental research where a relationship between game play and inter-temporal preferences has been found. We show that our new combination of social and inter-temporal preferences adds well to the explanatory power of economic theory on human decision making.
    Date: 2017–04
  10. By: Dominique, C-Rene
    Abstract: SUMMARY: Scientists question the ‘scientificity’ of Neoclassical Economic Theory because microeconomics depends on an un-observable utility function, while the modern version of the theory requires that macroeconomics be built on microfoundations. The first step in remedying such an incongruous analytics is to use ‘naïve’ set theory to show that the utility function is indeed a misleading appendage.
    Keywords: KEYWORDS: Properties of Relations, Order Isomorphisms, Individual Demand, Equilibrium, Attractors’ Reconstruction
    JEL: B4 D5 D50
    Date: 2017–05–21
  11. By: S\"uhan Altay; Katia Colaneri; Zehra Eksi
    Abstract: In this work, we study the dynamic portfolio optimization problem related to the pairs trading, which is an investment strategy that matches a long position in one security with a short position in an another security with similar characteristics. The relation between pairs, called spread, is modeled by a Gaussian mean-reverting process whose drift rate is modulated by an unobservable continuous-time finite state Markov chain. Using the classical stochastic filtering theory, we reduce this problem with partial information to the one with complete information and solve it for the logarithmic utility function, where the terminal wealth is penalized by the riskiness of the portfolio according to the realized volatility of the wealth process. We characterize optimal dollar-neutral strategies as well as optimal value functions under both full and partial information and show that the certainty principle holds for the optimal portfolio strategy. Finally, we provide a numerical analysis for a simple example with a two-state Markov chain.
    Date: 2017–04
  12. By: Hakan Yilmazkuday (Department of Economics, Florida International University)
    Abstract: This paper investigates whether consumer search behavior differs across zip codes within the U.S.. As an application, daily gasoline price data covering virtually all gas stations within the U.S. are employed to estimate the distribution of search costs in each zip code. The results show that there are significant differences across zip codes regarding the expected number of searches achieved before consumers purchase gasoline. In order to have a systematic explanation, such differences are further connected to geographic, demographic and economic conditions of the zip codes in a secondary analysis. The corresponding results imply several strategies for gas stations in order to maximize profits/markups; suggestions follow for policy makers and regulators to reduce redistributive effects of information barriers across locations.
    Keywords: Consumer Search, Price Dispersion, Retail Gasoline
    JEL: D12 D83 L81
    Date: 2017–04

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