nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2017‒05‒21
twenty-one papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Random Binary Choices that Satisfy Stochastic Betweenness By Matthew Ryan
  2. Bayesian Inference of the Multi-Period Optimal Portfolio for an Exponential Utility By David Bauder; Taras Bodnar; Nestor Parolya; Wolfgang Schmid
  3. Mentalism Versus Behaviourism in Economics: A Philosophy-of-Science Perspective By Franz Dietrich; Christian List
  4. Success, Survive or Escape? Aspirations and Poverty Traps By David Chivers
  5. Do You Save More or Less in Response to Bad News? A New Identification of the Elasticity of Intertemporal Substitution By Schmidt, Lawrence; Toda, Alexis Akira
  6. Egalitarianism in Nontransferable Utility Games By Dietzenbacher, Bas; Borm, Peter; Hendrickx, Ruud
  7. Preference Conditions for Invertible Demand Functions By Georgios Gerasimou
  8. Strategy-proof multi-object auction design: Ex-post revenue maximization with no wastage By Tomoya Kazumura; Debasis Mishra; Shigehiro Serizawa
  9. A degree-distance-based connections model with negative and positive externalities By Philipp Moehlmeier; Agnieszka Rusinowska; Emily Tanimura
  10. Dynamically Consistent Preferences Under Imprecise Probabilistic Information By Frank Riedel; Jean-Marc Tallon; Vassili Vergopoulos
  11. Only the brave? Risk and time preferences of decision makers and firms' investment in worker training By Jansen, Anika; Pfeifer, Harald; Raecke, Julia
  12. The premium of government debt: Disentangling safety and liquidity By Xiong, Qizhou
  13. Cognitive ability and the effect of strategic uncertainty By Nobuyuki Hanaki; Nicolas Jacquemet; Stéphane Luchini; Adam Zylbersztejn
  14. Addendum to: "Ranking opportunity sets on the basis of similarities of preferences: a proposal" By Luc Lauwers; Tom Potoms; Carmen Vázquez
  15. On a Class of Smooth Preferences By Attar, Andrea; Mariotti, Thomas; Salanié, François
  16. Reason-based choice and context-dependence: An explanatory framework By Franz Dietrich; Christian List
  17. Huggett Economies with Multiple Stationary Equilibria By Toda, Alexis Akira
  18. Random Dictatorship and the Value in Cooperative Games with Incomplete Information By Andrés Salamanca
  19. Intertemporal Abatement Decisions under Ambiguity Aversion in a Cap and Trade By Simon Quemin
  20. Multiple switching behavior in different display formats of multiple price lists By Bauermeister, Golo-Friedrich; Mußhoff, Oliver
  21. Predictive Power in Behavioral Welfare Economics By Elias Bouacida; Daniel Martin

  1. By: Matthew Ryan (School of Economics, Faculty of Business and Law, Auckland University of Technology)
    Abstract: Experimental evidence suggests that the process of choosing between lotteries (risky prospects) is stochastic and is better described through choice probabilities than preference relations. Binary choice probabilities admit a Fechner representation if there exists a utility function u such that the probability of choosing a over b is a non-decreasing function of the utility di¤erence u (a) - u (b). The representation is strict if u (a) u (b) precisely when the decision-maker is at least as likely to choose a from fa; bg as to choose b. Blavatskyy (2008) obtained necessary and su¢ cient conditions for a strict Fechner representation in which u has the expected utility form. One of these is the common consequence independence (CCI) axiom (ibid.,Axiom 4), which is a stochastic analogue of the mixture independence condition on preferences. Blavatskyy also conjectured that by weakening CCI to a condition he called stochastic betweenness (SB) a stochastic analogue of the betweenness condition on preferen-ces (Chew (1983)) one obtains necessary and suffcient conditions for a strict Fechner representation in which u has the implicit expected utility form (Dekel (1986)). We show that Blavatskyys conjecture is false, and provide a valid set of necessary and su¢ cient conditions for the desired representation.
    Date: 2017–01
  2. By: David Bauder; Taras Bodnar; Nestor Parolya; Wolfgang Schmid
    Abstract: We consider the estimation of the multi-period optimal portfolio obtained by maximizing an exponential utility. Employing Jeffreys' non-informative prior and the conjugate informative prior, we derive stochastic representations for the optimal portfolio weights at each time point of portfolio reallocation. This provides a direct access not only to the posterior distribution of the portfolio weights but also to their point estimates together with uncertainties and their asymptotic distributions. Furthermore, we present the posterior predictive distribution for the investor's wealth at each time point of the investment period in terms of a stochastic representation for the future wealth realization. This in turn makes it possible to use quantile-based risk measures or to calculate the probability of default. We apply the suggested Bayesian approach to assess the uncertainty in the multi-period optimal portfolio by considering assets from the FTSE 100 in the weeks after the British referendum to leave the European Union. The behaviour of the novel portfolio estimation method in a precarious market situation is illustrated by calculating the predictive wealth, the risk associated with the holding portfolio, and the default probability in each period.
    Date: 2017–05
  3. By: Franz Dietrich (PSE - Paris School of Economics, CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Christian List (LSE - London School of Economics and Political Science)
    Abstract: Behaviourism is the view that preferences, beliefs, and other mental states in social-scientific theories are nothing but constructs re-describing people's behaviour. Mentalism is the view that they capture real phenomena, on a par with the unobservables in science, such as electrons and electromagnetic fields. While behaviourism has gone out of fashion in psychology, it remains influential in economics, especially in 'revealed preference' theory. We defend mentalism in economics, construed as a positive science, and show that it fits best scientific practice. We distinguish mentalism from, and reject, the radical neuroeconomic view that behaviour should be explained in terms of brain processes, as distinct from mental states.
    Keywords: scientific realism,decision theory,revealed preference,Mentalism,behaviourism
    Date: 2016
  4. By: David Chivers (Durham Business School)
    Abstract: I present a model of occupational choice where an agent decides whether to invest in a project that yields risky returns or a project that yields safe returns. An agentís utility is affected by the presence of an aspiration level which will only be satisÖed if their Önal income is above the poverty line. I show that agents who are sufficiently above the poverty line will invest in the risky project and are able to aspire for success. An agent, however, who is just above the poverty line, may be so concerned about falling into poverty that they choose to invest in the safe project. These individuals aspire only to survive. Alternatively, if an agent is su¢ ciently below the poverty line, then they will invest in the risky project even if expected returns are lower than the safe project. These individuals have "nothing left to lose" and therefore aspire to escape. Two forms of poverty traps emerge from the resulting equilibria: one above the poverty line, and one below the poverty line. Finally, I o§er empirical support for the model based on individual level survey data across a large number of ountries.Keywords: Poverty Traps, Entrepreneurship, Aspirations, Loss aversion, Development
    JEL: D31 D81 E24 L26 O11
    Date: 2017–05
  5. By: Schmidt, Lawrence; Toda, Alexis Akira
    Abstract: We define the elasticity of intertemporal substitution (EIS) for general recursive preferences and identify a sharp comparative static from a general dynamic portfolio choice problem. In the homothetic case, if the EIS is smaller (larger) than 1, an investor will increase (decrease) current consumption in response to bad news about the future. Examples of bad news include if (i) she becomes more risk averse, (ii) investment opportunities shrink, (iii) investment returns become riskier, or (iv) she becomes more uncertain about the distribution of returns. Bad news effectively raises the price of future continuation utility, which produces the same qualitative changes in savings rates as lowering the interest rate.
    Keywords: elasticity of intertemporal substitution, optimal portfolio problem, recursive preference
    JEL: D91 E21 G11
    Date: 2015–05–26
  6. By: Dietzenbacher, Bas (Tilburg University, Center For Economic Research); Borm, Peter (Tilburg University, Center For Economic Research); Hendrickx, Ruud (Tilburg University, Center For Economic Research)
    Abstract: This paper studies egalitarianism in the context of nontransferable utility games by introducing and analyzing the egalitarian value. This new solution concept is based on an egalitarian negotiation procedure in which egalitarian opportunities of coalitions are explicitly taken into account. We formulate conditions under which it leads to a core element and discuss the egalitarian value for the well-known Roth-Shafer examples. Moreover, we characterize the new value on the class of bankruptcy games and bargaining games.
    Keywords: egalitarianism; NTU-games; egalitarian procedure; egalitarian value; egalitarian stability; constrained relative equal awards rule
    JEL: C71 D63
    Date: 2017
  7. By: Georgios Gerasimou
    Abstract: This paper identifies conditions on a utility-maximizing consumer’s preferences that are both necessary and sufficient for his demand function to be invertible in prices. The conditions in question are strict convexity, strict monotonicity and differentiability in the sense of Rubinstein (2006). It is further shown that such a demand function is continuous if and only if preferences have, in addition, smooth indifference sets. The latter condition is weaker than the standard notion of smooth preferences. We discuss some implications of these results for revealed preference theory, the “law of demand,” and market demand functions that can be generated by a representative agent.
  8. By: Tomoya Kazumura; Debasis Mishra; Shigehiro Serizawa
    Abstract: A seller is selling multiple objects to a set of agents. Each agent can buy at most one object and his utility over consumption bundles (i.e., (object, transfer) pairs) need not be quasilinear. The seller considers the following desiderata for her mechanism, which she terms desirable: (1) strategy-proofness, (2) ex-post individual rationality, (3) equal treatment of equals, (4) no wastage (every object is allocated to some agent). The minimum Walrasian equilibrium price (MWEP) mechanism is desirable. We show that at each preference profile, the MWEP mechanism generates more revenue for the seller than any desirable mechanism satisfying no subsidy. Our result works for quasilinear type space, where the MWEP mechanism is the VCG mechanism, and for various non-quasilinear type spaces, some of which incorporate positive income effect of agents. We can relax no subsidy to no bankruptcy in our result for certain type spaces with positive income effect.
    Date: 2017–05
  9. By: Philipp Moehlmeier (Bielefeld University); Agnieszka Rusinowska (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics); Emily Tanimura (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)
    Abstract: We develop a modification of the connections model by Jackson and Wolinsky (1996) that takes into account negative externalities arising from the connectivity of direct and indirect neighbors, thus combining aspects of the connections model and the co-author model. We consider a general functional form for agents' utility that incorporates both the effects of distance and of neighbors' degree. Consequently, we introduce a framework that can be seen as a degree-distance-based connections model with both negative and positive externalities. Our analysis shows how the introduction of negative externalities modifies certain results about stability and efficiency compared to the original connections model. In particular, we see the emergence of new stable structures, such as a star with links between peripheral nodes. We also identify structures, for example, certain disconnected networks, that are efficient in our model but which could not be efficient in the original connections model. While our results are proved for the general utility function, some of them are illustrated by using a specific functional form of the degree-distance-based utility.
    Keywords: distance, connections model,network, externality, degree
    Date: 2016–04
  10. By: Frank Riedel (University of Johannesburg, Bauhaus-Universität Weimar); Jean-Marc Tallon (PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics); Vassili Vergopoulos (PSE - Paris School of Economics, CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)
    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: imprecision aversion,multiple priors,Imprecise information,dynamic consistency
    Date: 2017–04
  11. By: Jansen, Anika; Pfeifer, Harald; Raecke, Julia
    Abstract: In this paper, we study the relation between decision makers’ preferences and training investments of their firms. First, we develop a theoretical framework, which takes the possibility into account that individual preferences of decision makers may influence firm behavior with respect to training. We then develop and test the hypothesis that the willingness to take risks or the preference for future profits of decision makers is positively related and procrastination negatively related to firms’ investment in worker training. Using unique firm-level data, including both person-level preference measures and firm-level information about training costs, we find empirical support for our hypothesis. Training investment is higher in firms with risk-inclined decision makers and lower in firms with procrastinating decision makers. The preference for future profits is relevant for training participation and the number of trained workers, but not for the training investment per worker. The results imply that firms have scope to adjust their profit-maximizing strategies by taking the individual preferences of their decision makers into account.
    Keywords: risk and time preferences, training investment, profit maximization
    JEL: J24 J31
    Date: 2017
  12. By: Xiong, Qizhou
    Abstract: The persistent premium of government debt attributes to two main reasons: absolute nominal safety and liquidity. This paper employs two types of measures of government debt supply to disentangle the safety and liquidity part of the premium. The empirical evidence shows that, after controlling for the opportunity cost of money, the quantitative impact of total government debt-to-GDP ratio is still significant and negative, which is consistent with the theoretical predictions of the CAPM with utility surplus of holding convenience assets. The relative availability measure, the ratio of total government liability to all sector total liability, separates the liquidity premium from the safety premium and has a negative impact too. Both theoretical and empirical results suggest that the substitutability between government debt and private safe assets dictates the quantitative impact of the government debt supply.
    Keywords: safe asset,government debt,liquidity premium,safety premium
    JEL: E41 E43 G12
    Date: 2017
  13. By: Nobuyuki Hanaki (GREDEG - Groupe de Recherche en Droit, Economie et Gestion - UNS - Université Nice Sophia Antipolis - CNRS - Centre National de la Recherche Scientifique); Nicolas Jacquemet (PSE - Paris School of Economics, CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Stéphane Luchini (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - CNRS - Centre National de la Recherche Scientifique - ECM - Ecole Centrale de Marseille); Adam Zylbersztejn (GATE - Groupe d'analyse et de théorie économique - UL2 - Université Lumière - Lyon 2 - Ecole Normale Supérieure Lettres et Sciences Humaines - CNRS - Centre National de la Recherche Scientifique)
    Abstract: How is one's cognitive ability related to the way one responds to strategic uncertainty? We address this question by conducting a set of experiments in simple 2 × 2 dominance solvable coordination games. Our experiments involve two main treatments: one in which two human subjects interact, and another in which one human subject interacts with a computer program whose behavior is known. By making the behavior of the computer perfectly predictable, the latter treatment eliminates strategic uncertainty. We find that subjects with higher cognitive ability are more sensitive to strategic uncertainty than those with lower cognitive ability.
    Keywords: Experiment,Strategic uncertainty,Bounded rationality,Robot
    Date: 2016
  14. By: Luc Lauwers; Tom Potoms; Carmen Vázquez
    Abstract: Vázquez (2014) proposes to rank opportunity sets on the basis of the similarities of the elements within each set. The ranking rule, denoted by SL, is lexicographic and takes into account the indirect utility, the number of elements that are similar to the best element, and finally 1 the utilities of representatives of subsequently lower similarity classes. This note corrects a gap in the characterization of this rule.
    Date: 2017
  15. By: Attar, Andrea; Mariotti, Thomas; Salanié, François
    Abstract: We construct a complete space of smooth strictly convex preference relations defined over physical commodities and monetary transfers. This construction extends the classic one by assuming that preferences are monotone in transfers, but not necessarily in all commodities. This provides a natural framework to perform genericity analyses in situations involving inventory costs or decisions under risk.
    Keywords: Smooth Preferences, Nonmonotonicity.
    JEL: C60 D11
    Date: 2017–04
  16. By: Franz Dietrich (PSE - Paris School of Economics, CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Christian List (LSE - London School of Economics and Political Science)
    Abstract: We introduce a "reason-based" framework for explaining and predicting individual choices. The key idea is that a decision-maker focuses on some but not all properties of the options and chooses an option whose "motivationally salient" properties he/she most prefers. Reason-based explanations can capture two kinds of context-dependent choice: (i) the motivationally salient properties may vary across choice contexts, and (ii) they may include "context-related" properties, not just "intrinsic" properties of the options. Our framework allows us to explain boundedly rational and sophisticated choice behaviour. Since properties can be recombined in new ways, it also offers resources for predicting choices in unobserved contexts.
    Keywords: Rational choice,reasons,context-dependence,bounded and sophisticated rationality,prediction of choice
    Date: 2016
  17. By: Toda, Alexis Akira
    Abstract: I obtain a closed-form solution to a Huggett economy with CARA utility when the vector of individual state variables follows a VAR(1) process with an arbitrary shock distribution. The stationary equilibrium is unique if the income process is AR(1), but not necessarily so otherwise. With Gaussian shocks, I provide general sufficient conditions for the existence of at least three equilibria when the income process is either ARMA(1,1), AR(2), or has a persistent-transitory (PT) representation with negatively correlated shocks. The possibility of multiple equilibria calls for caution in comparative statics exercises and policy analyses using heterogeneous-agent models.
    Keywords: CARA utility, income fluctuation problem, persistent-transitory representation
    JEL: C62 D52 D58 E21
    Date: 2017–03–13
  18. By: Andrés Salamanca (TSE - Toulouse School of Economics - Toulouse School of Economics)
    Abstract: In this paper we define a bargaining solution for cooperative games with incomplete information. Our solution concept is inspired in Myerson's (Econometrica, 1983) theory on the informed principal problem and the random dictatorship procedure. It has the essential feature of generalizing the Maschler-Owen consistent value for non-transferable utility games. Our main results are individual rationality, incentive (second best) efficiency and existence of our cooperative solution. To obtain these results we restrict our analysis to cooperative games with stochastically independent types, private values and orthogonal coalitions.
    Keywords: incomplete information,Cooperative games,virtual utility
    Date: 2017–04–20
  19. By: Simon Quemin (LEDa-CGEMP, Paris-Dauphine University – PSL Research University & Climate Economics Chair)
    Abstract: We study intertemporal abatement decisions by an ambiguity averse firm covered under a cap and trade. Ambiguity aversion is introduced to account for the prevalence of regulatory uncertainty in existing cap-and-trade schemes. Ambiguity bears on both the future permit price and the firm's demand for permits. Ambiguity aversion drives equilibrium choices away from intertemporal efficiency and induces two effects: a pessimistic distortion of beliefs that overemphasises ‘detrimental’ outcomes and a shift in the effective discount factor. Permit allocation is non neutral and the firm's intertemporal abatement decisions do not solely depend on expected future permit prices, but also on its own expected future market position. In particular, pessimism leads the expected net short (resp. long) firm to overabate (resp. underabate) early on relative to intertemporal efficiency. We show that there is a general incentive for early overabatement and that it is more pronounced under auctioning that under free allocation.
    Keywords: Emissions trading, Regulatory uncertainty, Permit banking, Ambiguity aversion
    JEL: D81 D92 Q58
    Date: 2017–05
  20. By: Bauermeister, Golo-Friedrich; Mußhoff, Oliver
    Abstract: A common approach to elicit risk attitude is the multiple price list with a series of binary choices. However, a frequently observed problem when using multiple price lists is that participants switch more than once from the safer to the riskier option, thus exhibiting multiple switching behavior. The present study analyzes whether the visualization of different multiple price lists reduce multiple switching behavior. Therefore, we conduct two types of multiple price lists in two different display formats. Participants are randomly assigned into a textual or a visual group and carry out both multiple price lists in the corresponding display format. Our results reveal that different types of multiple price lists lead to differences in the extent of multiple switching behavior. Moreover, we show that the visualization of a multiple price list can be an instrument to greatly reduce multiple switching behavior.
    Keywords: experiment,multiple price list,multiple switching behavior,visualization
    JEL: C90 D81 D89
    Date: 2017
  21. By: Elias Bouacida (PSE - Paris School of Economics, PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique); Daniel Martin (Kellogg School of Management - Northwestern University)
    Abstract: When choices appear inconsistent duet obehavioral biases, there is a theoretical debate about whether or not it is necessary to impose the structure of a model in order to provide meaning ful welfare guidance based on such choices. To address this question empirically, we evaluate the predictive power of the “model-free” and non-parametric approach to welfare analysis proposed by Bernheim and Rangel (2009). In two standard choice settings, we show that for most hypothetical demands, this approach does not offer clear welfare guidance. However, we find that for most observed demands, this approach can be used to make tight predictions, even though these demand functions exhibit inconsistencies. For the experimental choices of Manzini and Mariotti (2010), we show that the welfare guidance provided by these predictions is consistent with delaya version, eventhough the guidance provided by revealed preferences Is more ambiguous.
    Keywords: limited attention,scanner data,experimental economics,Welfare economics,behavioral economics,revealed preferences
    Date: 2017–04–04

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