nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2017‒05‒28
eighteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Sensitivity analysis of the utility maximization problem with respect to model perturbations By Oleksii Mostovyi; Mihai S\^irbu
  2. Discrete Choice and Rational Inattention: A General Equivalence Result By Mogens Fosgerau; Emerson Melo; André De Palma; Matthew Shum
  3. Safe Assets By Barro, Robert J.; Fernández-Villaverde, Jesús; Levintal, Oren; Mollerus, Andrew
  4. Revealed Price Preference: Theory and Stochastic Testing By Rahul Deb; Yuichi Kitamura; John K.-H. Quah; Jorg Stoye
  5. On the Black's equation for the risk tolerance function By Sigrid K\"allblad; Thaleia Zariphopoulou
  6. The Value of Biodiversity as an Insurance Device By Emmanuelle Augeraud-Véron; Giorgio Fabbri; Katheline Schubert
  7. Strategyproof Choice of Acts: Beyond Dictatorship By Eric Bahel; Yves Sprumont
  8. Decision process, preferences over risk and consensus rule: a group experiment By Morone, Andrea; Nuzzo, Simone; Temerario, Tiziana
  9. A Comparison of NTU Values in a Cooperative Game with Incomplete Information By Andrés Salamanca
  10. Concave utility and individual demand By Kannai, Yakar
  11. Investment, Rational Inattention, and Delegation By Lindbeck, Assar; Weibull, Jörgen
  12. Disappointment Aversion and Social Comparisons in a Real-Effort Competition By Gächter, Simon; Huang, Lingbo; Sefton, Martin
  13. Further Results on Preference Uncertainty and Monetary Conservatism By Keiichi Morimoto
  14. Bayesian Assessment of Lorenz and Stochastic Dominance By David Lander; David Gunawan; William Griffiths; Duangkamon Chotikapanich
  15. Data and uncertainty in extreme risks; a nonlinear expectations approach By Samuel N. Cohen
  16. Consumers' willingness to offset their CO2 emissions from traveling: A discrete choice analysis of framing and provider contributions By Schwirplies, Claudia; Dütschke, Elisabeth; Schleich, Joachim; Ziegler, Andreas
  17. ASYMPTOTIC MULTIVARIATE EXPECTILES By Véronique Maume-Deschamps; Didier Rullière; Khalil Said
  18. Representation of strongly independent preorders by sets of scalar-valued functions By McCarthy, David; Mikkola, Kalle; Thomas, Teruji

  1. By: Oleksii Mostovyi; Mihai S\^irbu
    Abstract: We study the sensitivity of the expected utility maximization problem in a continuous semi-martingale market with respect to small changes in the market price of risk. Assuming that the preferences of a rational economic agent are modeled with a general utility function, we obtain a second-order expansion of the value function, a first-order approximation of the terminal wealth, and construct trading strategies that match the indirect utility function up to the second order. If a risk-tolerance wealth process exists, using it as a num\'eraire and under an appropriate change of measure, we reduce the approximation problem to a Kunita-Watanabe decomposition.
    Date: 2017–05
  2. By: Mogens Fosgerau (DTU - Technical University of Denmark [Lyngby]); Emerson Melo (Indiana University [Bloomington]); André De Palma (ENS Cachan - Ecole Normale Supérieure de Cachan); Matthew Shum (CALTECH - California Institute of Technology)
    Abstract: This paper establishes a general equivalence between discrete choice and rational inattention models. Matejka and McKay (2015, AER) showed that when information costs are modelled using the Shannon entropy function, the resulting choice probabilities in the rational inattention model take the multinomial logit form. By exploiting convex-analytic properties of the discrete choice model, we show that when information costs are modelled using a class of generalized entropy functions, the choice probabilities in any rational inattention model are observationally equivalent to some additive random utility discrete choice model and vice versa. Thus any additive random utility model can be given an interpretation in terms of boundedly rational behavior. This includes empirically relevant specifications such as the probit and nested logit models.
    Keywords: convex analysis,generalized entropy,rational inattention,discrete choice,random utility
    Date: 2017–04–07
  3. By: Barro, Robert J.; Fernández-Villaverde, Jesús; Levintal, Oren; Mollerus, Andrew
    Abstract: A safe asset's real value is insulated from shocks, including declines in GDP from rare macroeconomic disasters. However, in a Lucas-tree world, the aggregate risk is given by the process for GDP and cannot be altered by the creation of safe assets. Therefore, in the equilibrium of a representative-agent version of this economy, the quantity of safe assets will be nil. With heterogeneity in coefficients of relative risk aversion, safe assets can take the form of private bond issues from low-risk-aversion to high-risk-aversion agents. The model assumes Epstein-Zin/Weil preferences with common values of the intertemporal elasticity of substitution and the rate of time preference. The model achieves stationarity by allowing for random shifts in coefficients of relative risk aversion. We derive the equilibrium values of the ratio of safe to total assets, the shares of each agent in equity ownership and wealth, and the rates of return on safe and risky assets. In a baseline case, the steady-state risk-free rate is 1.0% per year, the unlevered equity premium is 4.2%, and the quantity of safe assets ranges up to 15% of economy-wide assets (comprising the capitalized value of GDP). A disaster shock leads to an extended period in which the share of wealth held by the low-risk-averse agent and the risk-free rate are low but rising, and the ratio of safe to total assets is high but falling. In the baseline model, Ricardian Equivalence holds in that added government bonds have no effect on rates of return and the net quantity of safe assets. Surprisingly, the crowding-out coefficient for private bonds with respect to public bonds is not 0 or -1 but around -0.5, a value found in some existing empirical studies.
    Date: 2017–05
  4. By: Rahul Deb (University of Toronto); Yuichi Kitamura (Cowles Foundation, Yale University); John K.-H. Quah (Johns Hopkins University); Jorg Stoye (Bonn University)
    Abstract: We develop a model of demand where consumers trade-off the utility of consumption against the disutility of expenditure. This model is appropriate whenever a consumer’s demand over a strict subset of all available goods is being analyzed. Data sets consistent with this model are characterized by the absence of revealed preference cycles over prices. The model is readily generalized to the random utility setting, for which we develop nonparametric statistical tests. Our application on national household consumption data provides support for the model.
    Date: 2017–05
  5. By: Sigrid K\"allblad; Thaleia Zariphopoulou
    Abstract: We analyze a nonlinear equation proposed by F. Black (1968) for the optimal portfolio function in a log-normal model. We cast it in terms of the risk tolerance function and provide, for general utility functions, existence, uniqueness and regularity results, and we also examine various monotonicity, concavity/convexity and S-shape properties. Stronger results are derived for utilities whose inverse marginal belongs to a class of completely monotonic functions.
    Date: 2017–05
  6. By: Emmanuelle Augeraud-Véron (MIA - Mathématiques, Image et Applications - ULR - Université de La Rochelle); Giorgio Fabbri (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille 2 - Université Paul Cézanne - Aix-Marseille 3 - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - Ecole Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique); Katheline Schubert (PSE - Paris School of Economics)
    Abstract: This paper presents a benchmark endogenous growth model including biodiversity preservation dynamics. Producing food requires land, and increasing the share of total land devoted to farming mechanically reduces the share of land devoted to biodiversity conservation. However, the safeguarding of a greater number of species is associated to better ecosystem services – pollination, flood control, pest control, etc., which in turn ensure a lower volatility of agricultural productivity. The optimal conversion/preservation rule is explicitly characterized, as well as the value of biological diversity, in terms of the welfare gain of biodiversity conservation. The Epstein-Zin-Weil specification of the utility function allows us to disentangle the effects of risk aversion and aversion to fluctuations. A two-player game extension of the model highlights the effect of volatility externalities and the Paretian sub-optimality of the decentralized choice.
    Keywords: biodiversity,stochastic endogenous growth,insurance value,recursive preferences
    Date: 2017–03
  7. By: Eric Bahel; Yves Sprumont
    Abstract: We model social choices as acts mapping states of nature to (public) out- comes. A social choice function (or SCF) assigns an act to every profile of subjective expected utility preferences over acts. A SCF is strategyproof if no agent ever has an incentive to misrepresent her beliefs about the states of na- ture or her valuation of the outcomes; it is ex-post efficient if the act selected at any given preference profile picks a Pareto-efficient outcome in every state of nature. We offer a complete characterization of all strategyproof and ex-post efficient SCFs. The chosen act must pick the most preferred outcome of some (possibly different) agent in every state of nature. The set of states in which an agent’s top outcome is selected may vary with the reported belief profile; it is the union of all the states assigned to her by a collection of bilaterally dictatorial and bilaterally consensual assignment rules.
    Keywords: Social choice under uncertainty, strategyproofness, subjective expected utility, dictatorship, consensuality, bilaterality
    Date: 2017
  8. By: Morone, Andrea; Nuzzo, Simone; Temerario, Tiziana
    Abstract: The recent literature on individual vs. group decisions over risk has brought about divergent results, mainly depending on the institutional rules through which groups take decisions. While some studies where group decisions relied on the majority rule showed no appreciable difference between individuals and groups’ preferences, others where unanimity among group members was required found collective decisions to be less risk averse than individual ones. Of course, these studies share the imposition of a choice rule to determine the groups’ outcome. Alternatively, in the study at hand, we elicited groups’ preferences over risk using a consensus rule, i.e. leaving groups free to endogenously solve the potential disagreement among their members, just as in many real life instances. Our results from a logit regression unambiguously show that individuals’ preferences are systematically further from the risk neutrality than those of groups. In particular, individuals are more risk seeker than groups when facing gambles with positive expected payoff difference and more risk averse in the opposite case.
    Keywords: Risk attitudes, group’s behaviour
    JEL: C91 C92 D01
    Date: 2017–05–23
  9. By: Andrés Salamanca (TSE - Toulouse School of Economics - Toulouse School of Economics)
    Abstract: Several value-like solutions concepts are computed and compared in a cooperative game with incomplete information and non-transferable utility.
    Keywords: incomplete information, non-transferable utility,Cooperative games
    Date: 2017–02–15
  10. By: Kannai, Yakar (Center for Mathematical Economics, Bielefeld University)
    Date: 2017–05–15
  11. By: Lindbeck, Assar (Research Institute of Industrial Economics (IFN)); Weibull, Jörgen (Department of Economics)
    Abstract: We analyze investment decisions when information is costly, with and without delegation to an agent. We use a rational-inattention model and compare it with a canonical signal-extraction model. We identify three "investment conditions". In "sour" conditions, no information is acquired and no investment made. In "sweet" conditions, investment is made "blindly", i.e. without acquiring costly information. In intermediate, "normal" conditions, the decision-maker acquires information and conditions the investment decision upon the information obtained. We investigate if the investor can benefit from employing an agent when the agent's effort and information is private. Not even in the case of a risk neutral agent will the principal perfectly align the agent's incentives with her own at the moment of investment (had the principal known the agent's private information). Optimal contracts for risk neutral agents not only reward good investments but also punishes bad investments. Such contracts include three components: a fixed salary, stocks and options.
    Keywords: Investment; Rational inattention; Signal Extraction; Principal-agent; Information aquisition; Contract; Bonus; Penalty
    JEL: D01 D82 D86 G11 G23 G30
    Date: 2017–05–22
  12. By: Gächter, Simon (University of Nottingham); Huang, Lingbo (University of Nottingham); Sefton, Martin (University of Nottingham)
    Abstract: We present an experiment to investigate the source of disappointment aversion in a sequential real-effort competition. Specifically, we study the contribution of social comparison effects to the disappointment aversion previously identified in a two-person real-effort competition (Gill and Prowse, 2012). To do this we compare "social" and "asocial" versions of the Gill and Prowse experiment, where the latter treatment removes the scope for social comparisons. If disappointment aversion simply reflects an asymmetric evaluation of losses and gains we would expect it to survive in our asocial treatment, while if losing to or winning against another person affects the evaluation of losses/gains we would expect treatment differences. We find behavior in social and asocial treatments to be similar, suggesting that social comparisons have little impact in this setting. Unlike in Gill and Prowse we do not find evidence of disappointment aversion.
    Keywords: real effort competition, social comparison effects, disappointment aversion, reference-dependent preferences
    JEL: C91 D12 D81 D84
    Date: 2017–05
  13. By: Keiichi Morimoto (Meisei University)
    Abstract: This study re-examines the optimal delegation problem of monetary policy under preference uncertainty of the central banker. Liberal central bankers are desirable when uncertainty is strong, which is emphasized when the slope of the Phillips curve is flatter, as some empirical works report. However, appointing conservative central bankers is optimal with standard parameter values when monetary policies are conducted by committees, as in most actual economies.
    Keywords: monetary policy, delegation, uncertain preferences, committee
    JEL: E58
    Date: 2017–01
  14. By: David Lander (Pennsylvania State University); David Gunawan (University of New South Wales); William Griffiths (Department of Economics, University of Melbourne); Duangkamon Chotikapanich (Monash University)
    Abstract: Because of their applicability for ordering distributions within general classes of utility and social welfare functions, sampling theory tests for stochastic and Lorenz dominance have attracted considerable attention in the literature. We contribute to this literature by proposing a Bayesian approach for assessing Lorenz and stochastic dominance. For two income distributions, say X and Y, estimated via Markov chain Monte Carlo (MCMC), we compute posterior probabilities for (i) X dominates Y, (ii) Y dominates X, and (iii) neither Y nor X is dominant by counting the proportions of MCMC draws that satisfy the constraints implied by each of the alternatives. We apply the proposed approach to samples of Indonesian income distributions for 1999, 2002, 2005 and 2008. To ensure flexible modelling of the distributions, mixtures of gamma densities are fitted for each of the years. We introduce probability curves that depict the probability of dominance at each population proportion and which convey valuable information about dominance probabilities for restricted population proportions relevant when studying poverty orderings. The dominance probabilities are compared with p-values from some sampling theory tests; the probability curves are used to gain insights into seemingly contradictory outcomes
    Keywords: Dominance probabilities, poverty comparisons, MCMC, gamma mixture.
    JEL: C11 C12 D31 I32
    Date: 2017–03
  15. By: Samuel N. Cohen
    Abstract: Estimation of tail quantities, such as expected shortfall or Value at Risk, is a difficult problem. We show how the theory of nonlinear expectations, in particular the Data-robust expectation introduced in [4], can assist in the quantification of statistical uncertainty for these problems. However, when we are in a heavy-tailed context (in particular when our data are described by a Pareto distribution, as is common in much of extreme value theory), the theory of [4] is insufficient, and requires an additional regularization step which we introduce. By asking whether this regularization is possible, we obtain a qualitative requirement for reliable estimation of tail quantities and risk measures, in a Pareto setting.
    Date: 2017–05
  16. By: Schwirplies, Claudia; Dütschke, Elisabeth; Schleich, Joachim; Ziegler, Andreas
    Abstract: This paper identifies potential drivers and individuals' willingness to pay (WTP) for offsetting their emissions from traveling. We focus on the effects of framing the polluting activity with different modes of transportation (i.e. bus and plane) and travel occasions (i.e. holiday and professional training) as well as the effects of contributions from the travel provider. The analyses are based on discrete choice experiments with a representative sample of about 1000 consumers from Germany. Applying mixed logit and latent class logit models, the findings suggest substantial framing effects resulting from the variation in the mode of transportation as well as a significantly higher WTP when offsets are matched by the travel provider 1:1. The findings further indicate that re-/afforestation projects in the participants' region are the preferred mode for compensation. Respondents who are more willing to offset emissions from traveling seem to be younger and female, have a higher income, exhibit stronger environmental and social preferences, and believe that offsetting is effective in protecting the climate.
    Keywords: climate change,carbon offsetting,framing effects,provider contribution,willingness to pay,discrete choice experiments
    JEL: H41 Q54 Q58
    Date: 2017
  17. By: Véronique Maume-Deschamps (ICJ - Institut Camille Jordan [Villeurbanne] - ECL - École Centrale de Lyon - UCBL - Université Claude Bernard Lyon 1 - UJM - Université Jean Monnet [Saint-Etienne] - INSA - Institut National des Sciences Appliquées - CNRS - Centre National de la Recherche Scientifique); Didier Rullière (SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1); Khalil Said (Ecole d'Actuariat - Université Laval)
    Abstract: In [16], a new family of vector-valued risk measures called multivariate expectiles is introduced. In this paper, we focus on the asymptotic behavior of these measures in a multivariate regular variations context. For models with equivalent tails, we propose an estimator of these multivariate asymptotic expectiles, in the Fréchet attraction domain case, with asymptotic independence, or in the comonotonic case.
    Keywords: Risk measures, multivariate expectiles, regular variations, extreme values, tail dependence functions
    Date: 2017–04–18
  18. By: McCarthy, David; Mikkola, Kalle; Thomas, Teruji
    Abstract: We provide conditions under which an incomplete strongly independent preorder on a convex set X can be represented by a set of mixture preserving real-valued functions. We allow X to be infinite dimensional. The main continuity condition we focus on is mixture continuity. This is sufficient for such a representation provided X has countable dimension or satisfies a condition that we call Polarization.
    Keywords: Expected utility Multi-representation Incompleteness Mixture continuity
    JEL: D11 D81
    Date: 2017–05–22

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