
on Utility Models and Prospect Theory 
By:  Federica Ceron (Centre d'Economie de la Sorbonne  Paris School of Economics); Vassili Vergopoulos (Centre d'Economie de la Sorbonne  Paris School of Economics) 
Abstract:  This article reconsiders the issue of Bayesian aggregation by pointing at a conflict that may arise between two logically independent dominance criteria, Pareto dominance and statewise dominance, that are commonly imposed on social preferences. We propose a weaker dominance axiom that restricts statewise dominance to Pareto dominant alternatives and Pareto dominance to statewise dominant alternatives. The associated aggregation rule is a convex combination of two components., the first being a weighted sum of the individuals' subjective expected utility (SEU) functional, the second being a social SEU functional, with associated social utility function and social belief. Such representation establishes the existence of a trade off between adherence to the Pareto principle and compliance with statewise dominance. We then investigate what are the consequences of adding to our assumptions either of the two dominance criteria in their full force and obtain that each of them is equivalent to discarding the other, unless there is essentially a common prior probability 
Keywords:  Pareto dominance; Monotonicity; Preference aggregation; Social choice, Subjective expected utility 
JEL:  D71 D81 
Date:  2017–05 
URL:  http://d.repec.org/n?u=RePEc:mse:cesdoc:17028&r=upt 
By:  JeanPierre Fouque; Ruimeng Hu 
Abstract:  Empirical studies indicate the existence of long range dependence in the volatility of the underlying asset. This feature can be captured by modeling its return and volatility using functions of a stationary fractional OrnsteinUhlenbeck (fOU) process with Hurst index $H \in (\frac{1}{2}, 1)$. In this paper, we analyze the nonlinear optimal portfolio allocation problem under this model and in the regime where the fOU process is fast meanreverting. We first consider the case of power utility, and rigorously give first order approximations of the value and the optimal strategy by a martingale distortion transformation. We also establish the asymptotic optimality in all admissible controls of a zeroth order trading strategy. Then, we extend the discussions to general utility functions using the epsilonmartingale decomposition technique, and we obtain similar asymptotic optimality results within a specific family of admissible strategies. 
Date:  2017–06 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1706.03139&r=upt 
By:  Mogens Fosgerau (DTU  Technical University of Denmark [Lyngby]); André De Palma (CES  Centre d'économie de la Sorbonne  UP1  Université PanthéonSorbonne  CNRS  Centre National de la Recherche Scientifique) 
Abstract:  We formulate a family of direct utility functions for the consumption of a differentiated good. This family is based on a generalization of the Shannon entropy. It includes dual representations of all additive random utility discrete choice models, as well as models in which goods are complements. Demand models for market shares can be estimated by plain regression, enabling the use of instrumental variables. Models for microdata can be estimated by maximum likelihood. 
Keywords:  market shares,product differentiation,discrete choice,duality,generalized entropy , C25, L1 
Date:  2016–03–25 
URL:  http://d.repec.org/n?u=RePEc:hal:cesptp:hal01291347&r=upt 
By:  Flavia Corneli (Bank of Italy) 
Abstract:  We show that, in a twocountry model where the two economies differ in their level of financial market development and initial capital endowment, financial integration has sizeable transitory as well as permanent effects. We confirm that, consistent with the Lucas paradox, financial integration in the medium term can reduce capital accumulation and increase savings in the financially less developed country, characterized by domestic capital market distortions, due to a higher risk premium in production activities. In the long run, however, integration produces higher levels of capital than in the autarky steady state. The opposite happens to the financially advanced economy, where integration initially boosts consumption and leads to a lower saving rate, and in the long run causes a reduction in capital compared with the autarky steady state. Two forces drive these results: precautionary saving and the propensity to move resources from risky capital to safe assets until the riskadjusted return on capital equalizes the riskfree interest rate; assuming a constant relative risk aversion (CRRA) utility function, these forces are both decreasing in wealth. 
Keywords:  financial integration, international capital movements, incomplete markets, economic growth 
JEL:  F36 F43 G11 O16 
Date:  2017–06 
URL:  http://d.repec.org/n?u=RePEc:bdi:wptemi:td_1120_17&r=upt 
By:  DertwinkelKalt, Markus; Köster, Mats 
Abstract:  The newsvendor problem denotes the puzzle that a retailer facing an uncertain demand for some product underreacts to profit margins, and hence adjusts the order quantity toward the expected demand. Due to its range of applications in operations management, this problem has drawn much interest in recent years. Various articles have tried to reconcile the newsvendor problem with loss aversion under ad hoc assumptions on the underlying reference point. We, instead, argue that the newsvendor problem is an application of the wellstudied compromise effect. As the compromise effect is based on violations of the IIA axiom, we argue that models of contextdependent behavior, such as salience theory, better explain newsvendorlike behavior than loss aversionbased models. We conduct a novel experiment which allows us to clearly distinguish between the role of loss aversion and salience, and find strong support for the latter. Thereby, we also add to the agenda of comparing loss aversionbased models and salience theory. 
Keywords:  Newsvendor Problem,Loss Aversion,Salience,Compromise Effects 
JEL:  D03 
Date:  2017 
URL:  http://d.repec.org/n?u=RePEc:zbw:dicedp:253&r=upt 
By:  Breitmoser, Yves (Humboldt University Berlin) 
Abstract:  Experimenters have to make theoretically irrelevant decisions concerning user interfaces and ordering or labeling of options. Such presentation decisions affect behavior and cause results to appear contradictory across experiments, obstructing utility estimation and policy recommendations. The present paper derives a model of choice allowing analysts to control for both presentation effects and stochastic errors in econometric analyses. I test the model in a comprehensive reanalysis of dictator game experiments. Controlling for presentation effects, preference estimates are consistent across experiments and predictive outofsample, highlighting the fundamental role of presentation for choice, and this notwithstanding the possibility of reliable estimation and prediction. 
Keywords:  discrete choice; presentation effects; utility estimation; counterfactual predictions; laboratory experiment; 
JEL:  C10 C90 
Date:  2017–06–06 
URL:  http://d.repec.org/n?u=RePEc:rco:dpaper:35&r=upt 
By:  Hannah Krovetz; Rebecca Taylor; Sofia VillasBoas 
Abstract:  In the context of recent California drought years, we investigate empirically whether consumers are willing to pay for more efficient water usage in the production of four California agricultural products. We implement an internet survey choice experiment for avocados, almonds, lettuce, and tomatoes to elicit consumer valuation for water efficiency via revealed choices. We estimate a model of consumer choices where a product is defined as a bundle of three attributes: price, production method (conventional or organic), and water usage (average or efficient). Varying the attribute space presented to consumers in the experimental choice design gives us the data variation to estimate a discrete choice model—both conditional logit specifications and random coefficient mixed logit specifications. We find that on average consumers have a significant positive marginal utility towards waterefficiency and estimate that there is an implied positive willingness to pay (WTP) of about 12 cents per gallon of water saved on average. Moreover, informing consumers about the drought severity increases the WTP for low water footprint options, but not significantly. We find that there is heterogeneity in the WTP along respondents' education, race, and also with respect to stated environmental concern. Our findings have policy implications in that they suggest there to be a market based potential to nudge consumers who want to decrease their water footprint and follow a more sustainable diet, namely, by revealing information on the product's water footprint in a form of a label. Simulations of removing low water footprint labels from the choice set attributes imply significant consumer surplus losses, especially for the more educated, white, and more environmentally concerned respondents. 
JEL:  Q18 Q25 Q54 Q51 Q21 M30 
Date:  2017–06 
URL:  http://d.repec.org/n?u=RePEc:nbr:nberwo:23495&r=upt 
By:  S\"uhan Altay; Katia Colaneri; Zehra Eksi 
Abstract:  We consider an investor faced with the utility maximization problem in which the risky asset price process has purejump dynamics affected by an unobservable continuoustime finitestate Markov chain, the intensity of which can also be controlled by actions of the investor. Using the classical filtering theory, we reduce this problem with partial information to one with full information and solve it for logarithmic and power utility functions. In particular, we apply control theory for piecewise deterministic Markov processes (PDMP) to our problem and derive the optimality equation for the value function and characterize the value function as the unique viscosity solution of the associated dynamic programming equation. Finally, we provide a toy example, where the unobservable state process is driven by a twostate Markov chain, and discuss how investor's ability to control the intensity of the state process affects the optimal portfolio strategies as well as the optimal wealth under both partial and full information cases. 
Date:  2017–06 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1706.03567&r=upt 
By:  Alexander Zimper (Department of Economics, University of Pretoria, Pretoria, South Africa and Kiel Institute for the World Economy) 
Abstract:  Rational expectations equilibria (REE) assume that the ex post equilibrium price function is able to reveal ex ante information. This paper drops the assumption of information revealing prices and instead constructs an internal reasoning process through which highly rational pricetakers can infer information from other market participants under the assumption that their utility maximization problems are common knowledge. Based on this reasoning process, we introduce the novel competitive equilibrium concept of rationalizable information equilibria (RIE). Our formal analysis establishes that (i) the RIE concept amounts to a refinement of the (generalized) REE concept whereby (ii) REE with interior nettrades are generically RIE. 
Keywords:  General Equilibrium, Asset Exchange Economies, Asymmetric Information, Rational Expectations, Generalized Rational Expectations, Rationalizability 
JEL:  D53 D83 
Date:  2017–06 
URL:  http://d.repec.org/n?u=RePEc:pre:wpaper:201745&r=upt 
By:  Breitmoser, Yves (Humboldt University Berlin) 
Abstract:  Overbidding in auctions has been attributed to e.g. risk aversion, loser regret, levelk, and cursedness, relying on varying identifying assumptions. I argue that \"type projection\'\" organizes these findings and largely captures observed behavior. Type projection formally models that people tend to believe others have object values similar to their own  a robust psychological phenomenon that naturally applies to auctions. First, I show that type projection generates the main behavioral phenomena observed in auctions, including increased sense of competition (\"loser regret\") and broken Bayesian updating (\"cursedness\"). Second, reanalyzing data from seven experiments, I show that type projection explains the stylized facts of behavior across private and common value auctions. Third, in a structural analysis relaxing the identifying assumptions made in earlier studies, type projection consistently captures behavior best, insample and outofsample. The results reconcile bidding patterns across conditions and have implications for behavioral and empirical analyses as well as policy. 
Keywords:  auctions; overbidding; projection; risk aversion; cursed equilibrium; depth of reasoning; 
JEL:  C72 C91 D44 
Date:  2017–06–06 
URL:  http://d.repec.org/n?u=RePEc:rco:dpaper:36&r=upt 
By:  Kerkkamp, R.B.O.; van den Heuvel, W.; Wagelmans, A.P.M. 
Abstract:  We consider principalagent contracting models between a seller and a buyer with single dimensional private information. The buyer's type follows a continuous distribution on a bounded interval. We present a new modelling approach where the seller oers a menu of nitely many contracts to the buyer. The approach distinguishes itself from existing methods by pooling the buyer types using a partition. That is, the seller rst chooses the number of contracts oered and then partitions the set of buyer types into subintervals. All types in a subinterval are pooled and oered the same contract by the design of our menu. We call this approach robust pooling and apply it to utility maximisation and cost min imisation problems. In particular, we analyse two concrete problems from the literature. For both problems we are able to express structural results as a function of a single new parameter, which remarkably does not depend on all instance parameters. We determine the optimal par tition and the corresponding optimal menu of contracts. This results in new insights into the (sub)optimality of the equidistant partition. For example, the equidistant partition is optimal for a family of instances for one of the problems. Finally, we derive performance guarantees for the equidistant and optimal partitions for a given number of contracts. For the considered problems the robust pooling approach has good performances with only a few contracts. 
Keywords:  mechanism design, asymmetric information, robust pooling, optimal partitioning, performance guarantees 
Date:  2017–03–14 
URL:  http://d.repec.org/n?u=RePEc:ems:eureir:100165&r=upt 
By:  R Khraibani (Université de Cergy Pontoise); A De Palma (CES  Centre d'économie de la Sorbonne  UP1  Université PanthéonSorbonne  CNRS  Centre National de la Recherche Scientifique); N Picard (Université de Cergy Pontoise); I Kaysi (American University of Beirut [Beyrouth]) 
Abstract:  The Transportation EliminationbyAspects (TEBA) framework, a new evaluation and decision making framework (and methodology) for large transportation projects, is proposed to elicit, structure and quantify the preferences of stakeholder groups across project alternatives. The decision rule used for group decision making within TEBA is the individual noncompensatory model of choice elimination by aspects (EBA). TEBA is designed to bring out the decision rule employed by decision makers when ranking the options presented, incorporate various criteria types and ease communication of relevant information related to options and criteria for multiple stakeholder groups. It is a platform for democratizing the decision making process. The TEBA framework was tested using a case study investigating alternative land connections between Beirut and Damascus. Key results showed that (1) stakeholders have employed EBA in making decisions, (2) a defined group of decision makers will rank options differently when provided with modified sets of criteria, (3) the public sector and general public groups ranked Impact on Employment among the top criteria, (4) the most important criterion per group from EBA was as expected; (5) the EBA analysis suggested that only 3 to 4 criteria are significant in reaching a decision; (6) aggregation of user assigned weights masked relative importance of criteria in some cases; and (7) analysis of user assigned weights and Minimum Threshold (MT) values suggest higher risk perception with increased criterion importance. Policy implications include recommendation to reach out to stakeholders for input on decisions, including the " people " but refrain from relying on criteria weights assigned by " experts " and reduce the " experts " ' role in decision making. Also, it is recommended to model the decision making in a probabilistic framework rather than a deterministic " one score " approach, seek to identify a consensus ranking, place particular attention on determining the values of the criteria that emerged as " top " at the evaluation stage and continue to emphasize risk measures. 
Keywords:  Cost Benefit Analysis,Behavioral Choice ,Elimination by Aspects,Consensus Model / Joint Decision Making,Index of Dispersion,Transportation Investment,Collective Decision Making 
Date:  2016–03–21 
URL:  http://d.repec.org/n?u=RePEc:hal:cesptp:hal01291343&r=upt 
By:  Aleh Tsyvinski; Nicolas Werquin 
Abstract:  We generalize the classic concept of compensating variation and the welfare compensation principle to a general equilibrium environment with distortionary taxes. We show that the problem of designing a tax reform that compensates the welfare gains and losses induced by an economic disruption can be formalized as a solution to a system of differentialalgebraic equations (DAEs). We derive its solution in a closed form and therefore provide a complete analytical characterization of the welfarecompensating tax reform in general equilibrium. The partial equilibrium compensation consists of adjusting the average tax rate to exactly cancel out the initial wage disruption. We show that in general equilibrium, the compensating tax reform features three primary modifications to this benchmark. First, defining the relevant wage disruption that needs to be compensated requires accounting for the endogenous wage adjustments induced by the initial shock. The other two effects arise because the marginal tax rates, in general equilibrium, impact wages, and hence individual utility. The “progressivity” effect requires adjustments to the tax code that counteract the welfare effects implied by the decreasing marginal product of each skill's labor. This leads to exponentially decreasing or increasing taxes on incomes below those of the disrupted agents. The “compensation of compensation” effect requires adjustments that counteract the welfare effects implied by the complementarities between skills in production. This leads to an inductive procedure to implement compounding rounds of iterative compensation. While we provide a closed form expression for this effect in the general model, in the special case of a CES production function it reduces to a remarkably simple uniform shift of the marginal tax rates. Finally, we derive a closed form formula for the fiscal surplus of the wage disruption and the compensating tax reform, generalizing the traditional KaldorHicks criterion. 
JEL:  H20 H21 
Date:  2017–06 
URL:  http://d.repec.org/n?u=RePEc:nbr:nberwo:23509&r=upt 
By:  Bas Jacobs; Frederick van der Ploeg 
Abstract:  This paper analyses optimal corrective taxation and optimal income redistribution. The Pigouvian pollution tax is higher if pollution damages disproportionally hurt the poor due to equity weighting of pollution damages. Moreover, optimal pollution taxes should be set below the Pigouvian tax if the poor spend a disproportionate fraction of their income on polluting goods if preferences for commodities are not of the Gorman (1961) polar form. However, optimal pollution taxes should follow the firstbest rule for the Pigouvian corrective tax if preferences for commodities are of the Gorman polar form even if the government wants to redistribute income and the poor spend a disproportional part of their income on polluting goods. The oftenused quasilinear, CES and StoneGeary utility functions all belong to the Gorman polar class. If pollution taxes are not optimized, Paretoimproving green tax reforms exist that move the pollution tax closer to the Pigouvian tax if preferences are Gorman polar. Simulations demonstrate that optimal corrective taxes should be Pigouvian if the demand for polluting goods is derived from a LES demand system, but optimal corrective taxes deviate from the Pigouvian taxes if demand for polluting goods demand is derived from a PIGLOG demand system. 
Keywords:  redistributive taxation, corrective pollution taxation, Gorman polar form, StoneGeary preferences, PIGLOG preferences, green tax reform 
JEL:  H21 H23 Q54 
Date:  2017 
URL:  http://d.repec.org/n?u=RePEc:oxf:oxcrwp:191&r=upt 