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on Utility Models and Prospect Theory |
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Issue of 2017‒06‒25
ten papers chosen by |
| By: | Daniel Heyen |
| Abstract: | Maximum likelihood updating (MLU) is a well-known approach for extending static ambiguity sensitive preferences to dynamic set-ups. This paper develops an example in which MLU induces an ambiguity averse maxmin expected utility (MEU) decision-maker to (i) prefer a bet on an ambiguous over a risky urn and (ii) be more willing to bet on the ambiguous urn compared to an (ambiguity neutral) subjective expected utility (SEU) decision-maker. This is challenging since prior to observing (symmetric) draws from the urns, the MEU decision-maker (in line with the usual notion of ambiguity aversion) actually preferred the risky over the ambiguous bet and was less willing to bet on the ambiguous urn than the SEU decision-maker. The identified switch in betting preferences is not due to a violation of dynamic consistency or consequentialism. Rather, it results from MLU's selection of extreme priors, causing a violation of the stability of set-inclusion over the course of the updating process. |
| Keywords: | learning under ambiguity; maxmin expected utility; ambiguity aversion; maximum likelihood updating; dynamic decision making; belief dynamics |
| JEL: | D81 D83 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:80342&r=upt |
| By: | Hassan Nosratabadi (Rutgers University) |
| Abstract: | Reference-dependent choice behavior implies behavioral anomalies such as the so-called attraction effect, status quo bias, and endowment effect. This paper builds a new theory of revealed preference capturing preferences that depend on a reference point. The first main contribution of this work is a decomposition of the Weak Axiom of Revealed Preference (WARP) into three independent axioms. Referential revealed preference theory is then, naturally, constructed by only removing the WARP-rationales that are inconsistent with the data. This minimal deviation, in addition to explaining the mentioned behavioral anomalies, preserves the predictive power of the classical theory to the extent possible. Therefore, all sensible results are endogenously derived from the model. These results include: formation of references and reference preferences, the connection of the latter concept to the classical revealed preference, the nature of referential effects, and the characterization of choice. Interestingly, the notion of sequential rationalizability arises, endogenously, as a result in the referential revealed preference theory. |
| Keywords: | Reference-Dependent Choice, Reference Preferences, Attraction Effect, Status-Quo Bias |
| JEL: | D11 D81 |
| Date: | 2017–06–19 |
| URL: | http://d.repec.org/n?u=RePEc:rut:rutres:201705&r=upt |
| By: | Audrey Laporte; Brian Ferguson |
| Abstract: | One problem with the Becker-Murphy model of Rational Addiction, at least in the eyes of many public health specialists, is that it does not explain why so many rational, forward looking, smokers should apparently find it so hard to quit, especially since the terminal conditions are part of an intertemporal optimization problem. In this paper we apply techniques of stochastic control theory to introduce uncertainty into the individual’s perception of how her stock of addiction will accumulate over time as a consequence of her time path of smoking. We assume that addiction capital is basically unobservable, so she cannot adjust her smoking behaviour according to a feedback policy rule but instead builds uncertainty into her consumption plan from the beginning. We discuss the differences between the equation explaining her lifetime smoking trajectory in the deterministic and stochastic cases, and find that the quadratic utility function which underlies the familiar lead-lag consumption form of rational addiction equation is not, in fact, capable of allowing for the type of uncertainty which we consider here. |
| Date: | 2017–06 |
| URL: | http://d.repec.org/n?u=RePEc:cch:wpaper:170004&r=upt |
| By: | Piero Gottardi (European University Institute - Department of Economics); Jean-Marc Tallon (PSE - Paris School of Economics); Paolo Ghirardato (Collegio Carlo Alberto - Via Real Collegio 30) |
| Abstract: | This paper studies the costs and benefits of delegating decisions to superiorly informed agents, that is of adopting flexible contracts, relative to the use of rigid, non discretionary contracts. The main focus of the paper lies in the analysis of the costs of delegation, primarily agency costs, versus their benefits, primarily the flexibility of the action choice in two different environments, one with risk and one with ambiguity. We first determine and characterize the properties of the optimal flexible contract. We then show that the higher the agent's degree of risk aversion, the higher is the agency costs of delegation and the less profitable a flexible contract relative to a rigid one. When the parties have imprecise probabilistic beliefs, the agent's degree of imprecision aversion introduces another agency cost, which again reduces the relative profitability of flexible contracts. JEL Classification: D86, D82, D81. |
| Keywords: | Multiple Priors,Imprecision Aversion,Flexibility,Delegation,Agency Costs |
| Date: | 2017–05 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-01238046&r=upt |
| By: | Giuliano Curatola (Goethe University Frankfurt); Michael Donadelli (Goethe University Frankfurt); Patrick Grüning (Bank of Lithuania & Faculty of Economics, Vilnius University); Christoph Meinerding (Goethe University Frankfurt) |
| Abstract: | This paper proposes and tests a new source of time variation in real investment opportunities, namely long-run shocks to the productivity of the investment sector, to explain the joint behavior of macroeconomic quantities and asset prices. A two-sector general equilibrium model with long-run investment shocks and wage rigidities produces both positive co-movement among key macroeconomic variables and a sizable return volatility differential between the investment and consumption sector. Moreover, positive long-run investment shocks are associated with low marginal utility and thus command a positive risk premium. We test our model using data on sectoral TFP and find evidence in support of our theoretical predictions. |
| Keywords: | General Equilibrium Asset Pricing, Production Economy, Long-Run Risk, Investment-Specific Shocks, Wage Rigidities. |
| JEL: | E32 G12 |
| Date: | 2016–11–30 |
| URL: | http://d.repec.org/n?u=RePEc:lie:wpaper:36&r=upt |
| By: | Ethan M.J. Lieber (University of Notre Dame); Lee M. Lockwood (Northwestern University and NBER) |
| Abstract: | Many of the most important government programs make transfers in kind as opposed to in cash. Making transfers in kind has the obvious cost that recipients would at least weakly prefer cost-equivalent cash transfers. But making transfers in kind can have benefits as well, including better targeting transfers to desired recipients. In this paper, we exploit large-scale randomized experiments run by three state Medicaid programs to investigate this central tradeoff for in-kind provision. Despite the large distortion from the in-kind provision of formal home care, the benefit from better targeting transfers to high-marginal utility types appears to be even greater. This highlights an important cost of recent policy reforms toward more flexible, cash-like benefits. |
| Date: | 2017–01 |
| URL: | http://d.repec.org/n?u=RePEc:mrr:papers:wp359&r=upt |
| By: | Fabian Gouret; Stéphane Rossignol (Université de Cergy-Pontoise, THEMA) |
| Abstract: | This paper studies a continuous one-dimensional spatial model of electoral competition with two office-motivated candidates differentiated by their “intensity” valence. All voters agree that one candidate will implement more intensively his announced policy than his opponent. However, and contrary to existing models, the intensity valence has a different impact on the utility of voters according to their position in the policy space. The assumption that voters have utility functions with intensity valence, an assumption which has been found to be grounded empirically, generates very different results than those obtained with traditional utility functions with additive valence. First, the candidate with low intensity valence is supported by voters whose ideal points are on both extremes of the policy space. Second, there exist pure strategy Nash equilibria in which the winner is the candidate with high intensity if the distribution of voters in the policy space is sufficiently homogeneous. On the contrary, if the distribution of voters in the policy space is very heterogeneous, there are pure strategy Nash equilibria in which the candidate with low intensity wins. For moderate heterogeneity of the distribution of voters, there is no pure strategy Nash equilibrium. |
| Keywords: | valence, voter’s utility functions, Downsian model, spatial voting. |
| JEL: | D72 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:ema:worpap:2016-07&r=upt |
| By: | David, McCarthy; Kalle, Mikkola |
| Abstract: | A strongly independent preorder on a possibly infinite dimensional convex set that satisfies two of the following conditions must satisfy the third: (i) the Archimedean continuity condition; (ii) mixture continuity; and (iii) comparability under the preorder is an equivalence relation. In addition, if the preorder is nontrivial (has nonempty asymmetric part) and satisfies two of the following conditions, it must satisfy the third: (i') a modest strengthening of the Archimedean condition; (ii) mixture continuity; and (iii') completeness. Applications to decision making under conditions of risk and uncertainty are provided. |
| Keywords: | Continuity Completeness Archimedean Strong independence Expected utility |
| JEL: | D81 |
| Date: | 2017–06–17 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:79755&r=upt |
| By: | Coles, Melvyn (University of Essex); Francesconi, Marco (University of Essex) |
| Abstract: | This paper develops a new equilibrium model of two-sided search where ex-ante heterogenous individuals have general payoff functions and vectors of attributes. The analysis applies to a large class of models, from the non-transferable utility case to the collective household case with bargaining. The approach is powerful for it identifies a simple algorithm which, in the empirical application, is found to rapidly converge to equilibrium. Using indirect inference, we identify the differential effects of women's ability and charm on female match incentives. We use these results to assess the separate impacts of the arrival of equal opportunities for women in the labor market and the advent of the contraceptive pill on female economic activity and matching. |
| Keywords: | two-sided search, multiple attribute matching, marriage, female labor supply, contraceptive pill |
| JEL: | C6 J0 J1 N3 |
| Date: | 2017–06 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp10827&r=upt |
| By: | Tyler Abbot |
| Abstract: | This paper documents a new stylized fact about the leverage cycle and proposes a model of risk preference heterogeneity to explain this fact. In particular, leverage cyclicality depends on the preferences of the marginal agent in the economy, as this determines financial variables. I propose a model of risk preference heterogeneity to explain this fact and prove existence of a new, low dimensional Markovian equilibrium which may exist in other heterogeneous agent models. This equilibrium is studied in an application to margin constraints. It is shown how this type of constraint increases the market price of risk and decreases the interest rate, producing a higher equity risk premium and asset price bubbles. In addition, heterogeneity and margin constraints are shown to produce both pro- and counter-cyclical leverage cycles as seen in the data. Finally, more preference types causes a reduction in the severity of crisis and a lower relative deviation from complete markets in all variables. At the same time expected returns on the stock must remain high to compensate risk averse agents to hold a larger share. |
| Date: | 2017–06 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1706.05877&r=upt |