nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2017‒07‒16
ten papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Uncertainty Aversion in Game Theory: Experimental Evidence By Evan Calford
  2. What Do Consumers Consider Before They Choose? Identification from Asymmetric Demand Responses By Jason Abaluck; Abi Adams
  3. How Soon Is Now? Evidence of Present Bias from Convex Time Budget Experiments By Uttara Balakrishnan; Johannes Haushofer; Pamela Jakiela
  4. Back to Buchanan? Explorations of welfare and subjectivism in behavioral economics By Dold, Malte
  5. A Model of Interbank Flows, Borrowing, and Investing By Aditya Maheshwari; Andrey Sarantsev
  6. A Simple Model of Managerial Incentives and Portfolio-Investment Decision By Deng, Binbin
  8. Using Goals to Motivate College Students: Theory and Evidence from Field Experiments By Damon Clark; David Gill; Victoria Prowse; Mark Rush
  10. Utilitarianism, Voting and the Redistribution of Income By Dan Usher

  1. By: Evan Calford
    Abstract: This paper experimentally investigates the role of uncertainty aversion in normal form games. Theoretically, risk aversion will a ect the utility value assigned to realized outcomes while ambiguity aversion a ects the evaluation of strategies. In practice, however, utilities over outcomes are unobservable and the e ects of risk and ambiguity are confounded. This paper introduces a novel methodology for identifying the e ects of risk and ambiguity preferences on behavior in games in a laboratory environment. Furthermore, we also separate the e ects of a subject's beliefs over her opponent's preferences from the e ects of her own preferences. The results support the conjecture that both preferences over uncertainty and beliefs over opponent's preferences a ect behavior in normal form games.
    Keywords: Ambiguity Aversion, Game Theory, Experimental Economics, Preferences
    JEL: C92 C2 D81 D83
    Date: 2017–04
  2. By: Jason Abaluck; Abi Adams
    Abstract: Consideration set models relax the assumption that consumers are aware of all available options. Thus far, identification arguments for these models have relied either on auxiliary data on what options were considered or on instruments excluded from consideration or utility. In a discrete choice framework subsuming logit, probit and random coefficients models, we prove that utility and consideration set probabilities can be separately identified without these data intensive methods. In full-consideration models, choice probabilities satisfy a symmetry property analogous to Slutsky symmetry in continuous choice models. This symmetry breaks down in consideration set models when changes in characteristics perturb consideration, and we show that consideration probabilities are constructively identified from the resulting asymmetries. In a lab experiment, we recover preferences and consideration probabilities using only data on which items were ultimately chosen, and we apply the model to study hotel choices on and insurance choices in Medicare Part D.
    JEL: D0 D8
    Date: 2017–06
  3. By: Uttara Balakrishnan; Johannes Haushofer; Pamela Jakiela
    Abstract: Empirically observed intertemporal choices about money have long been thought to exhibit present bias, i.e. higher short-term compared to long-term discount rates. Recently, this view has been called into question on both empirical and theoretical grounds, and a spate of recent findings suggest that present bias for money is minimal or non-existent when one allows for curvature in the utility function and transaction costs are tightly controlled. However, an alternative interpretation of many of these findings is that, in the interest of equalizing transaction costs across earlier and later payments, small delays were introduced between the time of the experiment and the soonest payment. We conduct a laboratory experiment in Kenya in which we elicit time and risk preference parameters from 494 participants, using convex time budgets and tightly controlling for transaction costs. We vary whether same-day payments are made immediately after the experimental session or at the close of the business day. Using the Kenyan mobile money system M-Pesa to make real-time transfers to subjects' phones allows us to make the soonest payments truly immediate. We find strong evidence of present bias, with estimates of the present bias parameter ranging from 0.902 to 0.924 — but only when same-day payments are made immediately after the experiment. This result suggests that present bias for money does in fact exist, but only for truly immediate payments.
    JEL: C91 D90 O12
    Date: 2017–06
  4. By: Dold, Malte
    Abstract: In light of behavioral findings regarding inconsistent individual decision-making, economists have begun to re-conceptualize the notion of welfare. One prominent account is the preference purification approach (PP), which attempts to reconstruct preferences from revealed choices based on a normative understanding of neoclassical rationality. Using Buchanan's notion of creative choice, this paper criticizes PP's epistemic, ontological, and psychological assumptions. It identifies PP as a static position that assumes the satisfaction of given 'true preferences' as the normative standard for welfare. However, following Buchanan, choice should be understood dynamically as a process whereby preferences constantly regenerate. Accordingly, the meaning of welfare emerges from an ongoing quest for individual self-constitution. If this holds true, then rationality axioms cannot serve as a priori normative standards. Instead, creative imagination and learning processes must re-main central to any understanding of welfare in economics.
    Keywords: Behavioral Welfare Economics,Creative Choice,James M. Buchanan,Rationality,Methodology,Subjectivism
    JEL: B41 D03 P46
    Date: 2017
  5. By: Aditya Maheshwari; Andrey Sarantsev
    Abstract: We consider a model when private banks with interbank cash flows as in (Carmona, Fouque, Sun, 2013) borrow from the outside economy at a certain interest rate, controlled by the central bank, and invest in risky assets. The cash flow between private banks is also facilitated by the central bank. Each private bank aims to maximize its expected terminal logarithmic utility. The central bank, in turn, aims to control the overall size of financial system, and the rate of circulation between banks. A default occurs when the net worth of a bank goes below a certain threshold. We consider systemic risk by studying probability of a certain number of defaults over fixed finite time horizon.
    Date: 2017–07
  6. By: Deng, Binbin
    Abstract: What is the optimal portfolio allocation when a manager is investing both for his firm and for himself? I address this question by solving a manager’s decision problem under a specific executive compensation structure. I study how flat wage and stock compensation affect the manager’s investment decision. I show that the allocation is the same regardless of whether the manager is prohibited from trading the public shares of his own firm. Results from calibration show that the manager invests less in firm-specific technology and more in the aggregate stock market as the risk of the firm’s project increases. More stock compensation discourages him from investing in the firm’s risky technology, but encourages more risk-taking in terms of personal investment. In addition, I prove that flat wage, effectively as a riskless bond, hedges risk and leads to more risk-taking behavior both in firm investment and personal investment.
    Keywords: managerial incentives, executive compensation, corporate investment, portfolio choice, asset allocation, dynamic optimization
    JEL: D90 G11 J33 M12
    Date: 2016
  7. By: Roman Frydman (Department of Economics, New York University.); Søren Johansen (Department of Economics, University of Copenhagen); Anders Rahbek (Department of Economics, University of Copenhagen); Morten Nyboe (Department of Economics, University of Copenhagen)
    Abstract: We introduce the Qualitative Expectations Hypothesis (QEH) as a new approach to modeling macroeconomic and ?nancial outcomes. Building on John Muth?s seminal insight underpinning the Rational Expectations Hypothesis (REH), QEH represents the market?s forecasts to be consistent with the predictions of an economist?s model. However, by assuming that outcomes lie within stochastic intervals, QEH, unlike REH, recognizes the ambiguity faced by an economist and market participants alike. Moreover, QEH leaves the model open to ambiguity by not specifying a mechanism determining speci?c values that outcomes take within these intervals. In order to examine a QEH model?s empirical relevance, we formulate and estimate its statistical analog based on simulated data. We show that the proposed statistical model adequately represents an illustrative sample from the QEH model. We also illustrate how estimates of the statistical model?s parameters can be used to assess the QEH model?s qualitative implications.
    Keywords: Asset-Price Movements, Model Ambiguity, Models with Time-Varying Parameters, REH, Behavioral Finance, GAS Models
    JEL: D84 C65 G02 G12 C51
    Date: 2017–04–22
  8. By: Damon Clark; David Gill; Victoria Prowse; Mark Rush
    Abstract: Will college students who set goals for themselves work harder and achieve better outcomes? In theory, setting goals can help present-biased students to mitigate their self-control problem. In practice, there is little credible evidence on the causal e ects of goal setting for college students. We report the results of two eld experiments that involved almost four thousand college students in total. One experiment asked treated students to set goals for performance in the course; the other asked treated students to set goals for a particular task (completing online practice exams). Task-based goals had large and robust positive e ects on the level of task completion, and task-based goals also increased course performance. Further analysis indicates that the increase in task completion induced by setting task-based goals caused the increase in course performance. We also nd that performance-based goals had positive but small e ects on course performance. We use theory that builds on present bias and loss aversion to interpret our results. Since task-based goal setting is low-cost, scaleable and logistically simple, we conclude that our ndings have important implications for educational practice and future research.
    Keywords: Goal; Goal setting; Higher education; Field experiment; Self-control; Present bias; Time inconsistency; Commitment device; Loss aversion; Reference point; Task-based goal; Performance-based goal; Self-set goal; Performance uncertainty; Overcon dence; Student e ort; Student performance; Educational attainment.
    JEL: I23 C93
    Date: 2017–05
  9. By: Maria De Paola; Francesca Gioia; Fabio Piluso (Dipartimento di Economia, Statistica e Finanza "Giovanni Anania" - DESF, Università della Calabria)
    Abstract: We ran a field experiment to investigate whether nudge policies, consisting in behavioural insight messaging, help to improve performance in financial trading. Our experiment involved students enrolled in a financial trading course in an Italian University who were invited to trade on Borsa Italiana’s virtual platform. Students were randomly assigned to a control group and a treatment group. Treated students received a message reminding them of the existence of behavioural biases in financial trading. We find that treated students significantly improve the performance of their portfolio. This effect is mainly driven by students with a higher than average risk aversion. Several behaviours may explain the increase in performance. We find evidence pointing to a reduction in the home and status quo biases for risk averse nudged participants.
    Keywords: Financial trading, Behavioural biases, Reminders, Nudges, Home bias, Status quo bias, Risk aversion
    JEL: D14 E21 E22 O16
    Date: 2017–07
  10. By: Dan Usher (Queen's University)
    Abstract: Utilitarianism can be misplaced or ambiguous. As a prescription for individual behaviour, the injunction to seek the greatest good for the greatest number is misplaced because there remains a domain of life where, within the bounds of law and custom, one is free to act as selfishly or as altruistically as one pleases. As a criterion for responsible government, it is ambiguous because there is no universally-recognized perception of the greatest good; people have different perceptions which can only be reconciled by compromise or by voting. The greatest number must be of citizens alive today, but governments may be vicariously concerned about people in other countries or yet to be born, in so far as citizens today have such concerns and are prepared to sacrifice for the benefit of others. The greatest good for the greatest number has no rival as a criterion for government, but it is vague nonetheless. Utilitarian ambiguity is inherited in any attempt to combine the ordinary measure of economic growth with changes in the distribution of income on a common scale.
    Keywords: utilitarianism, voting, redistribution
    JEL: E31 E31 O40
    Date: 2017–07

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