
on Utility Models and Prospect Theory 
Issue of 2017‒07‒23
thirteen papers chosen by 
By:  René van den Brink (Department of Econometrics and Tinbergen Institute, VU University); Agnieszka Rusinowska (Centre d'Economie de la Sorbonne  Paris School of Economics) 
Abstract:  In this paper, we connect the social network theory on centrality measures to the economic theory of preferences and utility. Using the fact that networks form a special class of cooperative TUgames, we provide a foundation for the degree measure as a von NeumannMorgenstern expected utility function reflecting preferences over being in different positions in different networks. The famous degree measure assigns to every position in a weighted network the sum of the weights of all links with its neighbours. A crucial property of a preference relation over network positions is neutrality to ordinary risk. If an expected utility function over network positions satisfies this property and some regularity properties, then it must be represented by a utility function that is a multiple of the degree centrality measure. We show this in three steps. First, we characterize the degree measure as a centrality measure for weighted networks using four natural axioms. Second, we relate these network centrality axioms to properties of preference relations over positions in networks. Third, we show that the expected utility function is equal to a multiple of the degree measure if and only if it represents a regular preference relation that is neutral to ordinary risk. Similarly, we characterize a class of affine combinations of the outdegree and indegree measure in weighted directed networks and deliver its interpretation as a von NeumannMorgenstern expected utility function 
Keywords:  Weigthed network; network centrality; utility function; degree centrality, von NeumannMorgenstern expected utility function; coopeative TUgame; weighted directed network 
JEL:  D81 D85 C02 
Date:  2017–07 
URL:  http://d.repec.org/n?u=RePEc:mse:cesdoc:17035&r=upt 
By:  Benjamin L. Collier; Daniel Schwartz; Howard C. Kunreuther; Erwann O. MichelKerjan 
Abstract:  We examine risk preferences using the flood insurance decisions of over 100,000 households. In each contract, households make a small stakes decision, the deductible, and a large stakes one, the coverage limit. Expected utility models predict that households would choose high deductibles and low coverage limits, but households do the opposite. Allowing for probability distortions improves our models. Assessing rank dependent utility models, we find that households follow two tenants of prospect theory: overestimation of small probabilities and diminishing sensitivity to losses. In every tested model, different preferences characterize households' small and large stakes insurance decisions. 
JEL:  D12 D81 H42 Q54 
Date:  2017–07 
URL:  http://d.repec.org/n?u=RePEc:nbr:nberwo:23579&r=upt 
By:  SeEun Jung (Department of Economics, Inha University); Chung Choe (Hanyang University); Ronald L. Oaxaca (University of Arizona) 
Abstract:  In addition to discrimination, market power, and human capital, gender differences in risk preferences might also contribute to observed gender wage gaps. We conduct laboratory experiments in which subjects choose between a risky (in terms of exposure to unemployment) and a secure job after being assigned in early rounds to both types of jobs. Both jobs involve the same typing task. The risky job adds the element of a known probability that the typing opportunity will not be available in any given period. Subjects were informed of the exogenous risk premium being offered for the risky job. Women were more likely than men to select the secure job, and these job choices accounted for between 40% and 77% of the gender wage gap in the experiments. That women were more risk averse than men was also manifest in the PrattArrow Constant Absolute Risk Aversion parameters estimated from a random utility model adaptation of the meanvariance portfolio model. 
Keywords:  Occupational Choice, Gender Wage Differentials, Risk Aversion, Lab Experiment 
JEL:  J16 J24 J31 C91 D81 
Date:  2017–07 
URL:  http://d.repec.org/n?u=RePEc:inh:wpaper:20177&r=upt 
By:  Michail Anthropelos; Constantinos Kardaras; Georgios Vichos 
Abstract:  We consider thin financial markets involving a finite number of tradeable securities. Traders with heterogeneous preferences and risk exposures have motive to behave strategically regarding the level of risk aversion they reveal through the transaction, thereby impacting prices and allocations. We argue that traders relatively more exposed to market risk tend to submit more elastic demand functions, revealing higher risk tolerance. Noncompetitive equilibrium prices and allocations result as an outcome of a game among traders. General sufficient conditions for existence and uniqueness of such equilibrium are provided, with an extensive analysis of twotrader transactions. Even though strategic behaviour causes inefficient social allocations, traders with sufficiently high risk tolerance and/or large initial exposure to market risk obtain more utility surplus in the noncompetitive equilibrium, when compared to the competitive one. 
Date:  2017–07 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1707.05096&r=upt 
By:  Gao, Jianwei; Zhao, Feng 
Abstract:  A counterexample is presented to show that the sufficient condition for one transformation dominating another by the second degree stochastic dominance, proposed by Theorem 5 of Levy (Stochastic dominance and expected utility: Survey and analysis, 1992), does not hold. Then, by restricting the monotone property of the dominating transformation, a revised exact sufficient condition for one transformation dominating another is given. Next, the stochastic dominance criteria, proposed by Meyer (Stochastic Dominance and transformations of random variables, 1989) and developed by Levy (Stochastic dominance and expected utility: Survey and analysis, 1992), are extended to the most general transformations. Moreover, such criteria are further generalized to transformations on discrete random variables. Finally, the authors employ this method to analyze the transformations resulting from holding a stock with the corresponding call option. 
Keywords:  stochastic dominance,transformation,utility theory,option strategy 
JEL:  C51 D81 G1 
Date:  2017 
URL:  http://d.repec.org/n?u=RePEc:zbw:ifwedp:201740&r=upt 
By:  Luciano de Castro (University of Iowa); Antonio F. Galvao (University of Arizona); David M. Kaplan (University of Missouri) 
Abstract:  This paper develops theory for feasible estimation and testing of finitedimensional parameters identified by general conditional quantile restrictions. This includes instrumental variables nonlinear quantile regression as a special case, under much weaker assumptions than previously seen in the literature. More specifically, we consider a set of unconditional moments implied by the conditional quantile restrictions and provide conditions for local identification. Since estimators based on the sample moments are generally impossible to compute numerically in practice, we study a feasible estimator based on \emph{smoothed} sample moments. We establish consistency and asymptotic normality under general conditions that allow for weakly dependent data and nonlinear structural models, and we explore options for testing general nonlinear hypotheses.Simulations with iid and time series data illustrate the finitesample properties of the estimators and tests. Our indepth empirical application concerns the consumption Euler equation derived from quantile utility maximization. Advantages of the quantile Euler equation include robustness to fat tails, decoupling of risk attitude from the elasticity of intertemporal substitution, and loglinearization without any approximation error. For the four countries we examine, the quantile estimates of discount factor and elasticity of intertemporal substitution are economically reasonable for a range of quantiles just above the median, even when twostage least squares estimates are not reasonable. Code is provided for all methods, simulations, and applications at the third author's website. 
Keywords:  instrumental variables, nonlinear quantile regression, quantile utility maximization 
JEL:  C31 C32 C36 
Date:  2017–07–10 
URL:  http://d.repec.org/n?u=RePEc:umc:wpaper:1710&r=upt 
By:  SeEun Jung (Department of Economics, Inha University); Radu Vranceanu (ESSEC Business School) 
Abstract:  In a classical experiment, Niederle and Vesterlund (2007) used the dichotomous choice of individuals between a piece rate and a tournament payment scheme as an indication of their propensity to compete. This paper reports results from a two person interaction of a similar type to analyze whether the preference for competition is dependent on the gender of the partner. It introduces a BeckerDeGrootMarschak mechanism to elicit individual willingness to compete (WTC), defined as the amount of money that makes an individual indifferent between the two compensation schemes. Even when controlling for risk aversion, past performance and overconfidence, the male WTC is e3.30 larger than the female WTC. The WTC instrument allows for a more precise analysis of the impact of the partner's gender on the taste for competition. WTC data confirm that in this experiment the partner's gender has not a significant impact on the propensity to compete. 
Keywords:  Willingness to Compete, Gender, BDM mechanism 
JEL:  C91 D03 
Date:  2017–07 
URL:  http://d.repec.org/n?u=RePEc:inh:wpaper:20175&r=upt 
By:  Peter Van Tassel (Federal Reserve Bank of New York) 
Abstract:  Sellers of variance swaps earn timevarying risk premia for their exposure to realized variance,the level of variance swap rates, and the slope of the variance swap curve. To measure risk premia, we estimate a dynamic term structure model that decomposes variance swap rates into expected variances and term premia. Empirically, we document a strong global factor structure in variance term premia across the U.S., U.K., Europe, and Japan. We further show that variance term premia are negatively correlated with the risk appetite of hedge funds, brokerdealers, and mutual funds. Our results support the hypothesis that financial intermediaries are marginal investors in the variance swap market. 
Date:  2017 
URL:  http://d.repec.org/n?u=RePEc:red:sed017:149&r=upt 
By:  Emilio Calvo (Universidad de Valencia. ERICES); Esther GutiérrezLópez (Departamento de Economía Aplicada IV. Universidad del País Vasco U.P.V./E.H.U.) 
Abstract:  We present a general bargaining protocol between n players in the setting of coalitional games with transferable utility. We consider asymmetric players. They are endowed with di¤erent probabilities of being chosen as proposers and with di¤erent probabilities of leaving the game if o¤ers are rejected. Two particular speci…cations of this bargaining protocol yield equilibrium proposals that we refer to as weighted solidarity values and weighted Shapley values. We compare the behavior of these values when the players’ probabilities are changed. We supplement the analysis with axiomatic characterizations of both values. 
Keywords:  nperson bargaining; transferable utility games; asymmetric players; solidarity value; Shapley value. 
JEL:  C71 
Date:  2017–06 
URL:  http://d.repec.org/n?u=RePEc:dbe:wpaper:0217&r=upt 
By:  Emanuele Russo 
Abstract:  This paper presents a smallscale agentbased extension of the socalled neoKaleckian model. The aim is to investigate the emergence of Harrodian instability in decentralized market economies. We introduce a parsimonious microfoundation of investment decisions. Agents have heteroge neous expectations about demand growth and set idiosyncratically their investment expendi tures. Interactions occur through demand externalities. We simulate the model under different scenarios. First, when heterogeneity is ruled out, Harrodian instability is showed to emerge as for the aggregate model. Instead, when heterogeneity is accounted for, a stable dynamics with endogenous fluctuations arises. At the same time, in this second scenario, all the Keynesian implications are preserved, including the presence of macroeconomic paradoxes. Sensitivity analysis confirms the general robustness of our results and the logical consistency of the model. 
Keywords:  Harrodian Instability, AgentBased Models, Coordination Failures, Heterogeneous Expectations, NeoKaleckian model 
Date:  2017–07–13 
URL:  http://d.repec.org/n?u=RePEc:ssa:lemwps:2017/17&r=upt 
By:  Eli P. Fenichel; Matthew J. Kotchen; Ethan T. Addicott 
Abstract:  We develop a demographicallybased approach for estimating the utility discount rate (UDR) portion of the Ramsey rule. We show how agespecific mortality rates and life expectancies imply a natural UDR for individuals at each age in a population, and these can be aggregated into a populationlevel social UDR. We then provide empirical estimates for nearly all countries and for the world as a whole. A striking part of the analysis is how the estimated UDRs fall within the range of those currently employed in the macroeconomics and climate change literatures. We use our results to derive heterogenous social discount rates across countries and explore the consequences for an integrated assessment model of climate change. We find that introducing regional heterogeneity of UDRs into the RICE model has little impact on the businessasusual trajectory of global emissions. It does, however, change the trajectory of optimal emissions, the corresponding optimal carbon tax, and the distribution of emission reductions across countries. 
JEL:  H43 O21 Q54 
Date:  2017–07 
URL:  http://d.repec.org/n?u=RePEc:nbr:nberwo:23591&r=upt 
By:  Forni, Mario; Gambetti, Luca; Sala, Luca 
Abstract:  We formalize the idea that uncertainty is generated by news about future developments in economic conditions which are not perfectly predictable by the agents. Using a simple model of limited information, we show that uncertainty shocks can be obtained as the square of news shocks. We develop a twostep econometric procedure to estimate the effects of news and we find highly nonlinear effects. Large news shocks increase uncertainty. This mitigates the effects of good news and amplifies the effects of bad news in the short run. By contrast, small news shocks reduce uncertainty and increase output in the short run. The Volcker recession and the Great Recession were exacerbated by the uncertainty effects of news. 
Date:  2017–07 
URL:  http://d.repec.org/n?u=RePEc:cpr:ceprdp:12139&r=upt 
By:  Schünemann, Johannes; Trimborn, Timo 
Abstract:  There is empirical evidence that households use residential houses as status goods. Their visibility qualifies them as an excellent signaling device of the relative income and wealth position, in contrast to less visible financial assets. To this end we introduce a residential housing sector and status concerns for housing into a neoclassical framework. In the model, households derive utility from the absolute amount of housing and from comparing their stock of housing to a reference stock, which is composed of the current or past level of housing of their peers. We analyze how status concerns affect household behavior and find that they increase housing demand and labor supply. Furthermore, we find that status concerns exert a negative externality and elevate housing to inefficiently high levels. We derive a (state contingent) optimal tax that establishes the firstbest allocation along the transition path and at the steady state. Calibrating the model to the US we quantify the optimal tax on residential housing to 1.8%. Introducing the optimal tax entails a considerable welfare gain of 0.29% measured in consumption equivalents. 
Keywords:  Status Concerns,Residential Housing,Optimal Taxation 
JEL:  E03 O10 D10 H21 R31 
Date:  2017 
URL:  http://d.repec.org/n?u=RePEc:zbw:tuweco:052017&r=upt 