nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2017‒08‒06
thirteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Boundedly Rational Expected Utility Theory By Navarro-Martinez, Daniel; Loomes, Graham; Isoni, Andrea; Butler, David; Alaoui, Larbi
  2. Should Pollution Taxes be Targeted at Income Redistribution? By Bas B. Jacobs; Rick F. van der Ploeg
  3. Local Thinking and Skewness Preferences By Markus Dertwinkel-Kalt; Mats Köster
  4. Choosing the future: economic preferences for higher education using discrete choice experiment method By Mikołaj Czajkowski; Tomasz Gajderowicz; Marek Giergiczny; Gabriela Grotkowska; Urszula Sztandar-Sztanderska
  5. Il paradosso di S. Pietroburgo, una rassegna By Ruggero Paladini
  6. Specification Tests for the Multinomial Logit Model Revisited: The Role of Alternative-specific Constants By Jan J. Rouwendal
  7. Nash equilibria for game contingent claims with utility-based hedging By Klebert Kentia; Christoph K\"uhn
  8. Welfare Analysis in a Two-Stage Inverse Demand Model: An Application to Harvest Changes in the Chesapeake Bay By Chris Moore; Charles Griffiths
  9. Gender Differences in Trading Volume: Not Just Overconfidence By Carlos Cueva; Iñigo Iturbe-Ormaetxe; Giovanni Ponti; Josefa Tomás
  10. Tax Audits as Scarecrows: Evidence from a Large-Scale Field Experiment By Marcelo L. Bérgolo; Rodrigo Ceni; Guillermo Cruces; Matias Giaccobasso; Ricardo Perez-Truglia
  11. Quicksand or Bedrock for Behavioral Economics? Assessing Foundational Empirical Questions By Victor Stango; Joanne Yoong; Jonathan Zinman
  12. Stable Marriage With and Without Transferable Utility:Nonparametric Testable Implications By Laurens Cherchye; Thomas Demuynck; Bram De Rock; Frederic Vermeulen
  13. Dynamic Implementation, Verification, and Detection By Hitoshi Matsushima

  1. By: Navarro-Martinez, Daniel; Loomes, Graham; Isoni, Andrea; Butler, David; Alaoui, Larbi
    Abstract: We build a satisficing model of probabilistic choice under risk which embeds Expected Utility Theory (EUT) into a boundedly rational deliberation process. The decision maker accumulates evidence for and against alternative options by repeatedly sampling from her underlying set of EU preferences until the evidence favouring one option satisfies her desired level of confidence. Notwithstanding its EUT core, the model produces patterns of behaviour that violate standard axioms, while at the same time capturing the systematic relationship between choice probabilities, response times and confidence judgments, which is beyond the scope of theories that do not take deliberation into account.
    Keywords: Expected utility; bounded rationality; deliberation; probabilistic choice; confidence; response times.
    JEL: D03 D81
    Date: 2017–06–15
  2. By: Bas B. Jacobs (Erasmus University Rotterdam, Tinbergen Institute and CESifo; Tinbergen Institute, The Netherlands); Rick F. van der Ploeg (University of Oxford, Tinbergen Institute, CEPR and CESifo)
    Abstract: This paper analyses optimal corrective taxation and optimal income redistribution. Under general utility functions, 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. However, if preferences for commodities are of the Gorman (1961) polar form, optimal pollution taxes should follow the first-best rule for the Pigouvian corrective tax even if the government wants to redistribute income and the poor spend a disproportional part of their income on polluting goods. The often-used quasi-linear, CES and Stone-Geary utility functions all belong to the Gorman polar class. If preferences are Gorman polar, and if pollution taxes are not optimized, Pareto-improving green tax reforms exist that move the pollution tax closer to the Pigouvian tax. Simulations demonstrate that optimal corrective taxes should be Pigouvian if the demand for polluting goods is derived from a LES demand system, but 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; Stone-Geary preferences; PIGLOG preferences; green tax reform
    JEL: H21 H23 Q54
    Date: 2017–08–01
  3. By: Markus Dertwinkel-Kalt; Mats Köster
    Abstract: We show that continuous models of stimulus-driven attention can account for skewness-related puzzles in decision-making under risk. First,we delineate that these models provide awell-defined theory of choice under risk. We therefore prove that in continuous—in contrast to discrete—models of stimulus-driven attention each lottery has a unique certainty equivalent that is monotonic in probabilities (i.e., it monotonically increases if probability mass is shifted to more favorable outcomes). Second, we show that whether an agent seeks or avoids a specific risk depends on the skewness of the underlying probability distribution. Since unlikely, but outstanding payoffs attract attention, an agent exhibits a preference for right-skewed and an aversion toward left-skewed risks. While cumulative prospect theory can also account for such skewness preferences, it yields implausible predictions on their magnitude. We show that these extreme implications can be ruled out for continuous models of stimulus-driven attention.
    Date: 2017–07–26
  4. By: Mikołaj Czajkowski (Faculty of Economic Sciences, University of Warsaw); Tomasz Gajderowicz (Faculty of Economic Sciences, University of Warsaw); Marek Giergiczny (Faculty of Economic Sciences, University of Warsaw); Gabriela Grotkowska (Faculty of Economic Sciences, University of Warsaw); Urszula Sztandar-Sztanderska (Faculty of Economic Sciences, University of Warsaw)
    Abstract: This study illustrates how respondents’ stated choices (the discrete choice experiment method) combined with the random utility framework can be used to model preferences for higher education. The flexibility offered by stated preference data circumvents limitations of other approaches, and allows quantifying young people’ preferences for selected attributes of higher education programs that are typically highly correlated in revealed preference data. The empirical study presented here is based on a survey of 20,000 Polish respondents aged 18-30, who stated their preferences for higher education programs in carefully prepared hypothetical choice situations. The attributes we considered include tuition fee, expected salary after graduation, quality of institution, interest in the field of study, distance from home, and mode of study. Using random parameters and latent class mixed multinomial logit models, we can formally describe young peoples’ preferences, and identify the financial trade-offs they are willing to make, that is, estimate their willingness to pay for specific attribute levels in terms of increased tuition fees or expected salary after graduation. Accounting for respondents’ observed and unobserved preference heterogeneity, we address a few research questions related to, for example, distinct preferences of students whose neither parent attained tertiary education, students from lower socio-economic groups, or students of a particular gender. Overall, we demonstrate how stated preference methods can be a useful tool for exploring economic preferences, better understanding the determinants of choices, forecasting, and designing the services offered by higher education institutions in an optimal way.
    Keywords: higher education institution choice, random utility model, stated preferences, discrete choice experiment
    JEL: I23 D12 H52
    Date: 2017
  5. By: Ruggero Paladini (Università Sapienza di Roma - Dipartimento di Studi Giuridici, Filosofici ed Economici)
    Abstract: In 1738 Daniel Bernoulli presented for the first time a study with a functional relationship between utility and wealth. The goal was to provide a solution to a "curious" paradox on probability theory. Almost three centuries after the St. Petersburg paradox is still debated. Two strands of research can be identified: the first, both theoretically and with surveys, examines the reasons for the subjective behavior of a player who is not willing to offer, if not a modest sum, to play a game that has an infinite expected value. The second one is the analysis by computer simulations of a large number of games, where unexpected statistical distributions emerge. From all of the studies it turns out that not only players offer very modest figures, but also that no gambling house will ever offer a St. Petersburg game.
    Keywords: expected value, utility function, fractal distributions.
    JEL: C18 D81
    Date: 2017–07
  6. By: Jan J. Rouwendal (Vrije Universiteit Amsterdam; Tinbergen Institute, The Netherlands)
    Abstract: This paper considers specification tests for the multinomial logit model if alternative-specific constants are used to absorb the impact of omitted variables in the deterministic parts of the utilities. It finds that such tests then do not have any power. This implies that such tests have no power to detect violations of IIA, but only for specification errors in the deterministic part of the utility function.
    Keywords: multinomial logit; Hausman-McFadden specification test; nested logit; GEV models; mixed logit
    JEL: D1 D4
    Date: 2017–07–31
  7. By: Klebert Kentia; Christoph K\"uhn
    Abstract: Game contingent claims (GCCs) generalize American contingent claims by allowing the writer to recall the option as long as it is not exercised, at the price of paying some penalty. In incomplete markets, an appealing approach is to analyze GCCs like their European and American counterparts by solving option holder's and writer's optimal investment problems in the underlying securities. By this, partial hedging opportunities are taken into account. We extend results in the literature by solving the stochastic game corresponding to GCCs with both continuous time stopping and trading. Namely, we construct Nash equilibria by rewriting the game as a non-zero-sum stopping game in which players compare payoffs in terms of their exponential utility indifference values. As a by-product, we also obtain an existence result for the optimal exercise time of an American claim under utility indifference valuation by relating it to the corresponding nonlinear Snell envelope.
    Date: 2017–07
  8. By: Chris Moore; Charles Griffiths
    Abstract: Like many agricultural commodities, fish and shellfish are highly perishable and producers cannot easily adjust supply in the short run to respond to changes in demand. In these cases, it is more appropriate to conduct welfare analysis using inverse demand models that take quantities as given and allow prices to adjust to clear the market. One challenge faced by economists conducting demand analysis is how to limit the number of commodities in the analysis while accounting for the relevant substitutability and complementarity among goods. A common approach in direct demand modeling is to assume weak separability of the utility function and apply a multi-stage budgeting approach. This approach has not, however, been applied to an inverse demand system or the associated welfare analysis. This paper develops a two-stage inverse demand model and derives the total quantity flexibilities which describe how market clearing prices respond to supply changes in other commodity groups. The model provides the means to estimate consumer welfare impacts of an increase in finfish and shellfish harvest from the Chesapeake Bay while recognizing that harvests from other regions are potential substitutes. Comparing the two-stage results with single-stage analysis of the same data shows that ignoring differentiation of harvests from different regions, or the availability of substitutes not affected by a supply shock, can bias welfare estimates.
    Keywords: Two-stage budgeting, Inverse demands, Compensating surplus
    JEL: D12 D61 Q11 Q22
    Date: 2017–07
  9. By: Carlos Cueva; Iñigo Iturbe-Ormaetxe; Giovanni Ponti; Josefa Tomás
    Abstract: Men trade more than women. This has been attributed to men being more overconfident. However, no study has systematically tested this conjecture. We run an experiment where participants trade in a simulated market and measure ex-ante better-than-average confidence in an incentivized way. We find that men are more confident and trade more than women, but we do not find that our measure of confidence helps to reduce the gender gap in the number of transactions. Finally, risk aversion does not help to explain this gap either.
    Keywords: Behavioral Finance, Transaction Costs, Gender, Overtrading, Risk aversion
    JEL: C91 D70 D81 D91
  10. By: Marcelo L. Bérgolo; Rodrigo Ceni; Guillermo Cruces; Matias Giaccobasso; Ricardo Perez-Truglia
    Abstract: According to the canonical model of Allingham and Sandmo (1972), firms evade taxes by making a trade-off between a lower tax burden and higher expected penalties. However, there is still no consensus about whether real-world firms operate in this rational way. We conducted a large-scale field experiment, sending letters to over 20,000 firms that collectively pay over 200 million dollars in taxes per year. In our letters, we provided firms with exogenous but nondeceptive signals about key inputs for their evasion decisions, such as audit probabilities and penalty rates. We measure the effect of these signals on their subsequent perceptions about the auditing process, based on survey data, as well as on the actual taxes paid, according to administrative data. We find that firms do increase their tax compliance in response to information about audits. However, the patterns in these responses are inconsistent with utility maximization. The evidence suggests that, much like scarecrows frighten off birds, audits can be a significant deterrent for tax evaders even though they would be perceived as harmless by a rational optimizer.
    JEL: C93 H26 K42
    Date: 2017–07
  11. By: Victor Stango; Joanne Yoong; Jonathan Zinman
    Abstract: Behavioral economics lacks empirical evidence on some foundational empirical questions. We adapt standard elicitation methods to measure multiple behavioral factors per person in a representative U.S. sample, along with financial condition, cognitive skills, financial literacy, classical preferences and demographics. Individually, B-factors are prevalent, distinct from other decision inputs, and correlate negatively with financial outcomes in richly-conditioned regressions. Conditioning further on other B-factors does not change the results, validating common practice of modeling B-factors separately. Corrections for low task/survey effort modestly strengthen the results. Our findings provide bedrock empirical foundations for behavioral economics, and offer methodological guidance for research designs.
    JEL: D03 D14 D8 D9 G02
    Date: 2017–07
  12. By: Laurens Cherchye; Thomas Demuynck; Bram De Rock; Frederic Vermeulen
    Abstract: We show that transferable utility has no nonparametrically testable implications for marriage stability in settings with a single consumption observation per house- hold and heterogeneous individual preferences across households. This completes the results of Cherchye, Demuynck, De Rock, and Vermeulen (2017), who characterized Pareto efficient household consumption under the assumption of marriage stability without transferable utility. First, we show that the nonparametric testable conditions established by these authors are not only necessary but also sufficient for rationalizability by a stable marriage matching. Next, we demonstrate that exactly the same testable implications hold with and without transferable utility between household members. We build on this last result to provide a primal and dual linear programming characterization of a stable matching allocation for the observational setting at hand. This provides an explicit specification of the marital surplus function rationalizing the observed matching behavior.
    Keywords: marriage stability; household consumption; nonparametric testable implications; transferable utility
    JEL: C14 D11 C78
    Date: 2017–07
  13. By: Hitoshi Matsushima (University of Tokyo)
    Abstract: We investigate implementation of social choice functions, where we impose severe restrictions on mechanisms, such as boundedness, permitting only tiny transfers, and uniqueness of an iteratively undominated strategy profile in the ex-post term. We assume that there exists some partial information about the state that is verifiable. We consider the dynamic aspect of information acquisition, where players share information, but the timing of receiving information is different across players. By using this aspect, the central planner designs a dynamic, not a static, mechanism, in which each player announces what he (or she) knows about the state at multiple stages with sufficient intervals. By demonstrating a sufficient condition on the state and on the dynamic aspect, namely full detection, we show that a wide variety of social choice functions are uniquely implementable even if the range of players’ lies that the verified information can directly detect is quite narrow. With full detection, we can detect all possible lies, not by the verified information alone, but by processing a chain of detection triggered by this information. This paper does not assume either expected utility or quasi-linearity.
    Date: 2017–06

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