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on Utility Models and Prospect Theory |
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Issue of 2017‒08‒20
ten papers chosen by |
| By: | Jonathan W. Leland; Mark Schneider |
| Abstract: | A model of decision making is introduced that provides a unified approach for predicting choices under risk and over time. The model predicts systematic departures from expected utility and discounted utility using the same mathematical structure and the same psychological intuition and shows that a dozen diverse choice anomalies can be given a common underlying explanation. The model weights attribute differences both by their importance (consistent with expected utility and discounted utility) and by their salience or similarity (consistent with procedural models based on heuristics), and so provides a bridge between rational and heuristic representations of decision making. |
| Keywords: | Framing Effects, Risk, Time, Ambiguity |
| JEL: | D81 D91 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:chu:wpaper:17-16&r=upt |
| By: | McCarthy, David; Mikkola, Kalle; Thomas, Teruji |
| Abstract: | We generalize Harsanyi's social aggregation theorem. We allow the population to be infinite, and merely assume that individual and social preferences are given by strongly independent preorders on a convex set of arbitrary dimension. Thus we assume neither completeness nor any form of continuity. Under Pareto indifference, the conclusion of Harsanyi's theorem nevertheless holds almost entirely unchanged when utility values are taken to be vectors in a product of lexicographic function spaces. The addition of weak or strong Pareto has essentially the same implications in the general case as it does in Harsanyi's original setting. |
| Keywords: | Harsanyi's utilitarian theorem; discontinuous preferences; incomplete preferences; infinite populations |
| JEL: | D60 D63 D81 |
| Date: | 2017–08–16 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:80820&r=upt |
| By: | Jonathan W. Leland; Mark Schneider; Nathaniel Wilcox |
| Abstract: | It has been argued that behavior differs between transparent and nontransparent representations of a decision. However, the notion of a ‘transparent representation’ has not been precisely defined. We address this gap by providing formal definitions of ‘transparent frames’ for risk and time, establishing their uniqueness, presenting an approach to construct such frames, and comparing these frames to the ‘standard’ presentation format. Our typology of frames provides a logic for predicting systematic shifts in risk and time preferences as well as changes in the violation rates of rational choice theory. We conduct an experiment for choice under risk to investigate the framing effect between transparent and ‘standard’ frames and find such framing to be an important source of non-random variation in observed risk preferences. We also extend our approach to choice under uncertainty and derive the novel prediction that ambiguity aversion is frame dependent, a result supported by recent experimental evidence. |
| Keywords: | Risk, Time, Salience, Behavioral Biases |
| JEL: | D81 D91 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:chu:wpaper:17-15&r=upt |
| By: | McCarthy, David; Mikkola, Kalle; Thomas, Teruji |
| Abstract: | We show that without assuming completeness or continuity, a strongly independent preorder on a possibly infinite dimensional convex set can always be given a vector-valued representation that naturally generalizes the standard expected utility representation. More precisely, it can be represented by a mixture-preserving function to a product of lexicographic function spaces. |
| Keywords: | Expected utility; discontinuous preferences; incomplete preferences; lexicographic representations |
| JEL: | D81 |
| Date: | 2017–08–15 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:80806&r=upt |
| By: | Dietmar P.J. Leisen (University of Mainz); Eckhard Platen (Finance Discipline Group, UTS Business School, University of Technology, Sydney) |
| Abstract: | This paper studies long term investing by an investor that maximizes either expected utility from terminal wealth or from consumption. We introduce the concepts of a generalized stochastic discount factor (SDF) and of the minimum price to attain target payouts. The paper finds that the dynamics of the SDF needs to be captured and not the entire market dynamics, which simplifies significantly practical implementations of optimal portfolio strategies. We pay particular attention to the case where the SDF is equal to the inverse of the growth-optimal portfolio in the given market. Then, optimal wealth evolution is closely linked to the growth optimal portfolio. In particular, our concepts allow us to reconcile utility optimization with the practitioner approach of growth investing. We illustrate empirically that our new framework leads to improved lifetime consumption-portfolio choice and asset allocation strategies. |
| Keywords: | stochastic discount factor; minimum pricing; optimal portfolio; growth optimal portfolio |
| JEL: | G11 G13 |
| Date: | 2017–05–01 |
| URL: | http://d.repec.org/n?u=RePEc:uts:rpaper:381&r=upt |
| By: | Beqiraj Elton; Di Bartolomeo Giovanni; Serpieri Carolina |
| Abstract: | This paper builds a stylized simple sticky-price New Keynesian model where agents' beliefs are not homogeneous. We assume that agents choose optimal plans while considering forecasts of macroeconomic conditions over an infinite horizon. A fraction of them (boundedly rational agents) use heuristics to forecast macroeconomic variables over an infinite horizon. In our framework, we study optimal policies consistent with a second-order approximation of the policy objective from the consumers' utility function, assuming that the steady state is not distorted. |
| Date: | 2017–01 |
| URL: | http://d.repec.org/n?u=RePEc:ter:wpaper:00129&r=upt |
| By: | David S. Ahn (University of California, Berkeley); Ryota Iijima (Cowles Foundation, Yale University); Todd Sarver (Duke University) |
| Abstract: | We introduce and characterize a recursive model of dynamic choice that accommodates naiveté about present bias. The model incorporates costly self-control in the sense of Gul and Pesendorfer (2001) to overcome the technical hurdles of the Strotz representation. The important novel condition is an axiom for naiveté. We first introduce appropriate definitions of absolute and comparative naiveté for a simple two-period model, and explore their implications for the costly self-control model. We then extend this definition for infinite-horizon environments, and discuss some of the subtleties involved with the extension. Incorporating the definition of absolute naiveté as an axiom, we characterize a recursive representation of naive quasi-hyperbolic discounting with self-control for an individual who is jointly overoptimistic about her present-bias factor and her ability to resist instant gratification. We study the implications of our proposed comparison of naiveté for the parameters of the recursive representation. Finally, we discuss the obstacles that preclude more general notions of naiveté, and illuminate the impossibility of a definition that simultaneously incorporates both random choice and costly self-control. devices. |
| Keywords: | Naive, Sophisticated, Self-control, Quasi-hyperbolic discounting |
| JEL: | D11 D91 |
| Date: | 2017–08 |
| URL: | http://d.repec.org/n?u=RePEc:cwl:cwldpp:2099&r=upt |
| By: | Wright, Joshua |
| Abstract: | This study seeks to estimate whether income is predictive of an individual’s risk profile. The consensus amongst the existing literature is that income is predictive of an individual’s risk profile and the two do have a relationship. This study uses a quantitative approach by estimating a series of statistical models that estimate the relationship between an individual’s income and their risk profile using a large UK based longitudinal dataset. The research finds that income is positively related to risk and that for every £1,000 increase in income, an individual’s odds of becoming risk seeking increase by 1%. Moreover, the research finds that not only is income predictive of an individual’s risk, but so too are;; gender, education level, age and self-employment. |
| Keywords: | Individuals, Risk Profiles, Income, UK. |
| JEL: | D1 D81 |
| Date: | 2017–08–10 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:80757&r=upt |
| By: | Berens, Stefan (Center for Mathematical Economics, Bielefeld University); Chochua, Lasha (Center for Mathematical Economics, Bielefeld University) |
| Abstract: | This paper extends Harsanyi’s Impartial Observer Theorem by introducing Knightian Uncertainty in the form of individual belief systems. It features an axiomatic framework of societal decision-making in the presence of individual uncertainty. The model allows the analysis of scenarios where individuals agree on the ranking but not on the likelihood of social outcomes. The preferences of the impartial observer are represented by a weighted sum of utilities - each representing individual preferences with different belief systems. In order to incorporate common criticism of the framework of Harsanyi (1953), our approach is based on the generalized version by Grant et al. (2010). The belief systems are introduced as second-order beliefs following Seo (2009). |
| Keywords: | Impartial Observer, Uncertainty, Utilitarianism |
| Date: | 2017–08–10 |
| URL: | http://d.repec.org/n?u=RePEc:bie:wpaper:576&r=upt |
| By: | Sanchez Villalba, Miguel; Martinez Gorricho, Silvia |
| Abstract: | We propose a new, voluntary mechanism (the "hybrid lottery") as a means for financing the provision of public goods. We find that, under some conditions, the mechanism can mitigate the free-riding problem and that, for each player, the (weakly) dominant strategy is the one that -in equilibrium- implements the first best. We also find that the mechanism is quite robust to modifications of the basic model, including heterogeneity in incomes and preferences, different utility functions and incomplete information. Finally, the mechanism is "self-financed"(i.e., it never runs out of money, neither on- nor off-equilibrium path) and -because of the use of dominant strategies- it is very easy to solve by players. Thus, the mechanism is simple to implement in the real world by charities and other organisations that rely on voluntary contributions. |
| Keywords: | Public Goods; Voluntary Contribution Mechanism; Subsidy Schemes; Laboratory Experiments |
| JEL: | C72 C92 H41 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:80823&r=upt |