nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2017‒09‒03
sixteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Uncertainty Averse Preferences and Changing Uncertainty Aversion By Xue, Jingyi
  2. A Path Integral Approach to Interacting Economic Systems with Multiple Heterogeneous Agents By Pierre Gosselin; Aïleen Lotz; Marc Wambst
  3. Precautionary Saving with Changing Income Ambiguity By Kajii, Atsushi; Xue, Jingyi
  4. The varying relevance of impact factors in gravity models: An explanation of the delayed development towards global trade By Bernard M. Gilroy; Nico Stöckmann
  5. Optimal Contracts with Reflection By Yuzhe Zhang; Borys Grochulski
  6. Understanding the Impact of Tuition Fees in Foreign Education: the Case of the UK By Michel Beine; Marco Delogu; Lionel Ragot
  7. Cognitive Bias in Insurance: Evidence from India By Ontiveros, Darwin Ugarte; Platteau, Jean-Philippe
  8. Safe options induce gender differences in risk attitudes By Paolo Crosetto; Antonio Filippin
  9. Arranged Marriages under Transferable Utilities By Pauline Morault
  10. Optimal insurance for catastrophic risk: theory and application to nuclear corporate liability By Alexis Louaas; Pierre Picard
  11. Trends and Risk Premia: Update and Additional Plots By Tung-Lam Dao; Daniel Hoehener; Yves Lemp\'eri\`ere; Trung-Tu Nguyen; Philip Seager; Jean-Philippe Bouchaud
  12. Continuous Spatial Monopolistic Competition: Matching Goods With Consumers By Sergey Kokovin; Maxim Goryunov; Takatoshi Tabuchi
  13. Choice with Time By João Ferreira; Nicolas Gravel
  14. Income or Leisure? On the Hidden Benefits of (Un-)Employment By Adrian Chadi; Clemens Hetschko
  15. Environmental Tax Reform and Income Distribution with Imperfect Heterogeneous Labor Markets By Diane Aubert; Mireille Chiroleu-Assouline
  16. Secular Satiation By Gilles Saint-Paul

  1. By: Xue, Jingyi (School of Economics, Singapore Management University)
    Abstract: This paper provides two equivalent representations for the general class of uncertainty averse preferences studied by Cerreia-Vioglio, Maccheroni, Marinacci and Montrucchio (2011). The two representations employ respectively two important extensions of Gilboa and Schmeidler (1989)’s maxmin decision rule. The first is a weighted maxmin representation with a non-constant weight used in mixing the minimum and maximum expected utilities. The second is a variant constraint representation which evaluates a prospect by the worst expected utility over a neighborhood of approximating priors where the size of the neighborhood depends on the prospect. The equivalent representations have advantage in several respects. In the second part of this paper, we study the wealth effect under ambiguity. We propose axioms on absolute and relative uncertainty aversion and derive the three representations for the uncertainty averse preferences displaying decreasing (increasing) absolute uncertainty aversion. The characterization result not only provides a model of relevant behavior under ambiguity, but also shows how the two alternative representations stand out in presenting the changing patterns of one’s uncertainty aversion.
    Keywords: Ambiguity; Uncertainty Averse Preferences; Weighted Maxmin Representation; Variant Constraint Representation; Decreasing Absolute Uncertainty Aversion; Increasing Relative Uncertainty Aversion; Wealth Effect
    JEL: D81
    Date: 2016–03–17
  2. By: Pierre Gosselin (IF - Institut Fourier - UJF - Université Joseph Fourier - Grenoble 1 - CNRS - Centre National de la Recherche Scientifique); Aïleen Lotz (Cerca Trova - Aucune); Marc Wambst (IRMA - Institut de Recherche Mathématique Avancée - Université de Strasbourg - CNRS - Centre National de la Recherche Scientifique)
    Abstract: This paper presents an analytical treatment of economic systems with an arbitrary number of agents that keeps track of the systems' interactions and agent's complexity. The formalism does not seek to aggregate agents: it rather replaces the standard optimization approach by a probabilistic description of the agents' behaviors and of the whole system. This is done in two distinct steps. A first step considers an interacting system involving an arbitrary number of agents, where each agent's utility function is subject to unpredictable shocks. In such a setting, individual optimization problems need not be resolved. Each agent is described by a time-dependent probability distribution centered around its utility optimum. The whole system of agents is thus defined by a composite probability depending on time, agents' interactions, relations of strategic dominations, agents' information sets and expectations. This setting allows for heterogeneous agents with different utility functions, strategic domination relations, heterogeneity of information, etc. This dynamic system is described by a path integral formalism in an abstract space – the space of the agents' actions –and is very similar to a statistical physics or quantum mechanics system. We show that this description, applied to the space of agents' actions, reduces to the usual optimization results in simple cases. Compared to the standard optimization, such a description markedly eases the treatment of a system with a small number of agents. It becomes however useless for a large number of agents. In a second step therefore, we show that, for a large number of agents, the previous description is equivalent to a more compact description in terms of field theory. This yields an analytical, although approximate, treatment of the system. This field theory does not model an aggregation of microeconomic systems in the usual sense, but rather describes an environment of a large number of interacting agents. From this description, various phases or equilibria may be retrieved, as well as the individual agents' behaviors, along with their interaction with the environment. This environment does not necessarily have a unique or stable equilibrium and allows to reconstruct aggregate quantities without reducing the system to mere relations between aggregates. For illustrative purposes, this paper studies several economic models with a large number of agents, some presenting various phases. These are models of consumer/producer agents facing binding constraints , business cycle models, and psycho-economic models of interacting and possibly strategic agents.
    Keywords: phase transition,path integrals, business cycle, aggregation, budget constraint, forward-looking behavior,statistical field theory, non trivial vacuum, effective action, Green function, correlation functions, heterogeneous agents, multi-agent model, strategical advantage, interacting agents,psycho-economic models, integrated structures, emergence
    Date: 2017–06–28
  3. By: Kajii, Atsushi (Kyoto University, Singapore Management University (Visiting Professor)); Xue, Jingyi (School of Economics, Singapore Management University)
    Abstract: We study a two-period saving model where the agent’s future income might be ambiguous. Our agent has a version of the smooth ambiguity decision criterion (Klibanoff, Marinacci and Mukerji (2005)), where the agent’s perception about ambiguity is described by a second-order belief over first-order risks. We model increasing ambiguity as a spreading-out of the second-order belief. We show that under a “Risk Comonotonicity” condition, our agent saves more when ambiguity in future income increases. We argue that the condition is indispensable for our result.
    Keywords: Precautionary Saving; Smooth Ambiguity; Increasing Ambiguity; Risk Comonotonicity; Informativeness
    JEL: D80 D81 D91 E21
    Date: 2016–06–06
  4. By: Bernard M. Gilroy (Paderborn University); Nico Stöckmann (Paderborn University)
    Abstract: Factors in uencing bilateral trade between OECD members vary over time. The change in the relevance of binary variables with progressive globalisation can be attributed to individuals' decisions. These are aggregated as utility functions of heterogeneous agents to justify the delay towards global trade.
    Keywords: Globalisation, Trade, Utility Function, Gravity Equation
    JEL: F14 D81
    Date: 2017–06
  5. By: Yuzhe Zhang (Texas A&M University); Borys Grochulski (Federal Reserve Bank of Richmond)
    Abstract: In this paper, we show that whenever the agent's outside option is nonzero, the optimal contract in the continuous-time principal-agent model of Sannikov (2008) is reflective at the lower bound. This means the agent is never terminated or retired after poor performance. Instead, the agent is asked to suspend effort temporarily, as in Zhu (2013), which brings the agent's continuation value up. The agent is then asked to resume effort, and the contract continues. We show that a nonzero agent's outside option arises endogenously if the agent is allowed to quit and find a new rm. In addition, we find new dynamics of the reflection at the lower bound. In the baseline model, the reflection is slow, as in Zhu (2013), i.e., effort is suspended often. However, if the agent's disutility from the first unit of effort is zero, which is a standard Inada condition, or if his utility of consumption is unbounded below, the reflection becomes fast, i.e., effort is suspended seldom.
    Date: 2017
  6. By: Michel Beine (CREA, Université du Luxembourg); Marco Delogu (Université du Luxembourg, Université catholique de Louvain); Lionel Ragot (Université Paris Nanterre, EconomiX and CEPII)
    Abstract: This paper studies the determinants of international students’ mobility at the university- level, focusing specifically on the role of tuition fees. We first develop an original Random Utility Maximization model of location choice for international students in the presence of capacity constraints of the hosting institutions. The last layer of the model gives rise to a gravity equation. This equation is estimated using new data on student migration flows at the university level for the U.K. We control for the endogeneity of tuition fees by taking benefit of the institutional constraints in terms of tuition caps applied in the UK to European students at the bachelor level. The estimations support a negative impact of tuition fees and stress the need to account for the endogenous nature of the fees in the empirical identification of their impact. The estimations also support an important role of additional destination-specific variables such as host capacity, the expected return of education and the cost of living in the vicinity of the university.
    Keywords: Foreign students; Tuition fees; Location choice; University Quality.
    JEL: F22 H52 I23 O15
    Date: 2017
  7. By: Ontiveros, Darwin Ugarte; Platteau, Jean-Philippe
    Abstract: This paper is an attempt to understand the factors behind low contract renewal rates frequently observed in insurance programs in poor countries. This is done on the basis of the experience of a micro-insurance health program in India. We show that poor understanding of the insurance concept, compounded by a serious supply-side information failure, is a major cause of low contract renewal among households which had previously enrolled into the program. Controlling for the level of their information about how to collect the insurance payout, households that did not experience a health shock during the first year tended to pull out of the scheme when they are subject to a cognitive bias reflected in short-term framing. When they are classic expected utility maximizers, however, the absence of a health shock did not affect their contract renewal decision. The policy implication of our findings is considerable since they provide a strong justification for mandatory universal health insurance.
    Keywords: cognitive ability; health economics; information failure; Insurance; myopic behavior; non-governmental organizations
    JEL: D01 D03 I13 O12 O16
    Date: 2017–08
  8. By: Paolo Crosetto (INRA - Institut National de la Recherche Agronomique, GAEL - Grenoble Applied Economics Laboratory - UPMF - Université Pierre Mendès France - Grenoble 2 - INRA - Institut National de la Recherche Agronomique); Antonio Filippin (Institute for the Study of Labor (IZA) Bonn, University of Milan)
    Abstract: Gender differences in risk attitudes are frequently observed, although recent literature has shown that they are context dependent rather than ubiquitous. In this paper we try to rationalize the heterogeneity of results investigating experimentally whether the presence of a safe option among the set of alternatives explains why females are more risk averse than males. We manipulate three widely used risk elicitation methods finding that the availability of a safe option causally affects risk attitudes. The presence of a riskless alternative does not entirely explain the gender gap but it has a significant effect in triggering or magnifying (when already present) such differences. Despite the pronounced instability that usually characterizes the measurement of risk preferences, we show, estimating a structural model, that the effect of a safe option is remarkably stable accross tasks. This paper constitutes the first successful attempt to shed light on the determinants of gender differences in risk attitudes.
    Keywords: safe option,risk attitudes,gender differences,experiment
    Date: 2017–05–30
  9. By: Pauline Morault (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - CNRS - Centre National de la Recherche Scientifique - ECM - Ecole Centrale de Marseille, Sciences Po Paris, Department of Economics)
    Abstract: In many societies, marriage is a decision taken at the familial level. Arranged marriages are documented from Renaissance Europe to contemporary rural Kenya, and are still prevalent in many parts of the developing world. However, this family dimension has essentially been neglected by the existing matching literature on marriages. The objective of this paper is to introduce family considerations into the assignment game. We explore how shifting decision-making to the family level affects matching on the marriage market. We introduce a new concept of familial stability and find that it is weaker than individual stability. The introduction of families into the marriage market generates coordination problems, so the central result of the transferable utility framework no longer holds: a matching can be family-stable even if it does not maximize the sum of total marital surpluses. Interestingly, even when the stable matching is efficient, family decision-making drastically modifies how the surplus is shared-out. These results may have fundamental implications for pre-marital investments. We find that stable matchings depend on the type of family partitioning. Notably, when each family contains one son and one daughter, familial and individual stability are equivalent.
    Keywords: marriage,family,matching,transferable utility
    Date: 2017–06
  10. By: Alexis Louaas (Department of Economics, Ecole Polytechnique - Polytechnique - X - CNRS - Centre National de la Recherche Scientifique); Pierre Picard (Department of Economics, Ecole Polytechnique - Polytechnique - X - CNRS - Centre National de la Recherche Scientifique)
    Abstract: This paper analyzes the optimal insurance for low probability - high severity accidents, such as nuclear catastrophes, both from theoretical and applied standpoints. We show that the risk premium of such catastrophic events may be a non-negligible proportion of individuals’ wealth when the index of absolute risk aversion is sufficiently large in the accident state, and we characterize the optimal asymptotic insurance coverage when the probability of the accident tends to zero. In the case of the limited liability of an industrial firm that may cause large scale damage, the limit corporate insurance contract corresponds to a straight deductible indemnification rule, in which victims are ranked according to the severity of their losses. As an application of these general principles, we consider the optimal corporate liability insurance for nuclear risk, in a setting where the risk is transferred to financial markets through catastrophe bonds. A model calibrated with French data allows us to estimate the optimal liability of a nuclear energy producer. This leads us to the conclusion that the lower limit adopted in 2004 through the revision of the Paris Convention is probably inferior to the socially optimal level.
    Keywords: risk aversion, liability insurance, catastrophic risk,nuclear accident
    Date: 2017–05–24
  11. By: Tung-Lam Dao; Daniel Hoehener; Yves Lemp\'eri\`ere; Trung-Tu Nguyen; Philip Seager; Jean-Philippe Bouchaud
    Abstract: Recently, our group has published two papers that have received some attention in the finance community. One is about the profitability of trend following strategies over 200 years, the second is about the correlation between the profitability of "Risk Premia" and their skewness. In this short note, we present two additional plots that fully corroborate our findings on new data.
    Date: 2017–08
  12. By: Sergey Kokovin (National Research University Higher School of Economics); Maxim Goryunov (National Research University Higher School of Economics); Takatoshi Tabuchi (University of Tokyo - Faculty of Economics)
    Abstract: Our new approach enriches the general additive monopolistic competition model (AMCM) - with a space of product characteristics: consumers' "ideal varieties". Unlike Hotelling, such partially localized competition involves intersecting zones of service among (continuously distributed) producers. Then, the uniform equilibrium firms' density increases with growing population, as with the usual AMCM. However, now increasing/decreasing prices are determined by the increasing/decreasing elasticity of elementary utility (instead of demand elasticity in AMCM). A new characteristic - the firm's range of service - decreases. Such finer matching between buyers and sellers becomes a new source of welfare gain from a thicker market, unlike the variety benefit in AMCM. The free-entry competition remains socially excessive under some natural preferences.
    Keywords: monopolistic competition, spatial competition, optimal product diversity, gains from trade, finer matching.
    JEL: L11 L13
    Date: 2017
  13. By: João Ferreira (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - CNRS - Centre National de la Recherche Scientifique - ECM - Ecole Centrale de Marseille); Nicolas Gravel (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - CNRS - Centre National de la Recherche Scientifique - ECM - Ecole Centrale de Marseille)
    Abstract: We propose a framework for the analysis of choice behavior when the later explicitly depends upon time. We relate this framework to the traditional setting from which time is absent. We illustrate the usefulness of the introduction of time by proposing three possible models of choice behavior in such a framework: (i) changing preferences, (ii) preference formation by trial and error, and (iii) choice with endogenous status-quo bias. We provide a full characterization of each of these three choice models by means of revealed preference-like axioms that could not be formulated in a timeless setting.
    Keywords: choice behavior,time,revealed preferences,changing preferences,learning by trial-and-error,inertia bias
    Date: 2017–07
  14. By: Adrian Chadi; Clemens Hetschko
    Abstract: We study the usually assumed trade-off between income and leisure in labor supply decisions using comprehensive German panel data. We compare non-employed individuals after plant closures with employed people regarding both income and time use as well as their subjective perceptions of these two factors. We find that the gain of non-working time translates into higher satisfaction with free time, while time spent on hobbies increases to a lesser extent than home production. Additionally, satisfaction with family life increases, which may be a hidden benefit of being unemployed. In contrast, satisfaction with income strongly declines when becoming jobless. Identity utility from earning a living may play the role of a hidden benefit of employment. Finally, we examine subjective assessments of income and leisure as potential predictors for job take-up. Non-employed people are particularly likely to take up a job soon when they are dissatisfied withtheir income.
    Keywords: labor supply, plant closure, leisure, work-family conflict, life satisfaction, income satisfaction, free time satisfaction, family satisfaction
    JEL: D01 D13 I31 J22 J64 J65
    Date: 2017
  15. By: Diane Aubert (PSE - Paris School of Economics, PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique); Mireille Chiroleu-Assouline (ECO-PUB - Economie Publique - INRA - Institut National de la Recherche Agronomique - AgroParisTech, PSE - Paris School of Economics, PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique)
    Abstract: This paper investigates the distributional and efficiency consequences of an environmental tax reform, when the revenue from the green tax is recycled by varying labor tax rates. We build a general equilibrium model with imperfect heterogeneous labor markets, pollution consumption externalities, and non-homothetic preferences (Stone-Geary utility). We show that in the case where the reform appears to be regressive, the gains from the double dividend can be made Pareto improving by using a redistributive non-linear income tax if redistribution is initially not too large. Moreover, the increase of progressivity acts on unemployment and can moderate the trade-off between equity and efficiency. We finally provide numerical illustrations for three European countries featuring different labor market behaviors. We show that a double dividend may be obtained without worsening the initial inequalities if the green tax revenues are redistributed with a progressivity index lower for France than for Germany and UK.
    Keywords: Welfare analysis,Tax progressivity,Environmental tax reform,Heterogeneity,Unemployment
    Date: 2017–06
  16. By: Gilles Saint-Paul (PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics, New York University Abu Dhabi)
    Abstract: Satiation of need is generally ignored by growth theory. I study a model where con- sumers may be satiated in any given good but new goods may be introduced. A social planner will never elect a trajectory with long-run satiation. Instead, he will introduce enough new goods to avoid such a situation. In contrast, the decentralized equilibrium may involve long run satiation. This, despite that the social costs of innovation are second order compared to their social benefits. Multiple equilibria may arise: depending on expectations, the economy may then converge to a satiated steady state or a non satiated one. In the latter equilibrium, capital and the number of varieties are larger than in the former, while consumption of each good is lower. This multiplicity comes from the following strategic complementary: when people expect more varieties to be introduced in the future, this raises their marginal utility of future consumption, inducing them to save more. In turn, higher savings reduces interest rates, which boosts the rate of innovation. When TFP grows exogenously and labor supply is endogenized, the satiated equilibrium generically survives. For some parametrer values, its growth rate is positive while labor supply declines over time to zero. Its growth rate is then lower than that of the non satiated equilibrium. Hence, the economy may either coordinate on a high leisure, low growth, satiated "leisure society" or a low leisure, high growth, non satiated "consumption society".
    Keywords: Growth,satiation,innovation,new products,consumer society,leisure society,labor supply,multiple equilibra,strategic complementarities
    Date: 2017–07

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