nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2018‒01‒01
twenty-two papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Discrete Choice and Rational Inattention: a General Equivalence Result By Mogens Fosgerau; Emerson Melo; André de Palma; Matthew Shum
  2. Eliciting Second-Order Beliefs By Subir Bose; Arup Daripa
  3. Are Preferences for Food Quality Attributes Really Normally Distributed? An Analysis Using Flexible Mixing Distributions By Vincenzina Caputo; Riccardo Scarpa; Rodlofo M. Nayga; David L. Ortega
  4. Safe options induce gender differences in risk attitudes By Crosetto, P.; Filippin, A.
  5. What do consumers consider before they choose? Identification from asymmetric demand responses By Jason Abaluck; Abi Adams
  6. Risk Apportionment: The Dual Story By Louis R. Eeckhoudt; Roger J. A. Laeven; Harris Schlesinger
  7. Sequential equilibrium without rational expectations of prices: A theorem of full existence By Lionel De Boisdeffre
  8. The Demand and Supply of Favours in Dynamic Relationships By Jean Guillaume Forand; Jan Zapal
  9. Relative Nash welfarism By SPRUMONT, Yves
  10. Vulnerability from trade in Vietnam By Emiliano Magrini; Pierluigi Montalbano; L. Alan Winters
  11. Fixed Point Approaches to the Proof of the Bondareva-Shapley Theorem By Jean Guillaume Forand; Metin Uyanik
  12. Estimating Rationality in Economics: A History of Statistical Methods in Experimental Economics By Nicolas Vallois; Dorian Jullien
  13. Attitudes towards large income risk in welfare states: an international comparison. By Schroyen, Fred; Aarbu, Karl Ove
  14. Description-dependent Choices By Dino Borie; Dorian Jullien
  15. Priming app information privacy concerns in mobile ecosystems By Buck, Christoph; Burster, Simone; Eymann, Torsten
  16. Correlation neglect and case-based decisions By Benjamin Radoc; Robert Sugden; Theodore L. Turocy
  17. Bounded rationality in differential games By Beckmann, Klaus B.
  18. Spatial competition with demand uncertainty: A laboratory experiment By Aurélie Bonein; Stéphane Turolla
  19. "Climate Roots of Loss Aversion" By Oded Galor; Viacheslav Savitskiy
  20. The Impact of Price Information on Consumer Behavior: An Experiment By Francisco B. Galarza; Gabriella Wong
  21. Peer effects in risky choices among adolescents By Konstanting Lucks; Melanie Lührmann; Joachim K. Winter
  22. Entropy-based implied moments By Xiao Xiao; Chen Zhou

  1. By: Mogens Fosgerau (Department of Economics, Copenhagen University); Emerson Melo (Indiana University Bloomington); André de Palma (Ecole Normale Superieure de Cachan (ENS)); Matthew Shum (California Institute of Technology)
    Abstract: This paper establishes a general equivalence between discrete choice and rational inattention models. Matejka and McKay (2015, AER) showed that when information costs are modelled using the Shannon entropy, the resulting choice probabilities in the rational inattention model take the multinomial logit form. We show that when information costs are modelled using a class of generalized entropies, then the choice probabilities in any rational inattention model are observationally equivalent to some additive random utility discrete choice model and vice versa. This equivalence arises from convex- analytic properties of the random utility model. Thus any additive random utility model can be given an interpretation in terms of boundedly rational behavior. We provide examples of this equivalence utilizing the nested logit model, an empirically relevant random utility model allowing for flexible substitution possibilities between choices.
    Keywords: Rational Inattention, Discrete Choice, Random Utility, General Entropy, Convex Analysis
    JEL: D03 C25 D81
    Date: 2017–12–06
  2. By: Subir Bose (University of Leicester); Arup Daripa (Birkbeck, University of London)
    Abstract: We study elicitation of subjective beliefs of an agent facing ambiguity (model uncertainty): the agent has a non-singleton set of (first-order) priors on an event and a second-order prior on these first-order belief-states. Such a two-stage decomposition of uncertainty and non-reduction of compound lotteries resulting from nonneutrality to the second-order distribution plays an important role in resolving the Ellsberg Paradox. The problem of eliciting beliefs on unobservable belief-states with ambiguity-sensitive agents is novel, and we introduce new elicitation techniques using report-dependent prize variations. We construct a direct revelation mechanism that induces truthful reporting of the first-order belief states as well as the secondorder distribution on the belief-states as the unique best response. The technique requires knowledge of the sensitivity function to second-order distribution (capturing ambiguity attitude) and the vN-M utility function, which we also elicit.
    Keywords: Ambiguity, second-order beliefs, elicitation of second-order beliefs (support and distribution), Klibanoff-Marinacci-Mukerji (2005) representation, elicitation of second-order-distribution-sensitivity function, elicitation of the vN-M utility function.
    JEL: D81 D82
    Date: 2017–12
  3. By: Vincenzina Caputo (Michigan State University); Riccardo Scarpa (University of Waikato); Rodlofo M. Nayga (University of Arkansas); David L. Ortega (Michigan State University)
    Abstract: We empirically question the commonly employed distributional assumption of normality of taste distribution in mixed logit models with continuous random parameters. We use a WTP-space random utility discrete choice model with flexible distributions (Train 2016) on data from two choice experiments regarding beef with nested set of quality attributes. We specifically address distributional features such as asymmetry, multi-modality and range of variation, and find little support for normality. Our results are robust to attribute dimensionality in experimental design. Implications of our results for practitioners in the field are discussed.
    Keywords: flexible taste distributions; mixed logit; logit mixed logit; food preferences; preference heterogneity
    Date: 2017–11–30
  4. By: Crosetto, P.; Filippin, A.
    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.
    JEL: C81 C91 D81
    Date: 2017
  5. By: Jason Abaluck (Institute for Fiscal Studies); Abi Adams (Institute for Fiscal Studies and University of Oxford)
    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.
    Keywords: Asymmetric demand responses, consumers
    Date: 2017–07–07
  6. By: Louis R. Eeckhoudt; Roger J. A. Laeven; Harris Schlesinger
    Abstract: By specifying model free preferences towards simple nested classes of lottery pairs, we develop the dual story to stand on equal footing with that of (primal) risk apportionment. The dual story provides an intuitive interpretation, and full characterization, of dual counterparts of such concepts as prudence and temperance. The direction of preference between these nested classes of lottery pairs is equivalent to signing the successive derivatives of the probability weighting function within Yaari's (1987) dual theory. We explore implications of our results for optimal portfolio choice and show that the sign of the third derivative of the probability weighting function may be naturally linked to a self-protection problem.
    Date: 2017–12
  7. By: Lionel De Boisdeffre (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)
    Abstract: We consider a pure exchange economy, where agents, typically asymmetrically informed, exchange commodities, on spot markets, and securities of all kinds, on incomplete financial markets with no model of how future prices are determined. They have private characteristics, anticipations and beliefs. We show they face an incompressible uncertainty, represented by a so-called “minimum uncertainty set”, typically adding to the ‘exogenous uncertainty’, on tomorrow's state of nature, an ‘endogenous uncertainty’ on future spot prices, which may depend on every agent's private anticipations today. At equilibrium, all agents expect the ‘true’ price, in each realizable state, as a possible outcome, and elect optimal strategies, ex ante, which clear on all markets, ex post. Our main Theorem states that equilibrium exists as long as agents' prior anticipations, which may be refined from observing markets, embed that minimum uncertainty set. This result is stronger than the classical ones of generic existence, along Radner (1979), or Hart (1975), based on the rational expectations of prices.
    Abstract: L'on considère une économie d'échange pure, où des agents, asymétriquement informés et sans modèle de prix, échangent des biens de consommation, sur des marchés spots, et des actifs financiers sur des marchés incomplets. Leurs caractéristiques, croyances et anticipations sont privées. Nous montrons qu'ils sont alors confrontés à une incertitude incompressible sur les prix futurs sur chaque marché spot, représentée par un ensemble dit “d'incertitude minimale”. Celle-ci combine l'incertitude “ exogène ” sur l'état aléatoire de la nature à l'incertitude “ endogène ” sur ces prix spots, qui dépendent des anticipations privées des agents et que ceux-ci ne peuvent déterminer. A l'équilibre, le vrai prix dans chaque état réalisable sera anticipé comme possible par chaque agent qui optimisera sa consommation, et tous les marchés s'équilibreront ex post. Notre principal théorème montre que l'équilibre existe sous des conditions standard, dès que les anticipations de chaque agent s'étendent à l'ensemble minimal d'incertitude. Ce résultat d'existence est plus fort que le résultat classique, qui n'est que générique, que ce soit en régime d'asymétrie d'information ou en marché d'actifs réels. Cette existence génŕrique résulte notamment des travaux de Radner (1979), Hart (1975) et Duffie-Schaffer (1985), et est fondée sur des hypothèses d'anticipations rationnelles de prix que nous abandonnons ici.
    Keywords: sequential equilibrium,temporary equilibrium,perfect foresight,rational expectations,financial markets,asymmetric information,équilibre séquentiel,équilibre temporaire,anticipations parfaites,existence,anticipations rationnelles,marchés financiers,asymétrie d'information,arbitrage
    Date: 2017–06
  8. By: Jean Guillaume Forand (Department of Economics, University of Waterloo); Jan Zapal (CERGE-EI, Prague, Czech Republic)
    Abstract: We characterise the optimal demand and supply of favours in a dynamic principal-agent model of joint production, in which heterogenous project opportunities arrive stochastically and are publicly observed upon arrival, utility from these projects is non-transferable and commitment to future production is limited. Our results characterise the optimal dynamic contract, and we establish that the principal's supply of favours (the production of projects that benefit the agent but not the principal) is backloaded, that the principal's demand for favours (the production of projects that benefit the principal but not the agent) is frontloaded, and that the production of projects is ordered by their comparative advantage, that is, by their associated efficiency in extracting (for demanded projects) and providing (for supplied projects) utility to the agent. Furthermore, we provide an exact construction of the optimal contract when project opportunities follow a Markov process.
    JEL: D86 C73 L24
    Date: 2017–09
  9. By: SPRUMONT, Yves
    Abstract: Relative Nash welfarism is a solution to the problem of aggregating von Neumann-Morgenstern preferences over a set of lotteries. It ranks such lotteries according to the product of any collection of 0-normalized von Neumann-Morgenstern utilities they generate. We show that this criterion is characterized by the Weak Pareto Principle, Anonymity, and Independence of Harmless Expansions: the social ranking of two lotteries is unaffected by the addition of any alternative that every agent deems at least as good as the one she originally found worst. Relative Nash welfarism is more appealing than relative utilitarianism in contexts where the best relevant alternative for an agent is difficult to identify with confidence.
    Keywords: Preference aggregation; lotteries; relative utilitarianism; Nash product
    JEL: D63 D71
    Date: 2017
  10. By: Emiliano Magrini (Food and Agriculture Organization of the United Nations, Rome (IT).); Pierluigi Montalbano (Department of Economics and Social Sciences, Sapienza University of Rome (IT).); L. Alan Winters (Department of Economics, University of Sussex (UK))
    Abstract: This paper assesses vulnerability from trade in Vietnam by presenting an extended version of Ligon and Schechter’s (2003) Vulnerability as low Expected Utility (VEU) measure. It uses the VHLSS panel data covering the period 2002-06. The empirical results show that risk-induced vulnerability and het-erogeneity in trade exposure matters in determining household overall vulnerability and that this is not linked to the actual manifestation of shocks. Although it does not represent, by any means, an argument against free trade, this work is relevant for policymaking since it contributes to deepen our knowledge on the subtle links between trade openness and vulnerability providing some insight on the stabilisation needs of trade reforms. These include protecting vulnerable farmers from excessive price volatility, as well as fostering their risk management strategies.
    Keywords: trade openness, vulnerability, poverty, risk, consumption behaviour, Vietnam.
    JEL: F14 O12 D12 C31
    Date: 2017–11
  11. By: Jean Guillaume Forand (Department of Economics, University of Waterloo); Metin Uyanik (School of Economics, University of Queensland)
    Abstract: We provide two new proofs of the Bondareva-Shapley theorem, which states that the core of a transferable utility cooperative is nonempty if and only if the game is balanced. Both proofs exploit the fixed points of self-maps of the set of imputations, applying elementary existence arguments typically associated with noncooperative games to cooperative games.
    JEL: C71 C62
    Date: 2017–11
  12. By: Nicolas Vallois (CRIISEA - Centre de Recherche sur l'Industrie, les Institutions et les Systèmes Economiques d'Amiens - UPJV - Université de Picardie Jules Verne); Dorian Jullien (GREDEG - Groupe de Recherche en Droit, Economie et Gestion - CNRS - Centre National de la Recherche Scientifique - UNS - Université Nice Sophia Antipolis - UCA - Université Côte d'Azur - UCA - Université Côte d'Azur)
    Abstract: Experimental economists increasingly apply econometric techniques to interpret their data, as suggests the emergence of " experimetrics " in the 2000s. Yet statistics remains a minor topic in historical and methodological writings on experimental economics (EE). This article aims to address this lacuna. To do so, we analyze the use of statistical tools in EE from early economics experiments of the 1940s-1950s to the present days. Our narrative is based on qualitative analysis of papers published in early periods and quantitative analysis of papers published in more recent periods. Our results reveal a significant change in EE' statistical methods, namely an evolution from purely descriptive methods to more sophisticated and standardized techniques. We also highlight that, despite the decisive role played by statistics in the way EE estimate the rationality of individuals or markets, statistics are still considered as involving non-methodological issues, i.e., as involving only purely technical issues. Our historical analysis shows that this technical conception was the result of a long-run evolution of the process of scientific legitimization of EE, which allowed experimental economists to escape from psychologist's more reflexive culture toward statistics.
    Keywords: Experimental Economics, Statistics, Econometrics, History of Economic Thought, Methodology
    Date: 2017–11–28
  13. By: Schroyen, Fred (Dept. of Economics, Norwegian School of Economics and Business Administration); Aarbu, Karl Ove (Tryg Forsikring)
    Abstract: Using survey data and the instrument developed by Barsky et al.(1997), we estimate the distribution of attitudes towards income risk in a country where many employment and health-related risks are generously covered by a tax …financed social insurance system (Norway 2006) . Under a CRRA assumption, the sample average for the coefficient of relative risk aversion is 3.8 with a standard deviation of 2.3. This number is then contrasted to that for five other OECD countries where risk attitudes have been measured using the same instrument and also prior to the financial crisis: Chile, France, Italy, The Netherlands and the US. When we relate this distribution for stated relative risk aversion to that for generosity of social insurance and the risks related to employment and Health expenditure, a picture emerges suggesting that more extensive welfare states induce higher risk tolerance for foreground risks-–a- relationship that is in line with the theory on risk vulnerability.
    Keywords: Risk aversion; stated preferences; income lotteries; background risk; risk vulnerability; welfare state.
    JEL: D12 D81
    Date: 2017–12–05
  14. By: Dino Borie (GREDEG - Groupe de Recherche en Droit, Economie et Gestion - CNRS - Centre National de la Recherche Scientifique - UNS - Université Nice Sophia Antipolis - UCA - Université Côte d'Azur - UCA - Université Côte d'Azur); Dorian Jullien (GREDEG - Groupe de Recherche en Droit, Economie et Gestion - CNRS - Centre National de la Recherche Scientifique - UNS - Université Nice Sophia Antipolis - UCA - Université Côte d'Azur - UCA - Université Côte d'Azur)
    Abstract: The standard model of choice behavior relies on an implicit assumption that a decision maker is not affected by different descriptions of a given problem (description invariance). However, the behavioral economics and psychology literatures provide well-established evidence that descriptions do in fact influence decision makers. In this paper, we distinguish between descriptions of objects of choice and consequences of objects of choice in order to deduce a decision maker's preferences over the descriptions from observed choices over the consequences. We provide a choice theoretical foundation for maximizing preference relations subject to the class of framing effects where description invariance is violated. JEL Classification: D89, D90, D91.
    Keywords: Choice correspondence,framing effects,rational choice,description invariance,description dependence
    Date: 2017–11–28
  15. By: Buck, Christoph; Burster, Simone; Eymann, Torsten
    Abstract: In the course of experiential computing privacy is entering personal space. Due to the implementation of all kinds of sensors and computing in everyday life of users, their privacy is at high risk. The high risk of privacy is strengthened by the classification of mobile app download decisions in mobile ecosystems as low effort processes. The article follows the call of Dinev et al. (2015) to investigate the influences of behavioral economics on privacy decisions. The paper provides the development of an app information privacy concern and six independent experiments in the field of priming information privacy with altogether 1954 participants. The results support the assumption of app decision-making as low effort process and indicate the influence of priming on individuals' information privacy concerns. This research contributes to increasing importance of understanding individuals' behavior in digital ecosystems.
    Keywords: Mobile Applications,Information Privacy,Privacy Concerns,Behavioral Economics,Priming
    Date: 2017
  16. By: Benjamin Radoc (Ateneo de Manila University); Robert Sugden (University of East Anglia); Theodore L. Turocy (University of East Anglia)
    Abstract: We test the conjecture that case-based reasoning may be used, not only when state spaces are undefined, but also when relevant probabilities can be derived by Bayesian inference from observations of random processes. Our experiment elicits participants' valuations of a lottery after observing realisations of this and another lottery. Depending on the treatment, participants know that the two lotteries are independent, positively correlated, or negatively correlated. We find no evidence of correlation neglect indicative of case-based reasoning. However, in the negative correlation treatment, valuations cannot be explained by Bayesian reasoning, while stated qualitative judgements about chances of winning can.
    Keywords: case-based decision, correlation, experiment
    JEL: C91 D03 D81
    Date: 2017–11–27
  17. By: Beckmann, Klaus B. (Helmut Schmidt University, Hamburg)
    Abstract: The present paper proposes a myopic, boundedly rational heuristic for individual decision-making in differential game settings. I demonstrate that this type of behaviour converges to Nash equilibrium in infinitely repeated stage games without a state variable if the stage game is strategically symmetric. Two examples are used to illustrate the application of the heuristic in differential games.
    Keywords: differential games; simulation; bounded rationality
    JEL: C72
    Date: 2017–12–19
  18. By: Aurélie Bonein; Stéphane Turolla
    Abstract: Motivated by recent research on product differentiation, we conduct laboratory experiments to study how (aggregate) demand uncertainty influences location choices and price competition in the original Hotelling (1929)’s model. We provide new predictions on the effect of risk attitudes on both decisions under demand uncertainty and confront them with the data. Our experimental results support the predictions that demand uncertainty acts as a differentiation force for risk-neutral and risk-lover subjects. By contrast, we do not verify that demand uncertainty leads risk-averse subjects to agglomerate. This is explained primarily by learning effects and heterogeneous behaviors within this risk profile. Finally, we observe various price-setting behaviors, ranging from an attempt to collude to a price war, depending on the level of differentiation.
    Keywords: product differentiation, demand uncertainty, price competition, experiment
    JEL: C72 C91 D43 L13 R30
    Date: 2017
  19. By: Oded Galor; Viacheslav Savitskiy
    Abstract: This research explores the origins of loss aversion and the variation in its prevalence across regions, nations and ethnic group. It advances the hypothesis and establishes empirically that the evolution of loss aversion in the course of human history can be traced to the adaptation of individuals to the asymmetric eects of climatic shocks on reproductive success during the Malthusian epoch. Exploiting variations in the degree of loss aversion among second generation migrants in Europe and the US, as well as across precolonial ethnic groups, the research establishes that consistent with the predictions of the theory, individuals and ethnic groups that are originated in regions in which climatic conditions tended to be spatially correlated, and thus shocks were aggregate in nature, are characterized by greater intensity of loss aversion, while descendants of regions marked by climatic volatility have greater propensity towards loss-neutrality.
    Date: 2018
  20. By: Francisco B. Galarza (Universidad del Pacifico); Gabriella Wong (Innovations for Poverty Action)
    Abstract: We conduct blind tests to examine the connection between consumer’s choices and price differentials, for two goods with different levels of observable quality, bottled spring water and toilet paper (we pose that toilet paper’s quality is more easily observable). We gave subjects two samples of those goods, with no labels for their brands, but with two different prices. Given that the samples were exactly the same, we aimed at testing whether the price differentials influenced their perceptions of quality, for a given level of quality observability. The most striking result is that quality information inferred via price differentials have significant effects on consumer choices, when such difference is relatively high and quality is not easy to observe. Moreover, in such a case, prices shape the perceptions of quality: "If it is expensive, it tastes good". In contrast, when quality is easy to observe, we find no significant relationship between price differentials and perceived quality.
    Keywords: Price-quality, Experimental Economics, behavioral pricing, placebo effect, consumer decision-making
    JEL: C91 D03 D81 D89
    Date: 2017–12
  21. By: Konstanting Lucks (Institute for Fiscal Studies); Melanie Lührmann (Institute for Fiscal Studies and Royal Holloway, University of London); Joachim K. Winter (Institute for Fiscal Studies and Ludwig-Maximilians-Universität München)
    Abstract: We study the effects of peers on risky decision making among adolescents in the age range of 13 to 15 years. In a field experiment, we randomly allocated school classes to two social interaction treatments. Students were allowed to discuss their choices with a natural peer – either a friend or a randomly selected classmate – before individually making choices in an incentivised lottery task. In the control group, adolescents made choices without being able to discuss them with a peer. In addition, we collected information on existing peer networks. This novel design allows us to separate two channels of peer influence, assortative matching on preferences and the effect of social interaction on choices. We find that friends and classmates are matched on socio-demographic characteristics but not on risk preferences. In contrast, social interaction strongly increases the similarity of teenagers’ risky choices. A large fraction of peers align their choices perfectly.
    Keywords: peer effects; assortative matching; social interaction; risk and loss aversion
    Date: 2017–08–25
  22. By: Xiao Xiao; Chen Zhou
    Abstract: This paper investigates the maximum entropy method for estimating the option implied volatility, skewness and kurtosis.The maximum entropy method allows for non-parametric estimation of the risk neutral distribution and construction of confidence intervals around the implied volatility. Numerical study shows that the maximum entropy method outperforms the existing methods such as the Black-Scholes model and model-free method when the underlying risk neutral distribution exhibits heavy tail and skewness. By applying this method to the S&P 500 index options, we find that the entropy-based implied volatility outperforms the Black-Scholes implied volatility and model-free implied volatility, in terms of in-sample fit and out-of-sample predictive power. The differences between entropy based and model-free implied moments can be explained by the level of the higher-order implied moments of the underlying distribution.
    Keywords: Option pricing; risk neutral distribution; higher order moments
    JEL: C14 G13 G17
    Date: 2017–12

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