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on Utility Models and Prospect Theory |
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Issue of 2018‒01‒15
eighteen papers chosen by |
| By: | Schilirò, Daniele |
| Abstract: | The present contribution examines the emergence of expected utility theory by John von Neumann and Oskar Morgenstern, the subjective the expected utility theory by Savage, and the problem of choice under risk and uncertainty, focusing in particular on the seminal work “The Utility Analysis of Choices involving Risk" (1948) by Milton Friedman and Leonard Savage to show how the evolution of the theory of choice has determined a separation of economics from psychology. |
| Keywords: | Rational Choice; Risk; Uncertainty; Expected Utility Theory |
| JEL: | C70 D80 D81 |
| Date: | 2017–06 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:83366&r=upt |
| By: | Galichon, Alfred; Kominers, Scott Duke; Weber, Simon |
| Abstract: | We introduce an empirical framework for models of matching with imperfectly transferable utility and unobserved heterogeneity in tastes. Our framework allows us to characterize matching equilibrium in a flexible way that includes as special cases the classical fully- and non-transferable utility models, collective models, and settings with taxes on transfers, deadweight losses, or risk aversion. We allow for the introduction of a general class of additive unobserved heterogeneity on agents' preferences. We show existence and uniqueness of an equilibrium under minimal assumptions. We then provide two algorithms to compute the equilibrium in our model. The first algorithm operates under any structure of heterogeneity in preferences; the second is more efficient, but applies only in the case in which random utilities are logit. We show that the log-likelihood of the model has a simple expression and we compute its derivatives. As an empirical illustration, we build a model of marriage with preferences over the partner type and private consumption, which we estimate on a British dataset. |
| Keywords: | Imperfectly Transferable Utility; Intrahousehold Allocation; Marriage Market; Matching; sorting |
| JEL: | C78 D3 J21 J23 J31 J4 |
| Date: | 2017–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:12455&r=upt |
| By: | Hernán Bejarano (CIDE, Mexico; Chapman University, Orange, CA); Francisco Galarza (Universidad del Pacífico) |
| Abstract: | We study the consistency of risk preferences among undergraduate students in a developing country. Our design allow us to elicit consistency at the individual level in which each subject selects his or her most preferred lotteries under two different (but related) risk elicitation tasks. In the first task, subjects choose one lottery out of six alternatives, thus ruling out inconsistency. Our second task is a transformation of the first task into a multiple price-list lottery, intended to examine whether the choice in the first task is also revealed as preferred. Using these choices, we construct our measures of preferences inconsistency, and analyze their correlation with cognitive skills (as measured by Frederick (2005)'s Cognitive Reflection Test—CRT scores and students' GPAs) and risk preferences. We find that a low CRT score and a poor academic performance are, in general, good predictors of inconsistent choices. Results are mixed in terms of the role of risk aversion. |
| Keywords: | Inconsistent choices, risk aversion, cognitive skills, experimental economics |
| JEL: | C91 D81 |
| Date: | 2016–05 |
| URL: | http://d.repec.org/n?u=RePEc:pai:wpaper:16-03&r=upt |
| By: | Cocioc, Paul |
| Abstract: | The paper is intended to be a synthesis of the general approaches on economic risk and economic decisions under risk. Delimitation of the risk from the uncertainty is based on Knight’s views. Basically decisions are analyzed in a conventional manner by using the expected utility hypothesis. The paradigm is presented both historycal and critically from Bernoulli to von Neumann and Morgenstern. It develops some ideas on the elements encountered in establishing the minimal acceptable level of outcomes for risk-taking. The comments and conclusions highlight certain limits on rationality in economic decision. |
| Keywords: | risk; risk-aversion; uncertainty; decision-making; expected-utility hypothesis |
| JEL: | D01 D11 D81 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:83609&r=upt |
| By: | Rezai, Armon; van der Ploeg, Frederick |
| Abstract: | With the election of President Trump, climate deniers moved from the fringes to the centre of global policy making and need to be addressed in policy-making. An agnostic approach to policy, based on Pascal's wager, gives a key role to subjective prior probability beliefs about whether climate deniers are right. Policy makers that assign a 10% chance of climate deniers being correct set the global price on carbon to $19.1 per ton of emitted CO2 in 2020. Given that a non-denialist scientist making use of the DICE integrated assessment model sets the price at $21.1/tCO2, agnostics' reflection of remaining scientific uncertainty leaves climate policy essentially unchanged. The robustness of an ambitious climate policy also follows from using the max-min or the min-max regret principle. Letting the coefficient of relative ambiguity aversion vary from zero corresponding to expected utility analysis to infinity corresponding to the max-min principle, it is possible to show how policy makers deal with fundamental climate model uncertainty when they are prepared to assign prior probabilities to different views of the world being correct. Allowing for a wide range of sensitivity exercises including damage uncertainty, it turns out that pricing carbon is the robust response under rising climate scepticism. |
| Keywords: | ambiguity aversion; climate model uncertainty; climate scepticism; DICE integrated assessment model; max-min; min-max regret; robust climate policies |
| JEL: | H21 Q51 Q54 |
| Date: | 2017–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:12468&r=upt |
| By: | Samuel Mongrut Montalván (EGADE, ITESM, Campus Queretaro, Mexico) |
| Abstract: | So far, the estimation of discount rates required by entrepreneurs has remained a mystery. Mongrut and Ramirez (2006) made a contribution to this area by deriving the lower bound discount rate for a non-diversified entrepreneur in an emerging market. However, they used a quadratic utility function, which does not have desirable assumptions. In this research one extends the previous work by deriving expressions of discount rates using a Hyperbolic Absolute Risk Aversion (HARA) utility function that includes the quadratic and the logarithmic forms as special cases. Furthermore, one also assumes the entrepreneur with the lowest risk-aversion that invests almost all his capital in his project or firm and whose level of wealth approaches to zero. One finds that both expressions depend upon entrepreneur's riskaversion and a measure of the project total risk. Maintaining constant the risk-free rate, we simulate the expressions of discount rate for the quadratic form and the logarithmic form. As expected, the entrepreneur’s required returns (discount rates) are highly sensitive in both specifications and all values were lower than 50% and most of them were lower than 25%, but higher than the assumed risk-free rate. |
| Keywords: | Seed Capital, discount rates, entrepreneurship |
| JEL: | L26 M13 |
| Date: | 2016–03 |
| URL: | http://d.repec.org/n?u=RePEc:pai:wpaper:16-01&r=upt |
| By: | Victor Chernozhukov (Institute for Fiscal Studies and MIT); Ivan Fernandez-Val (Institute for Fiscal Studies and Boston University); Whitney K. Newey (Institute for Fiscal Studies and MIT) |
| Abstract: | Multinomial choice models are fundamental for empirical modeling of economic choices among discrete alternatives. We analyze identification of binary and multinomial choice models when the choice utilities are nonseparable in observed attributes and multidimensional unobserved heterogeneity with cross-section and panel data. We show that derivatives of choice probabilities with respect to continuous attributes are weighted averages of utility derivatives in cross-section models with exogenous heterogeneity. In the special case of random coefficient models with an independent additive effect, we further characterize that the probability derivative at zero is proportional to the population mean of the coefficients. We extend the identification results to models with endogenous heterogeneity using either a control function or panel data. In time stationary panel models with two periods, we find that differences over time of derivatives of choice probabilities identify utility derivatives "on the diagonal," i.e. when the observed attributes take the same values in the two periods. We also show that time stationarity does not identify structural derivatives "off the diagonal" both in continuous and multinomial choice panel models. |
| Keywords: | Multinomial choice, binary choice, nonseparable model, random coefficients, panel data, control function. |
| Date: | 2017–06–27 |
| URL: | http://d.repec.org/n?u=RePEc:ifs:cemmap:33/17&r=upt |
| By: | Jean-Michel Grandmont (ICEF; Department of Economics, University Ca’ Foscari di Venezia; CREST; RIEB Fellow; University of Kobe) |
| Abstract: | This work introduces a new mechanism generating procyclical comovements of labor productivity, employment, through endogenous variations of workers' effort, in a simple model with efficiency wages, near a locally indeterminate steady state. A current endogenous countercyclical uncertainty shock makes risk averse workers more willing to provide imperfectly monitored "precautionary effort" by increasing their expected utility gain of not shirking. If workers' relative prudence is small and decreasing fast near the steady state, firms' efficiency wage contracts generate significant endogenous procyclical variations of effort, employment and labor productivity, in particularwhen the capital-efficient labor elasticity of substitution is smaller than and close to 1. |
| Keywords: | efficiency wages, unemployment, expectation driven business cycles, conditionally heteroskedastic sunspots, countercyclical uncertainty shocks, prudence, procyclical labor effort and productivity |
| JEL: | E00 E24 E32 J41 |
| URL: | http://d.repec.org/n?u=RePEc:crs:wpaper:2017-12&r=upt |
| By: | Rehana Naz |
| Abstract: | Naz and Chaudhry [3] established multiple closed-form solutions for the basic Lucas-Uzawa model. According to Boucekkine and Ruiz-Tamarit [1] and Chilarescu [2] unique closed-form solutions exist for the basic Lucas-Uzawa model. We equate expressions for variables h(t) and u(t). We provide here condition for the unique closed-form solution and proposed an open question for evaluation of integral in closed-form. A similar analysis is carried out for the Lucas-Uzawa model with logarithmic utility preferences. |
| Date: | 2017–12 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1712.08654&r=upt |
| By: | Jorg Stoye (Institute for Fiscal Studies and Cornell University); Yuichi Kitamura (Institute for Fiscal Studies and Yale University) |
| Abstract: | This paper develops and implements a nonparametric test of Random Utility Models. The motivating application is to test the null hypothesis that a sample of cross-sectional demand distributions was generated by a population of rational consumers. We test a necessary and sufficient condition for this that does not restrict unobserved heterogeneity or the number of goods. We also propose and implement a control function approach to account for endogenous expenditure. An econometric result of independent interest is a test for linear inequality constraints when these are represented as the vertices of a polyhedron rather than its faces. An empirical application to the U.K. Household Expenditure Survey illustrates computational feasibility of the method in demand problems with 5 goods. |
| Keywords: | Stochastic Rationality |
| Date: | 2017–12–11 |
| URL: | http://d.repec.org/n?u=RePEc:ifs:cemmap:56/17&r=upt |
| By: | Giovanni Dosi (Scuola Superiore Sant'Anna Pisa Italy); Mauro Napoletano (OFCE Sciences PO Paris Franc); Andrea Roventini (Scuola Superiore Sant'Anna Pisa Italy also OFCE Sciences Po Paris); Joseph Stiglitz (Columbia University, New York, USA); Tania Treibich (Maastricht University and Scuola Superiore Sant'Anna,Pisa Italy & OFCE Sciences Po Paris France) |
| Abstract: | We analyze the individual and macroeconomic impacts of heterogeneous expectations and action rules within an agent-based model populated by heterogeneous, interacting firms. Agents have to cope with a complex evolving economy characterized by deep uncertainty resulting from technical change, imperfect information and coordination hurdles. In these circumstances, we find that neither individual nor macroeconomic dynamics improve when agents replace myopic expectations with less naïve learning rules. In fact, more sophisticated, e.g. recursive least squares (RLS) expectations produce less accurate individual forecasts and also considerably worsen the performance of the economy. Finally, we experiment with agents that adjust simply to technological shocks, and we show that individual and aggregate performances dramatically degrade. Our results suggest that fast and frugal robust heuristics are not a second-best option: rather they are “rational” in macroeconomic environments with heterogeneous, interacting agents and changing “fundamentals”. |
| Keywords: | Complexity, expectations, heterogeneity, heuristics, learning, agent based model, computational economics |
| JEL: | C63 E32 E6 G01 G21 O4 |
| Date: | 2017–12–14 |
| URL: | http://d.repec.org/n?u=RePEc:fce:doctra:1732&r=upt |
| By: | Burak Can (School of Business and Economics, Maastricht University - Department of Economics); Ali Ozkes (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); Ton Storcken (Department of Quantitative Economics, Maastricht University - (-)) |
| Abstract: | We provide axiomatic characterizations for measures of polarization in profiles of preferences that are represented as rankings of alternatives. Polarization is seen as the extent to which opinions are opposed. We provide characterizations for an extension of this simple intuition on the pairs of alternatives to the cases with more than two alternatives. Our primary generalization allows for different treatment among issues, i.e., pairs of alternatives. Secondly, we show that the characterization result continues to hold when preferences are allowed to attain indifferences. Finally, we show that we can also impose a domain restriction that only allows for single-peaked preferences and retain our characterization. Our results point to a fundamental feature of measures on profile of preferences that are based on pairwise comparisons of alternatives. |
| Keywords: | polarization,measurement,social choice,single-peaked preferences |
| Date: | 2017–09 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-01597720&r=upt |
| By: | Moschion, Julie (Melbourne Institute of Applied Economic and Social Research); Powdthavee, Nattavudh (University of Warwick) |
| Abstract: | This paper provides an empirical test of the rational addiction model, used in economics to model individuals' consumption of addictive substances, versus the utility misprediction model, used in psychology to explain the discrepancy between people's decision and their subsequent experiences. By exploiting a unique data set of disadvantaged Australians, we provide longitudinal evidence that a drop in life satisfaction tends to precede the use of illegal/street drugs. We also find that the abuse of alcohol, the daily use of cannabis and the weekly use of illegal/street drugs in the past 6 months relate to lower current levels of life satisfaction. This provides empirical support for the utility misprediction model. Further, we find that the decrease in life satisfaction following the consumption of illegal/street drugs persists 6 months to a year after use. In contrast, the consumption of cigarettes is unrelated to life satisfaction in the close past or the near future. Our results, though only illustrative, suggest that measures of individual's subjective wellbeing should be examined together with data on revealed preferences when testing models of rational decision-making. |
| Keywords: | life satisfaction, rational addiction, drugs, homeless, Australia, happiness |
| JEL: | D03 I12 I18 I30 |
| Date: | 2017–11 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp11181&r=upt |
| By: | Charles Bellemare; Alexander Sebald; Sigrid Suetens |
| Abstract: | Psychological games of guilt aversion assume that preferences depend on (beliefs about) beliefs and on the guilt sensitivity of the decision-maker. We present an experiment designed to measure guilt sensitivities at the individual level for various stake sizes. We use the data to estimate a structural choice model that allows for heterogeneity, and permits that guilt sensitivities depend on stake size. We find substantial heterogeneity of guilt sensitivities in our population, with 60% of decision makers displaying stake-dependent guilt sensitivity. For these decision makers, we find that average guilt sensitivities are significantly different from zero for all stakes considered, while significantly decreasing with the level of stakes. |
| Keywords: | guilt sensitivity, psychological game theory, Heterogeneity, stakes, dictator game |
| JEL: | A13 C91 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:lvl:crrecr:1708&r=upt |
| By: | Reyes, Celia M.; Domingo, Sonny N.; Agbon, Adrian D.; Olaguera, Ma. Divina C. |
| Abstract: | Valuing climate information is now an important discourse in mainstream economic thinking with the development of the von Neumann-Morgenstern utility hypothesis and of the refinement of decision theory under uncertainty. This discourse is important in valuing weather information and climate-related decision support, particularly among agricultural stakeholders. The need to understand better the use and value of climate information and climate-sensitive decisions among smallholder farmers in selected farmers in Atok and La Trinidad Benguet, Philippines is the aim of this paper. Measures implemented to mitigate the effects La Nina and El Nino include changing the timing of planting and crop shifting and changing the location of crops. Farmers rely to indigenous knowledge when it comes to frost forecasting. On the average, 300 truckers from the trading post transport commodities outside the province on a daily basis. But during typhoons, many traders prefer to delay their deliveries. Farmers shared that weather/climate information is a major factor taken into consideration in their planning and crop decision making. Climate date for the rainy and or dry season was considered as the most important information they need. Given the unique microclimatic condition of the province, farmers need a localized forecast from PAGASA. |
| Keywords: | climate, climate information, climate-sensitive decisions, weather information, Benguet |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:phd:dpaper:dp_2017-47&r=upt |
| By: | Bredtmann, Julia (RWI); Nowotny, Klaus (University of Salzburg); Otten, Sebastian (RWI) |
| Abstract: | This paper analyzes the interaction between migrant networks and linguistic distance in the location choice of migrants to the EU at the regional level. We test the hypothesis that networks and the ability to communicate in the host country language, proxied by linguistic distance, are substitutes in the location decision. Based on individual level data from a special evaluation of the European Labour Force Survey (EU-LFS) and a random utility maximization framework, we find that networks have a positive effect on the location decisions while the effect of linguistic distance is negative. We also find a strong positive interaction effect between the two factors: networks are more important the larger the linguistic distance between the home country and the host region, and the negative effect of linguistic distance is smaller the larger the network size. In several extensions and robustness checks, we show that this substitutable relationship is extremely robust. |
| Keywords: | location choice, ethnic networks, linguistic distance, EU migration, multilateral resistance |
| JEL: | F22 J61 R23 |
| Date: | 2017–11 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp11171&r=upt |
| By: | SHIKHMAN Vladimir (Technische Universität Chemnitz); NESTEROV Yurii (CORE, Université catholique de Louvain); GINSBURGH Victor (Université libre de Bruxelles) |
| Abstract: | We consider an economy with consumers maximizing Cobb-Douglas utilities from the algorithmic perspective. It is known that in this case finding equilibrium prices reduces to the eigenvalue problem for a particularly structured stochastic matrix. We show th |
| Keywords: | exchange economy, Cobb-Douglas utility, tâtonnement, power method, stochastic matrix, regular economy |
| JEL: | C6 D5 |
| Date: | 2017–09–04 |
| URL: | http://d.repec.org/n?u=RePEc:cor:louvco:2017024&r=upt |
| By: | Yamamura, Eiji; Ishida, Ryo |
| Abstract: | This paper attempts to investigate how information transparency affects human behavior. Thus, we empirically examine the influence of information disclosure ordinances on the income of mayors and chief executives in local governments in Japan. For the estimation, we use panel data of local governments covering 1999–2010, during which time many local governments implemented such ordinances. The key finding is that the income of mayors and chief executives in local governments decreased after the implementation of the ordinances. Furthermore, as the years passed, the income declined further. Hence, information disclosure regarding local government reduces the income of top officials and its influence becomes greater over time. Although the income of mayors and chiefs executives is open information without the need for an ordinance, it provided transparency regarding their work performance. Furthermore, the effect of the ordinance did not depend on the mayors or chief executives’ income level in 1999. Therefore, the reduction of income is mainly due to the government’s accountability rather than citizens’ inequality aversion. |
| Keywords: | Information disclosure ordinance; Japan; Local governments |
| JEL: | D72 H79 |
| Date: | 2017–12–05 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:83337&r=upt |