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on Utility Models and Prospect Theory |
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Issue of 2018‒02‒12
nineteen papers chosen by |
| By: | In Do Hwang (Economic Research Institute, The Bank of Korea) |
| Abstract: | This paper investigates how loss-aversion affects individuals' decisions on savings and insurance purchase. Specifically, this paper empirically tests if prospect theory's loss aversion decreases insurance demand and increases savings demand. Prospect theory predicts that boundedly rational consumers may view pure protection insurance, such as term-life insurance, as a risky investment because the insured may lose premiums if a bad event does not occur within the pre-specified term. Hence, those who are fairly sensitive to the potential loss choose not to buy term-life insurance. Instead, they may choose a more safe option to prepare for uncertain future events by increasing precautionary saving. This paper tests such prediction using individual-level data from the Health and Retirement Study (HRS) and finds empirical evidence consistent with the prediction: loss-averse individuals are less likely to own term-life insurance and more likely to own whole-life insurance, which serves as a partial savings instrument. These individuals also hold a higher level of wealth than others, suggesting that they tend to save more (presumably for precautionary motives), all other things being equal. |
| Keywords: | Loss aversion, Term life insurance, Whole life insurance, Precautionary saving, Prospect theory |
| JEL: | D03 D14 G22 |
| Date: | 2017–02–27 |
| URL: | http://d.repec.org/n?u=RePEc:bok:wpaper:1708&r=upt |
| By: | Harin, Alexander |
| Abstract: | A forbidden zones theorem is deduced in the present article. Its consequences and applications are preliminary considered. The following statement is proven: if some non-zero lower bound exists for the variance of a random variable, that takes on values in a finite interval, then non-zero bounds or forbidden zones exist for its expectation near the boundaries of the interval. The article is motivated by the need of rigorous theoretical support for the practical analysis that has been performed for the influence of scattering and noise in the behavioral economics, decision sciences, utility and prospect theories. If a noise can be one of possible causes of the above lower bound on the variance, then it can cause or broaden out such forbidden zones. So the theorem can provide new possibilities for mathematical description of the influence of such a noise. The considered forbidden zones can evidently lead to some biases in measurements. |
| Keywords: | probability; variance; noise; utility theory; prospect theory; behavioral economics; decision sciences; measurement; |
| JEL: | C02 C1 D8 D81 |
| Date: | 2018–01–29 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:84248&r=upt |
| By: | Mikl\'os R\'asonyi; Andrea Meireles-Rodrigues |
| Abstract: | We study the problem of maximising terminal utility for an agent facing model uncertainty, in a frictionless discrete-time market consisting of one safe asset and finitely many risky assets. We show that an optimal investment strategy exists if the utility function, defined either over the positive real line or over the whole real line, is bounded from above. We also find that, when wealth is required to satisfy the no-bankruptcy constraint, the boundedness assumption can be dropped provided that we impose a certain integrability condition, related to some strengthened form of no-arbitrage. These results are obtained in an alternative framework for model uncertainty, where all possible dynamics of the stock prices are represented by a collection of stochastic processes on the same filtered probability space, rather than by a family of probability measures. |
| Date: | 2018–01 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1801.06860&r=upt |
| By: | Anne Corcos (CURAPP-ESS UMR 7319; CNRS; Université de Picardie); François Pannequin (CREST; ENS Paris-Saclay; Université Paris-Saclay); Claude Montmarquette, (CIRANO; Université de Montréal) |
| Abstract: | This paper compares the Holt and Laury’s risk attitude elicitation with a risk attitude classification associated with insurance behavior. The standard Holt and Laury’s procedure (2002) is implemented in the loss domain, while the second tool is based on contextualized experimental hedging choices for insurance and loss reduction (secondary prevention). Our findings highlight the high consistency between the two procedures for more than two-thirds of the subjects, both measures leading to the same risk-attitude assignment. Interestingly, cases where the two measures do not coincide concern the only subjects whose Holt and Laury’s risk aversion coefficient is borderline. For these participants, using both measures allows for a more accurate assessment. Finally, the HL-irrational behavior of participants uncovers specific risk-averse behavior signature, while contextualized-irrational behavior reveals a risk-loving behavior. |
| Keywords: | risk-attitude classification, insurance demand, self-insurance demand, loss reduction, secondary prevention, multiple price list method, experimental study |
| JEL: | C91 D81 |
| Date: | 2017–12–01 |
| URL: | http://d.repec.org/n?u=RePEc:crs:wpaper:2017-79&r=upt |
| By: | Cason, Timothy; Masters, William; Sheremeta, Roman |
| Abstract: | This study provides a unified framework to compare three canonical types of contests: winner-take-all contests won by the best performer, winner-take-all lotteries where probability of success is proportional to performance, and proportional-prize contests in which rewards are shared in proportion to performance. We derive equilibria and observe outcomes from each contest in a laboratory experiment. Equilibrium and observed efforts are highest in winner-take-all contests. Lotteries and proportional-prize contests have the same Nash equilibrium, but empirically, lotteries induce higher efforts and lower, more unequal payoffs. Behavioral deviations from theoretical benchmarks in different contests are caused by the same underlying attributes, such as risk-aversion and the utility of winning. Finally, we find that subjects exhibit consistent behavior across different types of contests, with subjects exerting higher effort in one contest also exerting higher effort in another contest. |
| Keywords: | contests, rent-seeking, lotteries, incentives in experiments, risk aversion |
| JEL: | C72 D72 D74 J33 |
| Date: | 2018–01–29 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:84246&r=upt |
| By: | Strulik, Holger; Trimborn, Timo |
| Abstract: | It has been argued that hyperbolic discounting of future gains and losses leads to time-inconsistent behavior and thereby, in the context of health economics, not enough investment in health and too much indulgence of unhealthy consumption. Here, we challenge this view. We set up a life-cycle model of human aging and longevity in which individuals discount the future hyperbolically and make time-consistent decisions. This allows us to disentangle the role of discounting from the time consistency issue. We show that hyperbolically discounting individuals, under a reasonable normalization, invest more in their health than they would if they had a constant rate of time preference. Using a calibrated life-cycle model of human aging, we predict that the average U.S. American lives about 4 years longer with hyperbolic discounting than he would if he had applied a constant discount rate. The reason is that, under hyperbolic discounting, experiences in old age receive a relatively high weight in life time utility. In an extension we show that the introduction of health-dependent survival probability motivates an increasing discount rate for the elderly and, in the aggregate, a u-shaped pattern of the discount rate with respect to age. |
| Keywords: | discount rates,present bias,health behavior,aging,longevity |
| JEL: | D03 D11 D91 I10 I12 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cegedp:335&r=upt |
| By: | Levine, Sheen S.; Reypens, Charlotte |
| Abstract: | In many life situations, people choose sequentially between repeating a past action in expectation of a familiar outcome (exploitation), or choosing a novel action whose outcome is largely uncertain (exploration). For instance, in each quarter, a manager can budget advertising for an existing product, earning a predictable boost in sales. Or she can spend to develop a completely new product, whose prospects are more ambiguous. Such decisions are central to economics, psychology, business, and innovation; and they have been studied mostly by modelling in agent-based simulations or examining statistical relationships in archival or survey data. Using experiments across cultures, we add unique evidence about causality and variations. We find that exploration is boosted by three past experiences: When decision-makers fall below top performance; undergo performance stability; or suffer low overall performance. In contrast, individual-level variables, including risk and ambiguity preferences, are poor predictors of exploration. The results provide insights into how decisions are made, substantiating the micro-foundations of strategy and assisting in balancing exploration with exploitation. |
| Keywords: | Exploration, Exploitation, Decision Making, Experiment, Protocol Analysis, Cross-culture |
| JEL: | C93 M14 |
| Date: | 2016–07–18 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:82858&r=upt |
| By: | Yasuhiro Sakai (Faculty of Economics, Shiga University) |
| Abstract: | The economics of risk and uncertainty has a long history over 300 years. This paper aims to systematically summarize and critically reevaluate it, with special reference to John M. Keynes and Frank H. Knight, the two giants in modern times. In our opinion, there are the six stages of development, with each stage vividly reflecting its historical background. The first stage, named the Initial Age, corresponds to a long period before 1700, the one in which statistics was firmly established by B. Pascal as a branch of mathematics but economic theory per se was not well developed. The second stage, called the "B-A" Age, covers the period from 1700 to 1880, is characterized by the two superstars, Daniel Bernoulli and Adam Smith. The third stage from 1880 to 1940 may be named the "K-K" Age because it was dominated by J.M. Keynes and F.H. Knight. The fourth stage, called the "N-M" age, eyewitnesses the birth of game theory, with von Neumann and Morgenstern being its foundering fathers. The fifth stage from 1970 to 2000, named the "A-S" Age, is characterized by several distinguished scholars with their initials "A" or "S". Finally, in 2000 and onward, while many doubts have been raised about existing doctrines, new approaches have not emerged yet, thus being named the Uncertain Age. The relationship between Keynes and Knight is both complex and rather strange. It has a history of separating, approaching, separating again and approaching again. As the saying goes, a new wine should be poured into a new bottle. We would urgently need a Keynes and/or a Knight toward a new horizon of the economics of risk and uncertainty. |
| Keywords: | Economics of risk and uncertainty, Bernoulli, Keynes, Knight |
| Date: | 2018–01 |
| URL: | http://d.repec.org/n?u=RePEc:shg:dpapea:28&r=upt |
| By: | Jean Baccelli (Munich Center for Mathematical Philosophy, LMU - Ludwig Maximilian University [Munich], IHPST - Institut d'Histoire et de Philosophie des Sciences et des Techniques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - CNRS - Centre National de la Recherche Scientifique) |
| Abstract: | In this paper, I examine the decision-theoretic status of risk attitudes. I start by providing evidence showing that the risk attitude concepts do not play a major role in the axiomatic analysis of the classic models of decision-making under risk. This can be interpreted as reflecting the neutrality of these models between the possible risk attitudes. My central claim, however, is that such neutrality needs to be qualified and the axiomatic relevance of risk attitudes needs to be re-evaluated accordingly. Specifically, I highlight the importance of the conditional variation and the strengthening of risk attitudes, and I explain why they establish the axiomatic significance of the risk attitude concepts. I also present several questions for future research regarding the strengthening of risk attitudes. |
| Keywords: | cautious expected utility ,rank-dependent utility,risk aversion,conditional certainty equivalent,Allais paradox,non-expected utility |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-01620886&r=upt |
| By: | Landier, Augustin; Ma, Yueran; Thesmar, David |
| Abstract: | In this paper, we measure belief formation in an experimental setting where agents are incentivized to provide accurate forecasts of a random variable, drawn from a stable and simple statistical process. Using these data, we estimate an empirical model that builds on the recent literature on expectation dynamics: It nests rational expectations, but also allows for extrapolation and under-reaction. Our findings are threefold. First, the rational expectation hypothesis is strongly rejected in our setting. Second, both extrapolation and underreaction patterns are statistically discernible in the data, but extrapolation quantitatively dominates. Third, our model coefficients are very robust to changes in experimental setting: They do not depend on process parameters, individual characteristics or framing. These large and stable deviations from rationality occur even though the forecasting exercise is simple and transparent. |
| Date: | 2017–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:12527&r=upt |
| By: | Dorian Jullien (GREDEG - Groupe de Recherche en Droit, Economie et Gestion - UNS - Université Nice Sophia Antipolis - UCA - Université Côte d'Azur - CNRS - Centre National de la Recherche Scientifique - UCA - Université Côte d'Azur) |
| Abstract: | This paper conducts a systematic comparison of behavioral economics's challenges to the standard accounts of economic behaviors within three dimensions: under risk, over time and regarding other people. A new perspective on two underlying methodological issues, i.e., interdisciplinarity and the positive/normative distinction, is proposed by following the entanglement thesis of Hilary Putnam, Vivian Walsh and Amartya Sen. This thesis holds that facts, values and conventions have interdependent meanings in science which can be understood by scrutinizing formal and ordinary language uses. The goal is to provide a broad and self-contained picture of how behavioral economics is changing the mainstream of economics. |
| Keywords: | behavioral economics, economic rationality, expected utility, prospect the-,ory, exponential discounting, hyperbolic discounting, self-interest, other-regarding behav-,iors, economic methodology, history of economics, philosophy of economics, economics and,language,JEL: A12, B21, B41, D01, D03, D81, D90, D64 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-01651042&r=upt |
| By: | Olivier Gossner (CREST; CNRS; Ecole polytechnique; Université Paris-Saclay; London School of Economics); Christoph Kuzmics (University of Graz) |
| Abstract: | A decision maker (DM) makes choices from different sets of alternatives. The DM is initially ignorant of the payoff associated to each alternative, and learns these payoffs only after a large number of choices have been made. We show that, in the presence of an outside option once payoffs are learned, the optimal choice rule from sets of alternatives is one that is as if the DM had strict preferences over all alternatives. Under this model, the DM has preferences for preferences while being ignorant of what preferences are “right”. |
| Keywords: | consistency, rationality, weak axiom of revealed preferences, strict preference |
| JEL: | C73 D01 D11 |
| Date: | 2017–12–31 |
| URL: | http://d.repec.org/n?u=RePEc:crs:wpaper:2017-52&r=upt |
| By: | Jehiel, Philippe; Steiner, Jakub |
| Abstract: | A proposed model of information processing generates a prediction about the constrained-optimal stochastic choice that is robust to details of the feasible information structures. A decision-maker processes payoff-relevant information until she reaches her cognitive constraint, at which point she either terminates the decision-making and chooses an action, or restarts the process. By conditioning the probability of termination on the information collected, she controls the correlation between the payoff state and her terminal action. The constrained-optimal choice rule exhibits (i) confirmation bias, (ii) speed-accuracy complementarity, (iii) overweighting of rare events, and (iv) salience effect. |
| Date: | 2017–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:12546&r=upt |
| By: | Gordon M. Myers (Simon Fraser University) |
| Abstract: | A Faculty chooses a level of costly effort in generating revenue for the university. The revenue is deployed in the pursuit of academic excellence in research and teaching. The effort is not observable by the central Administration and the amount of revenue generated from given level of effort is uncertain. The Administration and Faculties are assumed risk averse. I show that when effort is observable, or there is no uncertainty, or the Faculty is not risk averse, pure Responsibility Center Budgeting (RCB) is efficient and optimal from the perspective of the Administration. The intuition for this is provided by pure RCB solving the incentive problem and leading to the right effort level by making the Faculty the residual claimant. Once the Faculty is risk averse I show partial RCB is optimal. A problem with pure RCB is that the Faculty holds all the revenue risk. Partial RCB then provides a balance between providing the right incentives to the Faculty and the Administration providing partial insurance to the Faculty. In my simple model I show that we move further away from pure RCB, the more uncertain the environment, the more risk averse the Faculty, and the less risk averse the Administration. |
| Keywords: | University Governance, Decentralization, Responsibility Center Budgeting |
| Date: | 2018–01 |
| URL: | http://d.repec.org/n?u=RePEc:sfu:sfudps:dp18-01&r=upt |
| By: | Richard T. Carson (Department of Economics, University of California); Mikołaj Czajkowski (Faculty of Economic Sciences, University of Warsaw) |
| Abstract: | We show a substantive problem exists with the widely-used ratio of coefficients approach to calculating willingness to pay (WTP) from choice models. The correctly calculated standard error for WTP using this approach is shown to always be infinity. A variant of this problem has long been recognized for mixed logit models. We show it occurs even in simple models like the conditional logit used as a baseline reference specification. It occurs because the standard error for the cost parameter implies some possibility that the true parameter value is arbitrarily close to zero. We propose a simple yet elegant way to overcome this problem by reparameterizing the coefficient of the (negative) cost variable to enforce the theoretically correct (and empirically almost always found) positive coefficient using an exponential transformation of the original parameter. This reparameterization enforces the desired restriction that no-part of the confidence region for original cost parameter spans zero. With it the confidence interval for WTP is now finite and well behaved. Our proposed model is straightforward to implement using readily available software. Its log-likelihood value is the same as the usual baseline discrete choice model and we recommend its use as the new standard baseline reference model. |
| Keywords: | conditional logit, confidence intervals, contingent valuation delta method, discrete choice experiment, Krinsky-Robb, multinomial logit, probit, welfare measures |
| JEL: | C01 C15 C18 Q0 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:war:wpaper:2018-04&r=upt |
| By: | Frédéric Gavrel (CREM - Centre de recherche en économie et management - UNICAEN - Université de Caen Normandie - NU - Normandie Université - UR1 - Université de Rennes 1 - CNRS - Centre National de la Recherche Scientifique); Thérèse Rebière (LIRSA - Laboratoire Interdisciplinaire de Recherche en Sciences de l'Action - CNAM - Conservatoire National des Arts et Métiers [CNAM], Institute for the Study of Labor (IZA) Bonn) |
| Abstract: | This paper provides an analysis of the social consequences of people seeking to get ahead of the Smiths. All individuals attempt to reach a higher rank than the Smiths, including the Smiths themselves. This attitude gives rise to an equilibrium in which all individuals have equal utilities but unequal (gross) incomes. Due to a rat-race effect, individuals devote too much energy to climbing the social scale.However, laissez-faire equilibrium is an equal-utility constrained social optimum. Conversely, a utilitarian social planner would not choose utility equality. Unexpectedly, this social ambition theory fairly well accounts for empirical intermediate wage inequality. |
| Keywords: | Efficiency ,Inequalities,Well-being,Getting ahead of the Smiths,Social interactions |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-01242504&r=upt |
| By: | Laurens Cherchye; Thomas Demuynck; Bram De Rock |
| Abstract: | We study the testable implications of normal demand in a two-goods setting. For a finite dataset on prices and quantities, we present the revealed preference conditions for normality of one or both goods. Our characterization provides an intuitive extension of the well-known Weak Axiom of Revealed Preference, and is easy to use in practice. We illustrate the empirical relevance of our theoretical results through an application to an experimental dataset. We also briefly discuss extensions of our conditions to a setting with more than two goods. |
| Keywords: | Normality; Revealed preference; Substitution effect |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:ulb:ulbeco:2013/262694&r=upt |
| By: | François Cochard (Université de Bourgogne Franche-Comté, CRESE); Alexandre Flage (Université de Bourgogne Franche-Comté, CRESE); Grolleau Gilles (University Bourgogne Franche-Comté, Burgundy School of Business); Sutan Angela (University Bourgogne Franche-Comté, Burgundy School of Business) |
| Abstract: | Using a loss-framed variant of the dictator game, we investigate how dictators split a loss between themselves and a recipient. In a loss context, we try to disentangle the effects of a more self-oriented preference from that of a higher social responsibility. We find that in the loss context, individuals offer more, and women offer more than men. This could be attributed to a more responsible response to a powerless recipient in a loss context. |
| Keywords: | dictator game, loss, loss aversion, own/other-regarding preferences, social responsibility |
| JEL: | C91 D03 |
| Date: | 2018–01 |
| URL: | http://d.repec.org/n?u=RePEc:crb:wpaper:2018-02&r=upt |
| By: | Mohajan, Haradhan |
| Abstract: | The mathematical techniques are considered here to explain the economical problems. This article deals with the Substitution and Reciprocity Theorems for the various commodities. Finally, it also has considered the Slutsky Equation for the minimization of the prices and the budget constraints. The study has included analysis of some explicit examples to clarify the concepts of the results. The aim of this paper is to make the mathematical concepts interesting to the economists. An attempt has been taken here to discuss the problems in some detailed mathematical analysis in an elegant manner. |
| Keywords: | Indifference Hypersurface, Lagrange Multiplier, Utility Function, Reciprocity and Substitution Theorems, Slutsky Equation. |
| JEL: | C6 C61 |
| Date: | 2017–01–14 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:82938&r=upt |