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on Utility Models and Prospect Theory |
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Issue of 2018‒02‒26
eighteen papers chosen by |
| By: | Bayrak, Oben K. (CERE - the Center for Environmental and Resource Economics); Hey, John D. (CERE - the Center for Environmental and Resource Economics) |
| Abstract: | When people take decisions under risk, it is not only the expected utility that is important, but also the shape of the distribution of returns: clearly the dispersion is important, but also the skewness. For given mean and dispersion, decision‐makers treat positively and negatively skewed prospects differently. This paper presents a new behaviourally‐inspired model for decision making under risk, incorporating both dispersion and skewness. We run a horse‐race of this new model against seven other models of decision‐making under risk, and show that it outperforms many in terms of goodness of fit and, perhaps more importantly, predictive ability. It can incorporate the prominent anomalies of standard theory such as the Allais paradox, the valuation gap, and preference reversals. |
| Keywords: | Decision under Risk; Anomalies; Valuation Gap; Preference Reversals; Allais Paradox; Skewness; Dispersion; Preference Functionals; Experiments; Pairwise Choice; Expected Utility; Non‐Expected Utility; Stochastic Specifications |
| JEL: | D81 |
| Date: | 2018–01–15 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:slucer:2018_001&r=upt |
| By: | John Wooders; Matt Van Essen (Department of Economics, Finance, and Legal Studies, University of Alabama) |
| Abstract: | We study the problem of allocating goods (or rights) and chores when participants have equal claim on a unit of the good or equal obligation to undertake a chore. We propose two dynamic auctions for solving problems of this type: a "goods" auction and a "chore" auction, which are duals of one another. Either auction can be used for allocating goods or chores by suitably deÖning a good or a chore. The auctions are efficient and payoff equivalent. We provide necessary and sufficient conditions for equilibrium for general utility functions for both auctions, and provide closed-form solutions when bidders are risk neutral and when they are CARA risk averse. The auctions have the same limit equilibrium bid function as bidders become infinitely risk averse. We show that the limit bid function is also the unique maxmin perfect strategy for both auctions. |
| Date: | 2018–01 |
| URL: | http://d.repec.org/n?u=RePEc:nad:wpaper:20180013&r=upt |
| By: | Nicole El Karoui (LPMA; UMR CNRS 6632; Université Pierre et Marie Curie); Caroline Hillairet (LAGA; UMR CNRS 7539; Université Paris 13); Mohamed Mrad |
| Abstract: | This paper provides an extension of the notion of consistent progressive utilities U to consistent progressive utilities of investment and consumption (U,V). It discusses the notion of market consistency in this forward framework, compared to the classic backward setting with a given terminal utility, and whose value function is an example of such consistent forward utility. To ensure the consistency with the market model or a given set of test processes, we establish a stochastic partial differential equation (SPDE) of Hamilton-Jacobi-Bellman (HJB)-type that U has to satisfy. This SPDE highlights the link between the utility of wealth U and the utility of consumption V, and between the drift and the volatility characteristics of the utility U. By associating with the HJB-SPDE two SDEs, we discuss the existence and the uniqueness of a concave solution. Finally, we provide explicit regularity conditions and characterize the consistent pairs of consistent utilities of investment and consumption. Some examples, such as power utilities, illustrate the theory. ;Classification-JEL: 60H15, 91B16, 91B70, 91G10 |
| Keywords: | Market-consistent progressive utility of investment and consumption, Forward/backward stochastic partial differential equation (SPDE) |
| Date: | 2017–01–26 |
| URL: | http://d.repec.org/n?u=RePEc:crs:wpaper:2017-74&r=upt |
| By: | Feucht, Yvonne; Zander, Katrin |
| Abstract: | The purchase of products labelled with Carbon footprints is one option for consumers to act climate-friendly and consumers frequently state that they are interested in this kind of labels. But even though various carbon footprint labelling schemes exist throughout Europe, their market relevance is low. In this context, the present research investigates preferences for climate-friendly food and identifies barriers for climate friendly food choices in the European market. Using a mixed methods approach combining an online survey (choice experiments and a questionnaire) with qualitative face-to-face interviews, the preferences and willingness to pay for different carbon labels and a climate-friendly claim were explored in six European countries. While the online survey mainly aimed at eliciting consumer preferences for different ways of communicating climate-friendliness, the face-to-face interviews which were based on the results of the online survey, deepened and broadened the quantitative results. Thereby, consumers' perceptions of climate-friendly food and their information needs with respect to climate-friendly food are elicited. Our results show that the presence of a carbon label on a product increases the purchase probability and that consumers are willing to pay a (small) price premium for a carbon label in all countries under investigation (France, Germany, Italy, Norway, Spain, Germany, UK). However, the contribution of a carbon label to a more climate-friendly consumption will be limited. Main reasons are the lack of knowledge of climate friendly actions, reluctance to change consumption habits (e.g. meat and dairy consumption), time preference and uncertainty regarding the relevance of climate change. Consumers appear to be frequently overstrained with respect to climate-friendly buying decisions. Policy makers and retailers are challenged to set appropriate structures to support climate-friendly consumption. |
| Keywords: | carbon footprint labelling,consumer research,climate change,climate-friendly food,mixed methods,choice experiments,CO2-Labels,Verbraucherforschung,Klimawandel,Klimafreundliche Lebensmittel,Mixed methods,Kaufexperimente |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:jhtiwp:78&r=upt |
| By: | Udo Broll; Soumyatanu Mukherjee |
| Abstract: | This paper extends the decision problem of a multinational regarding how much to invest abroad optimally under uncertainties stemmed from the exchange rate movements, with the presence of a correlated background risk, in a two moment decision model. This framework is based upon the utility from the expected value and the standard deviation of the uncertain random total profit of the multinational firm. This modelling approach allows us to explore not only how much a risk averse investor optimally invests abroad when facing uncertainties regarding the exchange rate movements; but also to discover how does (and under what conditions) any perturbation in the background risk (which is linearly related to the endogenous exchange rate risks) affect the optimal foreign investment decision for a risk averse investor. All comparative static effects are described in terms of the relative sensitivity of the investor towards risk. This simplest possible analytical framework is useful for explicit empirical estimation of risk aversion elasticities in the literature of multinational firm and FDI decision. |
| Keywords: | Multinational firm; Exchange rate risk; Two moment decision model; Background risk; Risk aversion elasticity. |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:not:notgep:18/02&r=upt |
| By: | Antonio Cabrales (University College London); Olivier Gossner (CREST; Ecole Polytechnique; London School of Economics); Roberto Serrano (Brown University) |
| Abstract: | Consider agents who are heterogeneous in their preferences and wealth levels. These agents may acquire information prior to choosing an investment that has a property of no-arbitrage, and each piece of information bears a corresponding cost. We associate a numeric index to each information purchase (information-cost pair). This index describes the normalized value of the information purchase: it is the risk-aversion level of the unique CARA agent who is indifferent between accepting and rejecting the purchase, and it is characterized by a“duality” principle that states that agents with a stronger preference for information should engage more often in information purchases. No agent more risk-averse than the index finds it profitable to acquire the information, whereas all agents less risk-averse than the index do. Given an empirically measured range of degrees of risk aversion in a competitive economy with no-arbitrage investments, our model therefore comes close to describing an inverse demand for information, by predicting what pieces of information are acquired by agents and which ones are not. Among several desirable properties, the normalized-value formula induces a complete ranking of information structures that extends Blackwell’s classic ordering. |
| Keywords: | Informativeness; Information purchases; Kullback–Leibler divergence; Relative entropy; No-arbitrageinvestment; Blackwell ordering |
| JEL: | C00 C43 D00 D80 D81 G11 |
| Date: | 2017–01–05 |
| URL: | http://d.repec.org/n?u=RePEc:crs:wpaper:2017-51&r=upt |
| By: | Galvis Ciro, Juan Camilo; Henao Atehortúa, Edison Fred |
| Abstract: | This document is about the theoretical foundations of neoclassical consumer theory. In the first part, the document makes a presentation of the Arrow-Debreu model and presents the problem of maximization of utility and minimization of expenditure from the real approach (set theory). In the second part, it analyzes the problem of integrability. Then, in the third part, it analyzes the classification of the goods by their elasticities. In the fourth and last part, we made empirical applications of consumer theory. |
| Keywords: | consumer theory, utility, expenditure, elasticities |
| JEL: | D11 D12 D5 |
| Date: | 2018–01–10 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:84507&r=upt |
| By: | Fally, Thibault |
| Abstract: | This paper examines demand systems where the demand for a good depends only on its own price, consumer income, and a single aggregator synthesizing information on all other prices. As indicated by Gorman (1972), symmetry of the Slutsky substitution terms implies that such demand can take only one of two simple forms. Conversely, here we show that only weak conditions ensure that such demand systems are integrable, i.e. can be derived from the maximization of a utility function. This paper further studies useful properties, special cases and applications of such demand systems. |
| Keywords: | integrability; Non-homothetic preferences.; Recoverability; Separable demand; Single aggregator |
| JEL: | D11 D40 L13 |
| Date: | 2018–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:12667&r=upt |
| By: | Perets, Gadi; Yashiv, Eran |
| Abstract: | In optimization problems in Economics there are explicit or implicit assumptions about the underlying structure. In particular, one typically assumes that optimal behavior will remain invariant, in a sense to be precisely defined. Inter alia, this relates to the rationale for empirical estimation of invariant structural models. This paper has three goals. First, to show how relevant restrictions pertaining to this invariance can be derived using the algebraic technique of Lie symmetries of differential equations. Importantly, the symmetries provide solutions of the optimization problems in question or generate rich information with respect to the properties of the solutions, when no closed-form solutions exist. Second, to provide an example of implementation of this algebra, using an issue of substance, thereby gaining insight on a key topic in utility theory and consumer-investor choice. Third, to outline topics that are at the research frontier, which would be amenable to such analysis, thereby providing a road map for a potentially important new literature. |
| Keywords: | consumption and portfolio choice; differential equations; economic optimization; Finance.; HARA utility; invariance; Lie symmetries; Macroeconomics; Structural Econometrics |
| Date: | 2018–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:12611&r=upt |
| By: | Manzini, Paola (University of Sussex); Mariotti, Marco (Queen Mary, University of London); Ülkü, Levent (ITAM, Mexico) |
| Abstract: | The Hicksian definition of complementarity and substitutability may not apply in contexts in which agents are not utility maximisers or where price or income variations, whether implicit or explicit, are not available. We look for tools to identify complementarity and substitutability satisfying the following criteria: they are behavioural (based only on observable choice data); model-free (valid whether the agent is rational or not); and they do not rely on price or income variation. We uncover a conflict between properties that it is arguably reasonable for a complementarity notion to possess. We discuss three different possible resolutions of the conflict. |
| Keywords: | complements and substitutes, correlation, stochastic choice |
| JEL: | D0 |
| Date: | 2018–01 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp11296&r=upt |
| By: | Pierre Alquier (CREST; ENSAE; Université Paris Saclay); Vincent Cottet (CREST; ENSAE; Université Paris Saclay); Guillaume Lecué (CREST; CNRS; Université Paris Saclay) |
| Abstract: | We obtain estimation error rates and sharp oracle inequalities for regularization procedures of the form [See the abstract on the paper for the formula] when ||.|| is any norm, F is a convex class of functions and l is a Lipschitz loss function satisfying a Bernstein condition over F. We explore both the bounded and subgaussian stochastic frameworks for the distribution of the f(Xi)'s, with no assumption on the distribution of the Yi's. The general results rely on two main objects: a complexity function, and a sparsity equation, that depend on the specific setting in hand (loss l and norm ||.||). As a proof of concept, we obtain minimax rates of convergence in the following problems: 1) matrix completion with any Lipschitz loss function, including the hinge and logistic loss for the so-called 1-bit matrix completion instance of the problem, and quantile losses for the general case, which enables to estimate any quantile on the entries of the matrix; 2) logistic LASSO and variants such as the logistic SLOPE; 3) kernel methods, where the loss is the hinge loss, and the regularization function is the RKHS norm. |
| Date: | 2017–02–01 |
| URL: | http://d.repec.org/n?u=RePEc:crs:wpaper:2017-30&r=upt |
| By: | Gustav Kjellsson (University of Gothenburg); Dennis Petrie (Monash University); Tom (T.G.M.) van Ourti (Erasmus University Rotterdam; Tinbergen Institute, The Netherlands) |
| Abstract: | The measurement of health disparities is a key component for the assessment of health systems. One aspect of these disparities – which hitherto has received limited attention – is the risk people face about their future health. This paper integrates risk into the standard inequality measurement which measures the extent to which disparities in realized health are systematically associated with income. It develops a rank dependent inequality index that considers not only inequalities in expected future health but also the dispersion of individuals’ future health prospects. It is useful when a social planner wants to account for risk averse preferences in the assessment of income-related health inequalities. The empirical application using Australian longitudinal data highlights that neglecting risk underestimates income-related health inequalities since the poor were not only expected to be in worse health in the future, but also faced greater dispersion in their future health prospects compared to the rich. |
| Keywords: | health inequality; risk; concentration index |
| JEL: | D63 I10 |
| Date: | 2018–01–26 |
| URL: | http://d.repec.org/n?u=RePEc:tin:wpaper:20180007&r=upt |
| By: | Peters, Hans (QE / Mathematical economics and game the); Roy, Souvik (eru; economic research unit, indian statistical institute; isi); Sadhukhan, Soumyarup (eru; economic research unit, indian statistical institute; isi) |
| Abstract: | Finitely many agents have single-peaked preferences on a finite set of alternatives structured as a tree. Under a richness condition on the domain we characterize all unanimous and strategy-proof random social choice functions. These functions are uniquely determined by the values they assign to preference profiles where all peaks are on leafs of the tree. |
| Keywords: | random social choice function, single-peaked domain, trees, strategy-proofness |
| JEL: | D71 |
| Date: | 2018–02–08 |
| URL: | http://d.repec.org/n?u=RePEc:unm:umagsb:2018004&r=upt |
| By: | Backes-Gellner, Uschi (University of Zurich); Herz, Holger (University of Zurich); Kosfeld, Michael (Goethe University Frankfurt); Oswald, Yvonne (University of Zurich) |
| Abstract: | Evidence suggests that acquiring human capital is related to better life outcomes, yet young peoples' decisions to invest in or stop acquiring human capital are still poorly understood. We investigate the role of time and reference-dependent preferences in such decisions. Using a data set that is unique in its combination of real-world observations on student outcomes and experimental data on economic preferences, we find that a low degree of long-run patience is a key determinant of dropping out of upper-secondary education. Further, for students who finish education we show that one month before termination of their program, present-biased students are less likely to have concrete continuation plans while loss averse students are more likely to have a definite job offer already. Our findings provide fresh evidence on students' decision-making about human capital acquisition and labor market transition with important implications for education and labor market policy. |
| Keywords: | economic preferences, education, dropout, human capital, job search |
| JEL: | D01 D03 D91 I21 J64 |
| Date: | 2018–01 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp11288&r=upt |
| By: | Antrobus, Emma (University of Queensland); Baranov, Victoria (University of Melbourne); Cobb-Clark, Deborah A. (University of Sydney); Mazerolle, Lorraine (University of Queensland); Tymula, Agnieszka (University of Sydney) |
| Abstract: | We use an incentivized experiment to measure the risk and time preferences of truant adolescents and their parents. We find that adolescent preferences do not predict school attendance and that a unique police-school partnership program targeting school absences was most effective in reducing the truancy of adolescents with relatively risk-averse parents. |
| Keywords: | adolescent preferences, time preferences, risk preferences, RCT, truancy |
| JEL: | D81 J13 I29 |
| Date: | 2017–12 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp11236&r=upt |
| By: | Jonathan James (Department of Economics, California Polytechnic State University) |
| Abstract: | Mixed logit models with normally distributed random coefficients are typically estimated under the extreme assumptions that either the random coefficients are completely independent or fully correlated. A factor structured covariance provides a middle ground between these two assumptions. However, because these models are more difficult to estimate, they are not frequently used to model preference heterogeneity. This paper develops a simple expectation maximization algorithm for estimating mixed logit models when preferences are generated from a factor structured covariance. The algorithm is easy to implement for both exploratory and confirmatory factor models. The estimator is applied to stated-preference survey data from residential energy customers (Train, 2007). Comparing the fit across five different models, which differed in their assumptions on the covariance of preferences, the results show that all three factor specifications produced a better fit of the data than the fully correlated model measured by BIC and two out of three performed better in terms of AIC. |
| Keywords: | Discrete Choice, Mixed Logit, EM Algorithm, Factor Models |
| JEL: | C02 C13 C25 C35 C38 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:cpl:wpaper:1802&r=upt |
| By: | Arbex, Marcelo; Mattos, Enlinson |
| Abstract: | We study optimal human and health linear policies when there is a paternalistic motive to overcome present bias problems of agents with heterogeneous cognitive skills. The paternalistic intervention rewards individuals for physical capital accumulation and the combined e ect of health and human capital on future earnings. Our results highlight a novel e ect of paternalistic policies due to the interaction between present-biased preferences and cognitive skills. We illustrate numerically that this policy package is the most e ective and we analyze the relevance of agent's cognitive skills and present-biased preferences for the determination of rst-best and constrained rst-best optimal policies. |
| Date: | 2017–10 |
| URL: | http://d.repec.org/n?u=RePEc:fgv:eesptd:465&r=upt |
| By: | Bayrak, Oben K. (CERE - the Center for Environmental and Resource Economics) |
| Abstract: | The idea of preference imprecision challenges an underlying assumption in economics: individuals make choices between options confidently and they can articulate their subjective valuations for goods in terms of single precise amounts. In this paper, I review different strands of literature related to preference imprecision. Besides distilling conclusions from the existing literature, I also initiate a discussion on modelling the imprecision from a deterministic perspective by introducing two new frameworks. |
| Keywords: | preference imprecision; stochastic models; stochastic specifications; incommensurability; anomalies; valuation gap; preference imprecision; strength of preference; SoP; economic preferences; interval valuations |
| JEL: | D80 D81 |
| Date: | 2018–01–15 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:slucer:2018_002&r=upt |