nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2018‒04‒16
sixteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Multidimensional Risk Aversion: The Cardinal Sin By Louis Raymond Eeckhoudt; Elisa Pagani; Eugenio Peluso
  2. Risk averse policies foster bio-economic sustainability in mixed fisheries By Violaine Tarizzo; Eric Tromeur; Olivier Thébaud; Richard Little; Sarah Jennings; Luc Doyen
  3. Forbidden zones and biases for the expectation of a random variable. Version 2 By Harin, Alexander
  4. Indifference Pricing in Reinsurance Using Coherent Monetary Criteria By Nabil Kazi-Tani
  5. A not so myopic axiomatization of discounting By Jean-Pierre Drugeon; Thai Ha-Huy
  6. Early retirement decisions: Lessons from a dynamic structural modelling By Eric Delattre; Richard Moussa
  7. Intuitive Solutions in Game Representations: The Shapley Value Revisited By Pradeep Dubey
  8. Reducing Estimation Risk in Mean-Variance Portfolios with Machine Learning By Daniel Kinn
  9. Stock Market Returns and Consumption By Di Maggio, Marco; Kermani, Amir; Majlesi, Kaveh
  10. Climatic Roots of Loss Aversion By Oded Galor; Viacheslav Savitskiy
  11. Mathematics vs. Statistics in tackling Environmental Economics uncertainty By Halkos, George; Kitsos, Christos
  12. How laboratory experiments could help disentangle the influences of production risk and risk preferences on input decisions By Bougherara, Douadia; Nauges, Céline
  13. A Reconsideration of the Equity Premium Puzzle By Miguel Cantillo Simon
  14. Just-noticeable difference as a behavioural foundation of the critical cost-efficiency By Pawel Dziewulski
  15. Do farmers follow the herd? The influence of social norms in the participation to agri-environmental schemes By Philippe Le Coent; Raphaële Preget; Sophie Thoyer
  16. Inferring Cognitive Heterogeneity from Aggregate Choices By Valentino Dardanoni; Paola Manzini; Marco Mariotti; Christopher J. Tyson

  1. By: Louis Raymond Eeckhoudt (Department of Economics (University of Verona)); Elisa Pagani (Department of Economics (University of Verona)); Eugenio Peluso (Department of Economics (University of Verona))
    Abstract: Attitudes towards multidimensional risk depend both on the shape of the indifference map under certainty and on the degree of concavity of the utility function representing preferences under risk. A decomposition of the risk premium is built on the new notion of "compensated risk aversion". The balance between the two components is shown to depend on the association of the risks. This result is then used to disentangle risk attitudes from the strength of the preferences, in the "intrinsic risk aversion" setting (Bell and Raiffa 1979).
    Keywords: Multivariate Risk Aversion, Risk Premium, Intrinsic Risk aversion, Compensated Risk Aversion, Household Risk Aversion.
    JEL: D01 D11 D81
    Date: 2017–07
  2. By: Violaine Tarizzo; Eric Tromeur; Olivier Thébaud; Richard Little; Sarah Jennings; Luc Doyen
    Abstract: This paper examines the role of risk aversion on the sustainable management of multispecies fisheries with technical interactions. We consider a bio-economic dynamic model of multiple species harvested by a single fleet with uncertain costs of effort. We assume that the regulatory agency aims at reaching MMEY (Multispecies Maxi-mum Economic Yield) in an uncertain context by maximizing the expected utility of total profits, where utility is a quadratic function capturing risk aversion. We ana-lyze the impact of risk aversion on optimal fishing effort, profit, production, biodiver-sity and conservation. We show analytically that such a risk-averse MMEY promotes bio-economic sustainability as it mitigates the risk of biological and economic over-exploitation of the different species. Risk aversion also enhances biodiversity in the sense of evenness within the portfolio of the fishery. However, by reducing the effort, risk aversion lessens the expected profit and food production. Thus, a trade-off be-tween different bio-economic goals is exhibited through risk aversion. We illustrate the analytical findings with the case study of the Australian South East Fishery, where small risk aversion levels allow for high global bio-economic performances and balanced management objectives, therefore fostering sustainability.
    Keywords: Multispecies fishery, ecosystem-based fisheries management, maximum economic yield, uncertainty, risk aversion, overexploitation
    JEL: Q22 Q57
    Date: 2018
  3. By: Harin, Alexander
    Abstract: A forbidden zones theorem is proven in the present article. If some non-zero lower bound exists for the variance of a random variable, whose support is located 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 a theoretical support for the practical analysis of the influence of a noise that was performed for the purposes of behavioral economics, utility and prospect theories, decision and social sciences and psychology. The four main contributions of the present article are: the mathematical support, approach and model those are developed for this analysis and the successful uniform applications of the model in more than one domain. In particular, the approach supposes that subjects decide as if there were some biases of the expectations. Possible general consequences and applications of the theorem for a noise and biases of measurement data are preliminary considered.
    Keywords: probability; variance; noise; bias; utility theory; prospect theory; behavioral economics; decision sciences; measurement;
    JEL: C02 C1 D8 D81
    Date: 2018–03–30
  4. By: Nabil Kazi-Tani (SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon)
    Abstract: This paper focuses on a non-proportional reinsurance pricing problem, for a layer contract with reinstatements. After defining the indifference price with respect to both a concave utility function and a convex risk measure, we prove that is is contained in some interval whose bounds are easily calculable. We provide numerical examples computed from real insurance data.
    Keywords: Insurance premium calculation, Coherent risk measures, Concave monetary utility functions, Reinstatements, Reinsurance layers
    Date: 2018–03–25
  5. By: Jean-Pierre Drugeon (Paris School of Economics and Centre National de la Recherche Scientifique); Thai Ha-Huy (EPEE, Université d'Evry, Université Paris-Saclay)
    Abstract: This article builds an axiomatization of inter-temporal trade-o)s that makes an explicit account of the distant future and therefore encompasses motives related to sustainability, transmission to o)springs and altruism. The focus is on separable representations and the approach is completed following a decision-theory index based approach that is applied to utility streams. This enlightens the limits of the commonly used tail intensity requesites for the evaluation of utility streams: in this article, these are supersed and replaced by an axiomatic approach to optimal myopia degrees that in its turn precedes the determination of optimal discount. The overall approach is anchored in the new and explicit proof of a temporal decomposition of the preference orders between the distant future and the close future itself directly related to the determination of the optimal myopia degrees. The argument is shown to provide a novel understanding of temporal biases with the scope for a distant future bias when the finite dimensional gets influenced by the infinite dimensional. The reference to robust orders and pessimism-like axioms finally allows for determining tractable representations for the indexes.
    Keywords: Axiomatization, Myopia, Discount, Temporal Order Decompositions, Infinite Dimensional Topologies
    JEL: D11 D90
    Date: 2018
  6. By: Eric Delattre; Richard Moussa (Université de Cergy-Pontoise, THEMA)
    Abstract: Early retirement has many causes according to economic and sociological literature. These causes may be the preference for leisure, nancial and health conditions, and social environment. In our paper, we aim to specify and estimate an econometric model to assess the early retirement decision-making process for aged workers. We specify a worker's utility function from which we derive worker's probability to retire earlier that depends on her health stock, estate value and preference for future. We also estimate an health production and an health consumption functions that are key factors in the individual's decision to retire earlier. Thus, we show that our model disentangles between three groups of workers: (i) those who choose early retirement, (ii) those who will never choose early retirement and (iii) those who are uncertain about early retirement. We also show that our predicted early retirement probability is a good predictor of early retirement as it is causal for observed early retirement.
    Keywords: Early retirement, Grossmann Model, Space-state model, Causality
    JEL: C32 C51 I12 J26
    Date: 2018
  7. By: Pradeep Dubey (Stony Brook Center for Game Theory)
    Abstract: We show that any transferable utility game can be represented by an assignment of facilities to players, in which it is intuitively obvious how to allocate the total cost of the facilities. The intuitive solution in the representation turns out to be the Shapley value of the game, and thus serves as an alternative justification of the value.
    Keywords: TU game, Characteristic function, Shapley value, Assignment, Representation
    JEL: C71 C72 D61 D63 D70 D79
    Date: 2018–03
  8. By: Daniel Kinn
    Abstract: In portfolio analysis, the traditional approach of replacing population moments with sample counterparts may lead to suboptimal portfolio choices. In this paper I show that selecting asset positions to maximize expected quadratic utility is equivalent to a machine learning (ML) problem, where the asset weights are chosen to minimize out of sample mean squared error. It follows that ML specifically targets estimation risk when choosing the asset weights, and that "off-the-shelf" ML algorithms obtain optimal portfolios taking parameter uncertainty into account. Linear regression is a special case of the proposed ML framework, equivalent to the traditional approach. Standard results from the machine learning literature may be used to derive conditions for when ML algorithms improve upon linear regression. Based on simulation studies and several datasets, I find that ML significantly reduce estimation risk compared to the traditional approach and several shrinkage approaches proposed in the literature.
    Date: 2018–04
  9. By: Di Maggio, Marco (Harvard Business School); Kermani, Amir (University of California, Berkeley); Majlesi, Kaveh (Lund University)
    Abstract: This paper employs Swedish data on households' stock holdings to investigate how consumption responds to changes in stock market returns. We instrument the actual capital gains and dividend payments with past portfolio weights. Unrealized capital gains lead to a marginal propensity to consume (MPC) of 13 percent for the bottom 50% of the wealth distribution, but a flat 5 percent for the rest of the distribution. Households' consumption is significantly more responsive to dividend payouts across all parts of the wealth distribution. Our findings are consistent with households treating capital gains and dividends as separate sources of income.
    Keywords: capital gain, dividend income, consumption, near-rational behavior
    JEL: E21 G12
    Date: 2018–02
  10. 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 effects 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.
    Keywords: loss aversion, cultural evolution, evolution of preferences, natural selection, Malthusian epoch, growth, development
    JEL: D81 D91 Z10 O10 O40
    Date: 2017
  11. By: Halkos, George; Kitsos, Christos
    Abstract: In this paper the appropriate background in Mathematics and Statistics is considered in developing methods to investigate Risk Analysis problems associated with Environmental Economics uncertainty. New senses of uncertainty are introduced and a number of sources of uncertainty are discussed and presented. The causes of uncertainty are recognized helping to understand how they affect the adopted policies and how important their management is in any decision-making process. We show Mathematical Models formulate the problem and Statistical models offer possible solutions, restricting the underlying uncertainty, given the model and the error assumptions are correct. As uncertainty is always present we suggest ways on how to handle it.
    Keywords: Uncertainty; Environmental Economics; Mathematics; Statistics.
    JEL: C02 C60 Q00 Q50 Q58
    Date: 2018–03
  12. By: Bougherara, Douadia; Nauges, Céline
    Abstract: The purpose of this article is to further our understanding of input choices (such as pesticides or fertilisers) when producers face production risk that depends on a random shock and on the quantity of input used. Using laboratory experiments, we study the role of risk preferences and public policies (here, a lump-sum subsidy and insurance) on producers’ input decisions in two situations: i) a risk-decreasing input; and ii) a risk-increasing input. Our findings raise questions on the sensitivity of optimal input choices to risk preferences and the relevance of the expected utility model to describe farmers’ decisions.
    Keywords: laboratory experiment; input choice; production risk; risk preferences; subsidy; insurance
    Date: 2018–03
  13. By: Miguel Cantillo Simon (Universidad de Costa Rica)
    Abstract: This paper develops an equilibrium asset pricing framework that allows for investor aggregation, and assumes a log-normally distributed aggregate endowment growth. This framework allows me to derive the equilibrium risk free rate, the expected market return, and expected returns for individual securities. To test how reasonable the results are, I use data of several developed economies from Campbell (2003, 2017) to find a median value of relative risk aversion of 1.57, and a time preference rate of 4.58%. The framework allows me to estimate a version of the CAPM and a multi-period pricing model.
    Date: 2017–05
  14. By: Pawel Dziewulski
    Abstract: Abstract Critical cost-efficiency index (or CCEI), proposed in Afriat (1972, 1973) and Varian (1990), is the most commonly used measure of revealed preference violations. By representing consumer preference with interval orders, as in Fishburn (1970), we show that this index is equivalent to a particular notion of the just-noticeable difference, i.e., a measure of dissimilarity between alternatives that is sufficient for the agent to tell them apart. Therefore, CCEI can be interpreted as the consumer's cognitive inability to discriminate among options. This characterisation sheds new light on the existing empirical findings.
    Keywords: utility maximisation, generalised axiom of revealed preference, critical cost-efficiency index, interval order, just-noticeable difference
    JEL: C14 C60 C61 D11 D12
    Date: 2018–04–05
  15. By: Philippe Le Coent; Raphaële Preget; Sophie Thoyer
    Abstract: This article analyses the role played by social norms in farmers’ decisions to enroll into an agri-environmental scheme (AES). First, it develops a simple theoretical model highlighting the interplay of descriptive and injunctive norms in farmers’ utility functions. Second, an empirical valuation of the effect of social norms is provided based on the results of a stated preference survey conducted with 98 wine-growers in the South of France. Proxies are proposed to capture and measure the weight of social norms in farmers’ decision to sign an agri-environmental contract. Our empirical results indicate that the injunctive norm seems to play a stronger role than the descriptive norm.
    Date: 2018–01
  16. By: Valentino Dardanoni (Università degli Studi di Palermo, Italy); Paola Manzini (University of Sussex, Falmer, UK; IZA (Institute of Labor Economics), Bonn, Germany); Marco Mariotti (Queen Mary University of London, UK); Christopher J. Tyson (Queen Mary University of London, UK)
    Abstract: We study the problem of identifying the distribution of cognitive characteristics in a population of agents when only aggregate choice behavior from a single menu is observable. Focusing on two models of limited attention, we demonstrate that both “consideration probability” and “consideration capacity” distributions are substantially identified by aggregate choice shares when tastes are homogeneous. We then show how our methodology can be extended to allow for heterogeneous tastes, and suggest how the attention models can be embedded in an econometric specification of the inference problem. Finally, we conduct Monte Carlo simulations of both models and use our results to recover the true parameters.
    Keywords: attention, bounded rationality, consideration set, stochastic choice
    JEL: D01 D12 D91
    Date: 2018–04

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