nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2018‒05‒07
nineteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Loss Aversion and Residential Property Development Decisions in China: A Semi-Parametric Estimation By Helen Bao; Chunming Meng
  2. Subjective Contingencies and Limited Bayesian Updating By Minardi, Stefania; Savochkin, Andrei
  3. Toward a Systematic Approach to the Economic Effects of Risk: Characterizing Utility Functions" By Gollier, Christian; Kimball, Miles S.
  4. Optimal Investment and Derivative Demand Under Price Impact By Michail Anthropelos; Scott Robertson; Konstantinos Spiliopoulos
  5. Rational Heuristics ? Expectations and behaviors in Evolving Economies with Heterogeneous interacting agents By Giovanni Dosi; Mauro Napoletano; Andrea Roventini; Joseph Stiglitz; Tania Treibich
  6. Impulsive Behavior in Competition: Testing Theories of Overbidding in Rent-Seeking Contests By Roman Sheremeta
  7. A large-scale test of the effects of time discounting, risk aversion, loss aversion and present bias on household adoption of energy efficient technologies By Schleich, Joachim; Gassmann, Xavier; Meissner, Thomas; Faure, Corinne
  8. The risk and refugee migration By Géraldine Bocqueho; Marc Deschamps; Jenny Helstroffer; Julien Jacob; Majlinda Joxhe
  9. Optimal taxes on capital in the OLG model with uninsurable idiosyncratic income risk By Krueger, Dirk; Ludwig, Alexander
  10. Cognition, optimism and the formation of age-dependent survival beliefs By Grevenbrock, Nils; Groneck, Max; Ludwig, Alexander; Zimper, Alexander
  11. Bayesian Decision Theory and Stochastic Independence By Mongin, Philippe
  12. Decision Sciences, Economics, Finance, Business, Computing, and Big Data: Connections By Chang, C-L.; McAleer, M.J.; Wong, W.-K.
  13. Fairness concerns and risk aversion on recycle pricing strategies: Implications for environmentally friendly supply chains By He, Jianhong; Zhang, Lei; Lu, Binbin; Li, Lin
  14. Belief-dependent Preferences and Reputation: Experimental Analysis of a Repeated Trust Game By Giuseppe Attanasi; Pierpaolo Battigalli; Elena Manzoni; Rosemarie Nagel
  15. The Levered Equity Risk Premium and Credit Spreads: A Unified Framework By Bhamra, Harjoat Singh; Kuehn, Lars-Alexander; Strebulaev, Ilya
  16. Reference Dependence and Choice Overload By Deb, Joyee; Zhou, Jidong
  17. Embezzlement and Guilt Aversion By Giuseppe Attanasi; Claire Rimbaud; Marie Villeval
  18. Multiple Misbehaving:Loss Averse and Inattentive to Monetary Incentives By Engström, Per; Nordblom, Katarina; Stefansson, Arnaldur
  19. Full surplus extraction in mechanism design with information disclosure By Daniel Kraehmer;

  1. By: Helen Bao; Chunming Meng
    Abstract: Loss aversion is a core concept in prospect theory that refers to people’s asymmetric attitudes with respect to gains and losses. More specifically, losses loom larger than gains. With the capability of loss aversion to explain economic phenomena, some of which are puzzling under expected utility theory, this concept has received significant attention. This study develops a behavioral model of loss aversion to explain the development decisions by residential property developers in the People’s Republic of China. Under the leasehold property right system, real estate development has two stages—first to lease land from the government, and then to develop the property according to the lease terms. This presents a unique opportunity to test the presence and effect of loss aversion in real estate development decisions. More specifically, this study determines when the land premium paid by a developer is substantially higher than the market value, whether and how this "paper loss" will affect the pricing of the housing products and development time of the project in future development. We use a sample of land and house transaction records from Beijing to test the hypothesis. This is the first study to use a semi-parametric model in estimating developers’ loss aversion. Results show that developers are most prone to loss aversion bias around the reference point or when facing large losses. The results also suggest that loss aversion contributes to the cyclical trading pattern in housing markets.
    Keywords: Behavioural Economics; China; Housing; Loss aversion
    JEL: R3
    Date: 2017–07–01
  2. By: Minardi, Stefania; Savochkin, Andrei
    Abstract: We depart from Savage’s (1954) common state space assumption and introduce a model that allows for a subjective understanding of uncertainty. Within the revealed preference paradigm, we uniquely identify the agent’s subjective state space via her preferences conditional on incoming information. According to our representation, the agent’s subjective contingencies are coarser than the analyst’s states; she uses an additively separable utility with respect to her set of contingencies; and she adopts an updating rule that follows the Bayesian spirit but is limited by her perception of uncertainty. We illustrate our theory with an application to the Confirmatory Bias.
    Keywords: understanding of uncertainty; subjective state space; non-Bayesian updating
    JEL: D81
    Date: 2017–05–01
  3. By: Gollier, Christian; Kimball, Miles S.
    Abstract: The Diffidence Theorem, together with complementary tools, can aid in illuminating a broad set of questions about how to mathematically characterize the set of utility functions with specified economic properties. This paper establishes the technique and illustrates its application to many questions, old and new. For example, among many other older and other technically more difficult results, it is shown that (1) several implications of globally greater risk aversion depend on distinct mathematical properties when the initial wealth level is known, (2) whether opening up a new asset market increases or decreases saving depends on whether the reciprocal of marginal utility is concave or convex, and (3) whether opening up a new asset market raises or lowers risk aversion towards small independent risks depends on whether absolute risk aversion is convex or concave.
    Date: 2018–04
  4. By: Michail Anthropelos; Scott Robertson; Konstantinos Spiliopoulos
    Abstract: This paper studies the effects of price impact upon optimal investment, as well as the pricing of, and demand for, derivative contracts. Assuming market makers have exponential preferences, we show for general utility functions that a large investor's optimal investment problem with price impact can be re-expressed as a constrained optimization problem in fictitious market without price impact. While typically the (random) constraint set is neither closed nor convex, in several important cases of interest, the constraint is non-binding. In these instances, we explicitly identify optimal demands for derivative contracts, and state three notions of an arbitrage free price. Due to price impact, even if a price is not arbitrage free, the resulting arbitrage opportunity only exists for limited position sizes, and might be ignored because of hedging considerations. Lastly, in a segmented market where large investors interact with local market makers, we show equilibrium positions in derivative contracts are inversely proportional to the market makers' representative risk aversion. Thus, large positions endogenously arise either as market makers approach risk neutrality, or as the number of market makers becomes large.
    Date: 2018–04
  5. By: Giovanni Dosi (Laboratory of Economics and Management); Mauro Napoletano (Observatoire français des conjonctures économiques); Andrea Roventini (Laboratory of Economics and Management (LEM)); Joseph Stiglitz (Columbia Business School); Tania Treibich (Observatoire français des conjonctures économiques)
    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 G1 G21 O4
    Date: 2017–12
  6. By: Roman Sheremeta (Weatherhead School of Management, Case Western Reserve University and Economic Science Institute, Chapman University)
    Abstract: Contests are commonly used in the workplace to motivate workers, determine promotion, and assign bonuses. Although contests can be very effective at eliciting high effort, they can also lead to inefficient effort expenditure (overbidding). Researchers have proposed various theories to explain overbidding in contents, including mistakes, systematic biases, the utility of winning, and relative payoff maximization. Using an eight-part experiment, we test and find significant support for the existing theories. Also, we discover some new explanations based on cognitive ability and impulsive behavior. Out of all explanations examined, we find that impulsivity is the most important factor explaining overbidding in contests.
    Keywords: contest, overbidding, impulsive behavior, experiments
    JEL: C72 C91 D01 D72
    Date: 2018
  7. By: Schleich, Joachim; Gassmann, Xavier; Meissner, Thomas; Faure, Corinne
    Abstract: This paper empirically and jointly analyses the relations between risk aversion, standard time discounting, present bias, and loss aversion and household stated adoption of low to high stake energy efficiency technologies (EETs) (light emitting diodes (LEDs), energy efficient appliances, and retrofit measures). The analysis relies on a large representative sample drawn from eight European Union countries. Preferences over time, risk and losses were elicited and jointly estimated from participant choices in incentivized, context-free multiple price list experiments. The findings from econometrically estimating EET adoption equations suggest that present-biased individuals are less likely to adopt EETs. They also provide (weak) evidence that individuals which are more risk-averse, or more loss-averse, or which exhibit a lower discount factor are less likely to adopt EETs. Finally, omitting one or several of the time and risk or loss-aversion parameters when estimating the EET adoption equations did not appear to cause omitted variable bias.
    Keywords: risk aversion,time discounting,present bias,loss aversion,energy efficiency,adoption
    JEL: D23 D81 Q41 Q48
    Date: 2018
  8. By: Géraldine Bocqueho (Université de Lorraine (UL)); Marc Deschamps (Université de Bourgogne); Jenny Helstroffer (Université de Lorraine (UL)); Julien Jacob (Université de Lorraine (UL)); Majlinda Joxhe (Université du Luxembourg (
    Abstract: This paper uses the experimental setup of Tanaka et al. (2010) to measure refugees’ risk preferences. A sample of 206 asylum seekers was interviewed in 2017-18 in Luxembourg. Contrary to studies which focus on risk aversion in general, we analyze its components using a cumulative prospect theory (CPT) frame-work. We show that refugees exhibit particularly low levels of risk aversion compared to other populations and that CPT provides a better fit for modelling risk attitudes. Moreover, we include randomised temporary treatments provoking emotions and find a small significant impact on probability distortion. Robustness of the Tanaka et al. (2010) experimental framework is confirmed by including treatments regarding the embedding effect. Finally, we propose a theoretical model of refugee migration that integrates the insights from our experimental outcomes regarding the functional form of refugees’ decision under risk and the estimated parameter values. The model is then simulated using the data from our study
    Keywords: Refugee migration; Risk preferences; Experimental economics; Cumulative prospect theory; Psychological priming
    JEL: C93 D74 D81 D91 F22
    Date: 2018–03
  9. By: Krueger, Dirk; Ludwig, Alexander
    Abstract: We characterize the optimal linear tax on capital in an Overlapping Generations model with two period lived households facing uninsurable idiosyncratic labor income risk. The Ramsey government internalizes the general equilibrium feedback of private precautionary saving. For logarithmic utility our full analytical solution of the Ramsey problem shows that the optimal aggregate saving rate is independent of income risk. The optimal time-invariant tax on capital is increasing in income risk. Its sign depends on the extent of risk and on the Pareto weight of future generations. If the Ramsey tax rate that maximizes steady state utility is positive, then implementing this tax rate permanently generates a Pareto-improving transition even if the initial equilibrium is dynamically efficient. We generalize our results to Epstein-Zin-Weil utility and show that the optimal steady state saving rate is increasing in income risk if and only if the intertemporal elasticity of substitution is smaller than 1.
    Keywords: Idiosyncratic Risk,Taxation of Capital,Overlapping Generations,Precautionary Saving,Pecuniary Externality
    JEL: H21 H31 E21
    Date: 2018
  10. By: Grevenbrock, Nils; Groneck, Max; Ludwig, Alexander; Zimper, Alexander
    Abstract: This paper investigates the roles psychological biases play in empirically estimated deviations between subjective survival beliefs (SSBs) and objective survival probabilities (OSPs). We model deviations between SSBs and OSPs through age-dependent inverse S-shaped probability weighting functions (PWFs), as documented in experimental prospect theory. Our estimates suggest that the implied measures for cognitive weakness, likelihood insensitivity, and those for motivational biases, relative pessimism, increase with age. We document that direct measures of cognitive weakness and motivational attitudes share these trends. Our regression analyses confirm that these factors play strong quantitative roles in the formation of subjective survival beliefs. In particular, cognitive weakness is an increasingly important contributor to the overestimation of survival chances in old age.
    Keywords: Subjective Survival Beliefs,Probability Weighting Function,Confirmatory Bias,Cognition,Optimism
    JEL: D12 D83 I10
    Date: 2018
  11. By: Mongin, Philippe
    Abstract: Stochastic independence has a complex status in probability theory. It is not part of the definition of a probability measure, but it is nonetheless an essential property for the mathematical development of this theory. Bayesian decision theorists such as Savage can be criticized for being silent about stochastic independence. From their current preference axioms, they can derive no more than the definitional properties of a probability measure. In a new framework of twofold uncertainty, we introduce preference axioms that entail not only these definitional properties, but also the stochastic independence of the two sources of uncertainty. This goes some way towards filling a curious lacuna in Bayesian decision theory.
    Keywords: Stochastic Independence; Probabilistic Independence; Bayesian Decision Theory; Savage
    JEL: D81 D89
    Date: 2017–11–01
  12. By: Chang, C-L.; McAleer, M.J.; Wong, W.-K.
    Abstract: This paper provides a review of some connecting literature in Decision Sciences, Economics, Finance, Business, Computing, and Big Data. We then discuss some research that is related to the six cognate disciplines. Academics could develop theoretical models and subsequent econometric and statistical models to estimate the parameters in the associated models. Moreover, they could then conduct simulations to examine whether the estimators or statistics in the new theories on estimation and hypothesis have small size and high power. Thereafter, academics and practitioners could then apply their theories to analyze interesting problems and issues in the six disciplines and other cognate areas.
    Keywords: Decision sciences, economics, finance, business, computing, and big data, theoretical models, econometric and statistical models, applications
    JEL: A10 G00 G31 O32
    Date: 2018–03–01
  13. By: He, Jianhong; Zhang, Lei; Lu, Binbin; Li, Lin
    Abstract: This paper studies the pricing strategy in the closed-loop supply chain with Nash bargaining when considering fairness concerns and risk aversion. Mainly, the authors argue that behavioral factors (i.e., fairness concern and risk aversion) should be introduced into pricing process. They consider three different pricing models: the first is that both manufacturer and retailer have fairness concern; the second is both manufacturer and retailer have risk aversion and the final is manufacturer has risk aversion but retailer has both risk aversion and fair concern. Then the authors analyze the model with game theory. The results showthat fairness and risk aversion change the optimal pricing strategy, which affects the expected profits of retailers and manufacturers. The impact of the two (relatively irrational) behavioral factors on wholesale price and retail price of new products, as well as the recycle price and recycle transfer price of the waste products are not the same. For new products, wholesale price is the most affected by the behavioral factors, and the sales price as the second. For the waste recycling products, the transfer price is the most affected by the behavioral factors, and recycle price as the second. When facing the fairness and risk aversion retailer, retailers' fairness concern is good for both manufacturers and retailers. This innovative model for pricing strategy adds implications for sustainability in supply chain operations.
    Keywords: closed-loop supply chain,irrational behavior education,fairness concerns,risk aversion,pricing strategy
    JEL: D4 L11
    Date: 2018
  14. By: Giuseppe Attanasi; Pierpaolo Battigalli; Elena Manzoni; Rosemarie Nagel
    Abstract: We study in a theoretical and experimental setting the interaction between belief-dependent preferences and reputation building in a nitely repeated trust game. We focus mainly on the effect of guilt aversion. In a simple two-types model, we analyze the effect of reputation building in presence of guilt-averse players and derive behavioral predictions. In the experiment, we elicit information on trustees belief-dependent preferences and disclose it to the paired trustor before the repeated game. Our ex- perimental results show that disclosing information on the trustees belief-dependent preferences and thus letting players play the repeated trust game in presence of almost complete information leads to higher trust and cooperation than in the corresponding incomplete information game setting. In particular, disclosure of information on preferences of guilt-averse trustees also enhances the trustorscooperation. Disclosure of information on belief-dependent preferences of reciprocity-concerned trustees, instead, does not lead to higher trust and cooperation. We show that this is theoretically consistent with subjects featuring low reciprocity concerns. JEL classifi cation: C72; C73; C91. Keywords: Repeated psychological game; reputation; guilt; reciprocity; almost complete information.
    Date: 2018
  15. By: Bhamra, Harjoat Singh; Kuehn, Lars-Alexander; Strebulaev, Ilya
    Abstract: We embed a structural model of credit risk inside a dynamic continuous-time consumption-based asset pricing model, which allows us to price equity and corporate debt in a unified framework. Our key economic assumptions are that the first and second moments of earnings and consumption growth depend on the state of the economy which switches randomly, creating intertemporal risk, which agents prefer to resolve sooner rather than later, because they have Epstein-Zin-Weil preferences. Agents optimally choose dynamic capital structure and default times. For a dynamic cross-section of firms, our model endogenously generates a realistic average term structure and time series of actual default probabilities and credit spreads, together with a reasonable levered equity risk premium, which varies with macroeconomic conditions.
    Keywords: Capital Structure; corporate bond credit spread; default; Equity premium; jumps; macroeconomic conditions; predictability
    JEL: E44 G12 G32 G33
    Date: 2018–03
  16. By: Deb, Joyee; Zhou, Jidong
    Abstract: This paper offers an explanation for choice overload based on reference-dependent preferences. Consumers construct an ideal object that combines the best attributes of all objects in their choice set, and use this as a reference point. When the choice set expands, it is more likely to find a better object, but meanwhile the reference point improves, which makes all existing objects appear worse. We characterize when the latter reference-dependence effect dominates such that choice overload arises. We also show that purchase probability can decrease with object complexity, measured by the number of attributes.
    Keywords: choice overload, reference dependence, loss aversion
    JEL: D11 D9 M30
    Date: 2018
  17. By: Giuseppe Attanasi (Université de Lille, Sciences Humaines et Sociales); Claire Rimbaud (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - ENS Lyon - École normale supérieure - Lyon - UL2 - Université Lumière - Lyon 2 - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon - UJM - Université Jean Monnet [Saint-Étienne] - Université de Lyon - CNRS - Centre National de la Recherche Scientifique); Marie Villeval (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - ENS Lyon - École normale supérieure - Lyon - UL2 - Université Lumière - Lyon 2 - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon - UJM - Université Jean Monnet [Saint-Étienne] - Université de Lyon - CNRS - Centre National de la Recherche Scientifique)
    Abstract: Donors usually need intermediaries to transfer their donations to recipients. A risk is that donations can be embezzled before they reach the recipients. Using psychological game theory, we design a novel three-player Embezzlement Mini-Game to study whether intermediaries suffer from guilt aversion and whether guilt aversion toward the recipient is stronger than toward the donor. Testing the predictions of the model in a laboratory experiment, we show that the proportion of guilt-averse intermediaries is the same irrespective of the direction of the guilt. However, structural estimates indicate that the effect of guilt on behaviour is higher when the guilt is directed toward the recipient.
    Keywords: Embezzlement, Dishonesty, Guilt Aversion, Psychological Game Theory, Experiment
    Date: 2018–04–26
  18. By: Engström, Per (Department of Economics and UCFS, Uppsala University, Sweden); Nordblom, Katarina (Department of Economics, School of Business, Economics and Law, Göteborg University); Stefansson, Arnaldur (Department of Economics, UCFS and UCLS, Uppsala University, Sweden)
    Abstract: We study what determines taxpayers’ deduction behavior when filing tax returns. Pre-liminary deficits might be viewed as losses assuming zero preliminary balance as reference point. Swedish taxpayers may escape these losses by claiming deductions after receiving information about the preliminary balance. Furthermore, the Swedish income tax system has a substantial kink (20 percentage points) where the central government tax applies. Taxpayers slightly above the governmental tax kink have substantially higher (standard economic) incentives to claim deductions than taxpayers slightly below the kink. Using a regression kink and discontinuity approach with individual fixed effects, we study a panel of 4.1 million Swedish taxpayers in 1999 to 2006. We find strong causal effects of preliminary deficits on the probability of claiming deductions. The initial em-pirical evidence for a kink in deduction probability at the central government threshold, anticipated by standard economic theory, is weaker but significant. However, a more detailed analysis reveals that the kink at the tax threshold is not likely due to the tax incentives per se. When controlling for the preliminary tax deficit, the kink at the tax threshold disappears. Taxpayers just above the tax kink are namely more likely to run a preliminary tax deficit than those just below it. Hence, the most plausible explanation also for the kink at the tax threshold is therefore loss aversion and not standard economic incentives. The Swedish taxpayers are thus “misbehaving”, in a Thaler (2015) sense, on two separate margins: they are highly loss averse but surprisingly inattentive to standard monetary incentives.
    Keywords: tax compliance; loss aversion; prospect theory; quasi-experiment; regression kink; regression discontinuity
    JEL: C21 D91 H24 H26
    Date: 2018–04
  19. By: Daniel Kraehmer;
    Abstract: I study mechanism design settings with quasi-linear utility where the principal can provide agents with additional private information about their valuations beyond the private information they hold at the outset. I demonstrate that the principal can design information and a mechanism so as to fully extract the complete information first-best surplus if agents’ ex ante information only affects their beliefs about, yet not their valuations. Otherwise, the result holds if each agent’s initial private beliefs satisfy a spanning condition.
    Keywords: information design, mechanism design, quasi-linear utility, rent extraction
    JEL: D82 H57
    Date: 2018–04

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