nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2018‒05‒28
sixteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. The Welfare Implications of Unobserved Heterogeneity By Sarantis Tsiaplias
  2. Are women more risk averse than men:? Evidence from a residential real estate bubble By Paul Ryan; Clare Branigan
  3. What is the Normative Basis for Selecting the Measure of 'Average' Preferences for Use in Social Choices? By Devlin, N.; Shah, K.K; Buckingham, K.
  4. Why Has Idiosyncratic Risk Been Historically Low in Recent Years? By Bartram, Sohnke M.; Brown, Gregory W.; Stulz, Rene M.
  5. The non-linear nature of country risk and its implications for DSGE models By Michal Brzoza-Brzezina; Jacek Kotlowski
  6. Age and Utilities: Issues for HTA By Cubi-Molla, P.; Shah, K.K; Garside, J.; Herdman, M.; Devlin, N.
  7. A New Valuation Method: Directly Eliciting Personal Utility Functions By Devlin, N.; Shah, K.; Mulhern, B.; Pantiri, K.; van Hout, B.
  8. Construction of Forward Performance Processes in Stochastic Factor Models and an Extension of Widder's Theorem By Levon Avanesyan; Mykhaylo Shkolnikov; Ronnie Sircar
  9. Elusive Beliefs: Why Uncertainty Leads to Stochastic Choice and Errors By Irenaeus Wolff; Dominik Bauer
  10. Is fairness intuitive? An experiment accounting for subjective utility differences under time pressure By Merkel, Anna; Lohse, Johannes
  11. Housing Price Network Effects from Public Transit Investment: Evidence from Vancouver By Alex Chernoff; Andrea Craig
  12. Monotonicity and weighted prenucleoli: A characterization without consistency By Calleja, Pedro; Llerena, Francesc; Sudhölter, Peter
  14. Sufficient Statistics for Unobserved Heterogeneity in Structural Dynamic Logit Models By Aguirregabiria, Victor; Gu, Jiaying; Luo, Yao
  15. Does the framing of patient cost-sharing incentives matter? The effects of deductibles vs. no-claim refunds By Hayen, Arthur; Klein, Tobias; Salm, Martin
  16. Unobserved Heterogeneity in Auctions under Restricted Stochastic Dominance By Yao Luo

  1. By: Sarantis Tsiaplias (Melbourne Institute: Applied Economic & Social Research and Department of Economics, The University of Melbourne)
    Abstract: Conditions are derived for relating household well-being functions to household utility. In particular, an isomorphic relationship between the equivalent incomes stemming from subsistence-based utility functions and well-being functions is established. This allows estimates from standard models of well-being based on a CDF (eg. probit and logit models) to be given a formal welfare interpretation. New measures of the welfare distortion due to unobserved heterogeneity are also derived. An Australian household-level dataset is used as a case study for exploring the proposed measures of distortion. The results indicate that the failure to account for unobserved heterogeneity produces significant welfare distortions (primarily in the form of under-compensation). A unique welfare sensitivity curve is also estimated that indicates the presence of non-linearities that impair the typically monotonic relationship between household income, the household’s capacity to adjust its income and its marginal utility of consumption. The results are significant for better understanding the welfare implications of tax and transfer policies.
    Keywords: Household expenditure, social welfare, consumption, heterogeneity, equivalence scales, income
    JEL: D12 D10 C33 C35 D60
    Date: 2017–09
  2. By: Paul Ryan; Clare Branigan
    Abstract: A substantial literature in economics and finance has found that women tend to be more risk averse than men. In addition, compared to their male counterparts they tend to shy away from competitive situations. However, there are no extant studies exploring the relative degree of risk aversion and competitive behaviour of men vs. women in a bubble market context. Bubble markets provide a rich context to explore the potential impact of behavioural biases and emotions in investors’ decision making processes (e.g. Shiller, 2000, 2008, 2014; Kindleberger and Aliber, 2011). Drawing on auction data from the Irish residential real estate market, in the middle of a real estate bubble, we find that female winning bidders are no less risk averse or less likely to shy away from competition than their male counterparts. Our results have implications for how gender impacts on decision making in highly charged emotional contexts.
    Keywords: bubble market; Competition; Gender; risk aversion
    JEL: R3
    Date: 2017–07–01
  3. By: Devlin, N.; Shah, K.K; Buckingham, K.
    Abstract: The aim of this paper is to consider what normative arguments might exist for advocating the use of any given measure of the average in the context of health state values. We begin by providing examples of the importance and implications of the choice of the measure of central tendency in stated preference studies (including both EQ-5D values and corresponding issues in the willingness to pay literature). Then, drawing on the theory of social choice, voting models and welfare economics, we consider the criteria that are available for judging the 'goodness' of alternative approaches to aggregation, and evaluate their relevance to the selection of the measure of average EQ-5D values.
    Keywords: Health Statistics and Data Analyses
    JEL: I1
    Date: 2017–02–01
  4. By: Bartram, Sohnke M. (University of Warwick); Brown, Gregory W. (University of North Carolina); Stulz, Rene M. (Ohio State University)
    Abstract: Since 1965, average idiosyncratic risk (IR) has never been lower than in recent years. In contrast to the high IR in the late 1990s that has drawn considerable attention in the literature, average market-model IR is 44% lower in 2013-2017 than in 1996-2000. Macroeconomic variables help explain why IR is lower, but using only macroeconomic variables leads to large prediction errors compared to using only firm-level variables. As a result of the dramatic change in the number and composition of listed firms since the late 1990s, listed firms are larger and older. Larger and older firms have lower idiosyncratic risk. Models that use firm characteristics to predict firm-level idiosyncratic risk estimated over 1963-2012 can largely or completely explain why IR is low over 2013-2017. The same changes that bring about historically low IR lead to unusually high market-model R-squareds.
    JEL: G10 G11 G12
    Date: 2018–01
  5. By: Michal Brzoza-Brzezina; Jacek Kotlowski
    Abstract: Country risk premia can substantially affect macroeconomic dynamics. We concentrate on one of their most important determinants - a country’s net foreign asset position and - in contrast to the existing research - investigate its nonlinear link to risk premia. The importance of this particular non-linearity is twofold. First, it allows to identify the NFA level above which the elasticity becomes much (possibly dangerously) higher. Second, such a non-linear relationship is a standard ingredient of DSGE models, but its proper calibration/ estimation is missing. Our estimation shows that indeed the link is highly nonlinear and helps to identify the NFA position where the non-linearity kicks in at approximately -70% to -75% of GDP. We also provide a proper calibration of the risk premium - NFA relationship which can be used in DSGE models and demonstrate that its slope matters significantly for economic dynamics in such a model.
    Keywords: Risk premium, PSTR model, open economy DSGE model
    JEL: C23 E43 E44
    Date: 2018–05
  6. By: Cubi-Molla, P.; Shah, K.K; Garside, J.; Herdman, M.; Devlin, N.
    Abstract: Several studies have found differences in health state values by age. We investigate whether and how age affects respondents' Time Trade-Off (TTO) and Visual Analogue Scale (VAS) valuations of hypothetical EQ-5D health states using data from the 1993 MVH UK valuation study. The authors identify the existence of an inverse U-shaped age-utility pattern, with respondents in their forties tending to provide the highest values for the majority of the health states analysed. The TTO values obtained from the oldest respondents are systematically (and significantly, for the majority of profiles) lower than those obtained from younger age groups. Our study also finds that significant differences in values amongst age groups seem to be associated with profiles with level 3 in the mobility dimension or level 2 or 3 in the self-care dimension. VAS valuations appear to be less affected by age than TTO valuations. The authors conclude the paper with a thought-provoking debateby assessing the arguments for and against about a case for using age-specific utilities in HTA. Compared to previous research, this study analyses differences in utilities amongst a greater number of age-defined subgroups and at the individual health state level. It also examines how the findings relate to the various arguments for and against using age-specific utilities in HTA.
    Keywords: Economics of Health Technology Assessment; Health Statistics and Data Analyses
    JEL: I1
    Date: 2017–04–01
  7. By: Devlin, N.; Shah, K.; Mulhern, B.; Pantiri, K.; van Hout, B.
    Abstract: Standard methods for eliciting the preference data upon which value sets are based (e.g. time trade-off, standard gamble) generally have in common an aim to 'uncover' the preferences of survey respondents by asking them to evaluate a sub-set of health states. The responses are then used to infer their preferences over all possible dimensions and levels. An alternative approach is to ask respondents directly about the relative importance to them of the dimensions, levels and interactions between them This OHE Research Paper describes a new stated preference approach for directly eliciting personal utility functions (PUFs) from members of the general public. The approach focuses on helping respondents to reflect and deliberate on their preferences. A computer-based tool was developed and used to administer the questions via face-to-face interviews. The Research Paper reports the methods and findings of piloting work to test the feasibility and acceptability of the PUF approach for valuing a simplified version of the EQ-5D-5L, a measure of patient-reported outcomes. The PUF approach appears to be feasible. The authors conclude that it has the potential to - (a) yield meaningful, well-informed preference data from respondents; and (b) provide individual preference data that can be aggregated to yield a social value set for the EQ-5D. The paper concludes by describing the research and testing needed to further refine some elements of the approach.
    JEL: I1
    Date: 2017–08–01
  8. By: Levon Avanesyan; Mykhaylo Shkolnikov; Ronnie Sircar
    Abstract: We consider the problem of optimal portfolio selection under forward investment performance criteria in an incomplete market. Given multiple traded assets, the prices of which depend on multiple observable stochastic factors, we construct a large class of forward performance processes with power-utility initial data, as well as the corresponding optimal portfolios. This is done by solving the associated non-linear parabolic partial differential equations (PDEs) posed in the "wrong" time direction, for stock-factor correlation matrices with eigenvalue equality (EVE) structure, which we introduce here. Along the way we establish on domains an explicit form of the generalized Widder's theorem of Nadtochiy and Tehranchi [NT15, Theorem 3.12] and rely hereby on the Laplace inversion in time of the solutions to suitable linear parabolic PDEs posed in the "right" time direction.
    Date: 2018–05
  9. By: Irenaeus Wolff; Dominik Bauer
    Abstract: People often cannot assign a clear probability to an event but face uncertainty about their subjective probabilities. We model belief uncertainty by assuming that agents’ beliefs are characterized by a distribution over subjective-probability distributions that agents cannot access directly. Our model produces stochastic choice because each decision-relevant belief is but one realization out of the distribution over all possible beliefs. Our model predicts that when comparing unknown situations to routine choices, people will make more ex-ante suboptimal choices in unknown situations. The model also offers an explanation for experiment participants not playing a best-response to their stated beliefs: participants are uncertain what belief to report or base their decision on, and hence, act on momentaneous ‘belief realizations’. In an experiment, we exogenously manipulate participants’ belief uncertainty. We find support for both predictions. Low belief uncertainty leads to fewer errors and thus, higher earnings, even when controlling for the accuracy of participants’ beliefs. Second, under low belief uncertainty, observed best response rates are high and increasing in the amount of information we provide. Conversely, high belief uncertainty leads to lower consistency.
    Keywords: Stochastic choice, Belief-Action Consistency, Belief Elicitation, Discoordination Game
    Date: 2018
  10. By: Merkel, Anna; Lohse, Johannes
    Abstract: Evidence from response time studies and time pressure experiments has led several authors to conclude that "fairness is intuitive". In light of conflicting findings we provide theoretical arguments showing under which conditions an increase in "fairness” due to time pressure indeed provides unambiguous evidence in favor of the "fairness is intuitive" hypothesis. Drawing on recent applications of the Drift Diffusion Model (Krajbich et al., 2015a), we demonstrate how the subjective diffculty of making a choice affects decisions under time pressure and time delay, there by making an unambiguous interpretation of time pressure effects contingent on the choice situation. To explore our theoretical considerations and to retest the "fairness is intuitive" hypothesis, we analyze choices in two-person binary dictator and prisoner’s dilemma games under time pressure or time delay. In addition, we manipulate the subjective difficulty of choosing the fair relative to the selfish option. Our main finding is that time pressure does not consistently promote fairness in situations where this would be predicted after accounting for choice difficulty. Hence, our results cast doubt on the hypothesis that "fairness is intuitive".
    Keywords: distributional preferences; cooperation; time pressure; response times; cognitive processes; drift diffusion models
    Date: 2018–05–16
  11. By: Alex Chernoff; Andrea Craig
    Abstract: In this paper, we estimate the effect on housing prices of the expansion of the Vancouver SkyTrain rapid transit network during the period 2001–11. We extend the canonical residential sorting equilibrium framework to include commuting time in the household utility function. We estimate household preferences in the sorting model using confidential micro data and geographic information systems (GIS) data on the SkyTrain network. Using these preference estimates and observed data for 2001, we simulate the equilibrium effects of expanding the SkyTrain. In our counterfactual analysis, the SkyTrain expansion increases housing prices not only in neighborhoods where the expansion occurred, but also in those with access to pre-existing segments of the network. We show how these network housing price effects depend on household commuting patterns, and discuss the implications of our results for targeted taxation policies designed to capture the housing price appreciation stemming from a public transit investment.
    Keywords: Asset Pricing, Economic models, Housing
    JEL: H41 R21 R41
    Date: 2018
  12. By: Calleja, Pedro (Departament de Matematica Economica, Financera i Actuarial); Llerena, Francesc (Departament de Gestió d'Empreses); Sudhölter, Peter (Department of Business and Economics)
    Abstract: A solution on a set of transferable utility (TU) games satisfies strong aggregate monotonicity (SAM) if every player can improve when the grand coalition becomes richer. It satisfies equal surplus division (ESD) if the solution allows the players to improve equally. We show that the set of weight systems generating weighted prenucleoli that satisfy SAM is open which implies that for weight systems close enough to any regular system the weighted prenucleolus satisfies SAM. We also provide a necessary condition for SAM for symmetrically weighted nucleoli. Moreover, we show that the per capita nucleolus on balanced games is characterized by single-valuedness (SIVA), translation and scale covariance (COV), and equal adjusted surplus division (EASD), a property that is comparable but stronger than ESD. These properties together with ESD characterize the per capita prenucleolus on larger sets of TU games. EASD and ESD can be transformed to independence of (adjusted) proportional shifting and these properties may be generalized for arbitrary weight systems p to I(A)Sp. We show that the p-weighted prenucleolus on the set of balanced TU games is characterized by SIVA, COV, and IASp; and on larger sets by additionally requiring ISp.
    Keywords: TU games; weighted prenucleolus; equal surplus division
    JEL: C71
    Date: 2018–05–17
  13. By: Petr Musil (University of Economics in Prague); Michaela Jirková (University of Economics in Prague)
    Abstract: The economic and financial situation of persons depends on the size and structure of their household. The level of the economies of scale of living together is reflected in an equivalence scale. This scale of consumption units assigns to each individual household member the specific weight according to defined rules. In this time the scales for all European country are applied. OECD uses the OECD scale while Eurostat uses the OECD-modified equivalence scale. It allows the international comparison of income and consumption level of households across all states. However, this commonly used scales may not be suitable for all countries, because they do not reflect any country specific economic conditions. Economies of scales are highly dependent on the structure of household consumption and expenditures which varies significantly across countries. Therefore, the need of national equivalence scales appropriate for each country is observed.The aim of this contribution is to compare the international scales with the equivalence scales estimated within our research. These scales are suitable for the Czech Republic as they take into account the economies of scale realized by Czech households. Two alternative approaches have been applied: an expenditure equation and utility function. The first one uses household budget survey data (HBS), the second approach is based on survey on income and living conditions (SILC). It has been proved that estimated equivalence scales differ to international ones. Subsequently, the impact in income and poverty indicators has been assessed. Overall effect on poverty indicators is not big, however a significant impact on specific group of people is observed. Mainly influenced groups are children and pensioners.The national scales affect the countries differently, especially in comparison of specific groups of by their social status. The second approach allows also international comparison as SILC is harmonized in Europe. The different impact of equivalence scales across European states is provided.
    Keywords: consumption units, equivalence scale, household expenditures, utility function, economies of scale
    JEL: D12 D31
    Date: 2018–04
  14. By: Aguirregabiria, Victor; Gu, Jiaying; Luo, Yao
    Abstract: We study the identification and estimation of structural parameters in dynamic panel data logit models where decisions are forward-looking and the joint distribution of unobserved heterogeneity and observable state variables is nonparametric, i.e., fixed-effects model. We consider models with two endogenous state variables: the lagged decision variable, and the time duration in the last choice. This class of models includes as particular cases important economic applications such as models of market entry-exit, occupational choice, machine replacement, inventory and investment decisions, or dynamic demand of differentiated products. The identification of structural parameters requires a sufficient statistic that controls for unobserved heterogeneity not only in current utility but also in the continuation value of the forward-looking decision problem. We obtain the minimal sufficient statistic and prove identification of some structural parameters using a conditional likelihood approach. We apply this estimator to a machine replacement model.
    Keywords: Panel data discrete choice models; Dynamic structural models; Fixed effects; Unobserved heterogeneity; Structural state dependence; Identification; Sufficient statistic.
    JEL: C23 C25 C41 C51 C61
    Date: 2018–05
  15. By: Hayen, Arthur; Klein, Tobias; Salm, Martin
    Abstract: In light of increasing health care expenditures, patient cost-sharing schemes have emerged as one of the main policy tools to reduce medical spending. We show that the effect of patient cost-sharing schemes on health care expenditures is not only determined by the economic incentives they provide, but also by the way these economic incentives are framed. Patients react to changes in economic incentives almost twice as strongly under a deductible policy than under a no-claims refund policy. Our preferred explanation is that individuals are loss-averse and respond differently to both schemes because they perceive deductible payments as a loss and no-claim refunds as a gain.
    Keywords: framing; Health Insurance; loss aversion.; Patient cost-sharing
    JEL: D91 H51 I13
    Date: 2018–05
  16. By: Yao Luo
    Abstract: We study the identification of first-price auctions with nonseparable unobserved heterogeneity. In particular, we extend Hu, McAdams, and Shum (2013) by relaxing the first-order stochastic dominance condition. Instead, we assume restricted stochastic dominance relations among the value quantile functions and show that the same relations pass to the bid quantile functions. An ordered tree summarizes these relations and provides a total ordering. Relying on the proposed restricted stochastic dominance ordering, we extend a list of identification results in the empirical auction literature.
    Keywords: Restricted Stochastic Dominance, Unobserved Heterogeneity, Identification, Misclassification, Auction, Risk Aversion
    JEL: C14 D44
    Date: 2018–05–19

This nep-upt issue is ©2018 by Alexander Harin. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.