nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2018‒06‒18
fourteen papers chosen by

  1. Utility maximization with proportional transaction costs under model uncertainty By Shuoqing Deng; Xiaolu Tan; Xiang Yu
  2. Forbidden zones for the expectation. New mathematical results for behavioral and social sciences By Harin, Alexander
  3. Preference Elicitation and Robust Optimization with Multi-Attribute Quasi-Concave Choice Functions By William B. Haskell; Wenjie Huang; Huifu Xu
  4. Inequity Aversion, Welfare Measurement and the Gini Index By Ulrich Schmidt; Philipp Christoph Wichardt
  5. Clusters Of International Eq-5d Health-States Valuations By Mario Garcia-Molina; Liliana Alejandra Chicaiza; Carlos Javier Rincon; Giancarlo Romano
  6. Aggregate behavior in matching markets with flexible contracts and non-transferable representations of preferences By John K. Dagsvik; Zhiyang Jia
  7. Does the Framing of Patient Cost-Sharing Incentives Matter? The Effects of Deductibles vs. No-Claim Refunds By Hayen, Arthur P.; Klein, Tobias J.; Salm, Martin
  8. Robust Optimal Policies in a Behavioural New Keynesian Model By Giovanni Di Bartolomeo; Carolina Serpieri
  9. Structural Labour Supply Models and Microsimulation By Rolf Aaberge; Ugo Colombino
  10. The (Un)compromise Effect By Ekström, Mathias
  11. The Optimum Quantity of Capital and Debt By Acikgöz, Ömer; Hagedorn, Marcus; Holter, Hans; Wang, Yikai
  12. A Behavioral Theory of Allocation in the Dictator Game By Osório, António (António Miguel)
  13. Volatility as an Alternative asset Class: Does It Improve Portfolio Performance? By Elvira Caloiero; Massimo Guidolin
  14. Microsimulation Analysis of Optimal Income Tax Reforms. An Application to New Zealand By Creedy, John; Gemmell, Norman; Hérault, Nicolas; Mok, Penny

  1. By: Shuoqing Deng; Xiaolu Tan; Xiang Yu
    Abstract: We consider a discrete time financial market with proportional transaction costs under model uncertainty, and study a semi-static utility maximization for the case of exponential utility preference. Using randomization techniques recently developed in \cite{BDT17}, we can transform the original problem into a frictionless market framework, however, with the extra probability uncertainty on an enlarged space. This allows us to prove all together the existence of the optimal strategy, the auxiliary dynamic programming principle as well as the convex duality theorem in our context with transaction costs. As an application of the duality representation, some important features of utility indifference prices are investigated in the robust setting.
    Date: 2018–05
  2. By: Harin, Alexander
    Abstract: A forbidden zones theorem, mathematical approach and model are proposed in the present article. In particular, the approach supposes that people decide as if there were some biases of the expectations of measurement data. The article is motivated by the need of a theoretical support for the practical analysis performed for the purposes of utility and prospect theories, behavioral economics, psychology, decision and social sciences. Possible general consequences and applications of the theorem and approach for a noise and biases of measurement data are preliminary considered as well.
    Keywords: probability; variance; noise; bias; measurement; utility theory; prospect theory; behavioral economics; psychology; decision sciences; social sciences;
    JEL: C02 C1 D8 D81
    Date: 2018–05–10
  3. By: William B. Haskell; Wenjie Huang; Huifu Xu
    Abstract: Decision maker's preferences are often captured by some choice functions which are used to rank prospects. In this paper, we consider ambiguity in choice functions over a multi-attribute prospect space. Our main result is a robust preference model where the optimal decision is based on the worst-case choice function from an ambiguity set constructed through preference elicitation with pairwise comparisons of prospects. Differing from existing works in the area, our focus is on quasi-concave choice functions rather than concave functions and this enables us to cover a wide range of utility/risk preference problems including multi-attribute expected utility and $S$-shaped aspirational risk preferences. The robust choice function is increasing and quasi-concave but not necessarily translation invariant, a key property of monetary risk measures. We propose two approaches based respectively on the support functions and level functions of quasi-concave functions to develop tractable formulations of the maximin preference robust optimization model. The former gives rise to a mixed integer linear programming problem whereas the latter is equivalent to solving a sequence of convex risk minimization problems. To assess the effectiveness of the proposed robust preference optimization model and numerical schemes, we apply them to a security budget allocation problem and report some preliminary results from experiments.
    Date: 2018–05
  4. By: Ulrich Schmidt; Philipp Christoph Wichardt
    Abstract: Over the last decades, research in behavioural economics has demonstrated that individual welfare (utility), as relevant for economic decision making, depends not only on absolut but also on distributional aspects. Moreover, evidence is gathering that something similar holds for aggregate welfare, i.e. that GDP alone is an insufficient predictor for various supposedly welfare related variables on a societal level. This note shows that distributional concerns on an aggregate level can indeed be derived from distributional concerns on an individual level: integrating individual inequity aversion into a utilitarian social welfare function yields a simple welfare measure which comprises both GDP and income inequality as measured by the Gini index.
    Keywords: Gini index, inequality, welfare
    JEL: D01 D63
    Date: 2018
  5. By: Mario Garcia-Molina; Liliana Alejandra Chicaiza; Carlos Javier Rincon; Giancarlo Romano
    Abstract: PURPOSE: Countries without EQ-5D general-population surveys might use valuations from another country with similar health valuations. This study aimed to identify whether there are groups of countries with similar health-state valuations. METHODS: A cluster analysis was performed for the 242 states of the EQ-5D valuations for 23 studies in 18 countries, excluding the perfect-health state. Clusters were identified by means of the Ward algorithm with the Euclidean measure and hierarchical clustering. RESULTS: 5 clusters were identified. Valuations are sensitive to the preference elicitation methodology. Some countries in the same cluster have cultural similarities but a particular cluster included otherwise dissimilar countries and methodologies. Using the states associated to diabetes and breast cancer, the choice of cluster is shown to be relevant for cost-utility analysis. CONCLUSIONS: Health-state valuations tend to be clustered in a few groups of countries. The clusters found might be useful for performing cost-utility analysis in countries without such valuations.
    Keywords: Quality-adjusted life years; Utility assessment; EQ5D; Health-state utility; Outcomes research
    JEL: D10 D61 H51 I10
    Date: 2018–06–06
  6. By: John K. Dagsvik; Zhiyang Jia (Statistics Norway)
    Abstract: This paper modifies and extends the aggregate equilibrium models for matching markets developed earlier in the literature. Agents in the matching market search for a match among potential partners, including agreements about a flexible contract, such as hours and wage combinations in the labor market. Under general utility representations that are non-transferable and assuming the matching is stable, we derive a probabilistic framework for the probability of realizing a particular match, including the choice of contract. We also show that the popular transferable utility model with transferable utilities can be viewed as a limiting case within our modelling framework. The framework is practical to apply for empirical analysis and is at the same time sufficiently general to accommodate essential features of matching markets with heterogeneous agents.
    Keywords: Matching markets; Aggregation; Latent choice sets; Random utility matching models
    JEL: J22 C51
    Date: 2018–05
  7. By: Hayen, Arthur P. (Tilburg University); Klein, Tobias J. (Tilburg University); Salm, Martin (Tilburg University)
    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: patient cost-sharing, health insurance, framing, loss aversion
    JEL: I13 D91 H51
    Date: 2018–04
  8. By: Giovanni Di Bartolomeo (University La Sapienza); Carolina Serpieri (European Commission - JRC)
    Abstract: This paper introduces model uncertainty into a behavioral New Keynesian DSGE framework and derives robust optimal monetary policies. We build a heterogeneous agents DSGE model, where a fraction of agents behave according to some forms of bounded rationality (boundedly rational agents), while the reminder operate on the basis of expectations that are corrected on average (rational agents). We consider two potential mechanisms of expectations formation to generate beliefs. The central bank observes the aggregate economic dynamics, but it ignores the fraction of boundedly rational agents and/or the mechanism they use to form their expectations. Non-Bayesian robust control techniques are then adopted to minimize a welfare loss derived from the second-order approximation of agents’ utilities. We account of model uncertainty considering both commitment and discretion regime.
    Keywords: robust techniques, optimal policy, New Keynesian DSGE models, bounded rationality.
    Date: 2018–04
  9. By: Rolf Aaberge (Statistics Norway); Ugo Colombino
    Abstract: The purpose of the paper is to provide a discussion of the various approaches for accounting for labour supply responses in microsimulation models. The paper focus attention on two methodologies for modelling labour supply: • The discrete choice model • The random utility – random opportunities model The paper then describes approaches to utilising these models for policy simulation in terms of producing and interpreting simulation outcomes, outlining an extensive literature of policy analyses utilising these approaches. Labour supply models are not only central for analyzing behavioural labour supply responses but also for identifying optimal tax-benefit systems, given some of the challenges of the theoretical approach. Combining labour supply results with individual and social welfare functions enables the social evaluation of policy simulations. Combining welfare functions and labour supply functions, the paper discusses how to model socially optimal income taxation.
    Keywords: Behavioural microsimulation; Labour supply; Discrete choice; Tax reforms
    JEL: C50 D10 D31 H21 H24 H31 J20
    Date: 2018–06
  10. By: Ekström, Mathias (Department of Economics, NHH – Norwegian School of Economics)
    Abstract: The current study provides the first experimental test of the compromise effect, i.e. the tendency to choose middle options, in a naturally occurring setting. Simultaneously, I propose and evaluate a novel nudge intended to stimulate active choice—the (un)compromise effect—a compromise effect without an explicit middle option. 63,494 recipients of a mail fundraiser were randomly assigned to one of three sets of suggested donations: [$10, $50, $100, $__ ]; [$10, $50, $100, $250, $500, $__ ]; or [$10, $500, $__ ]. The results support both the compromise effect and the (un)compromise effect: extending the range increased the fraction donating $100 as well as the average donation—independent of whether the middle suggested donations were present or not. Hence, by only providing informative end points, organizations can affect decision-making and at the same time promote individuality through active choice. The results also shed light on why suggested alternatives affect choice in general: they reduce the cognitive cost of figuring out what actions are appropriate.
    Keywords: Choice architecture; Compromise effect; Consumer choice; Field experiment; Philanthropy
    JEL: C93 D03 D64
    Date: 2018–05–07
  11. By: Acikgöz, Ömer; Hagedorn, Marcus; Holter, Hans; Wang, Yikai
    Abstract: In this paper we solve the dynamic optimal Ramsey taxation problem in a model with incomplete markets, where the government commits itself ex-ante to a time path of labor taxes, capital taxes and debt to maximize the discounted sum of agents' utility starting from today. Whereas the literature has bee limited mainly to studying policies that maximize steady-state welfare only, we instead characterize the optimal policy along the full transition path. We show theoretically that in the long run the capital stock satisfies the modified golden rule. More importantly, we prove that in contrast to complete markets economies, in incomplete markets economies the long run steady state resulting from an infinite sequence of optimal policy choices is independent of initial conditions. This result is not only of theoretical interest but moreover, enables us to compute the long-run optimum independently from the transition path such that a quantitative analysis becomes tractable Quantitatively we find, robustly across various calibrations, that in the long run the government debt-to-GDP ratio is high, capital is taxed at a low rate and labor income at a high rate when compared to current U.S. values. Along the optimal transition to the steady state, labor taxes initially are lowered, financed through issuing more debt and taxing capital income heavily, before they are eventually increased to their steady-state level.
    Keywords: Capital taxation; Dynamically Optimal Taxation; incomplete markets; Optimal Government Debt
    JEL: E62 H20 H60
    Date: 2018–05
  12. By: Osório, António (António Miguel)
    Abstract: This paper attempts to explain the behavior observed in the dictator game without explicitly assuming a utility function. Alternatively, I consider the representative behavior of a society composed of heterogeneous individuals in terms of altruism and self-interest. Based on these two principles, I present an allocation that aggregates the society's preferences. The result depends crucially on the value of the resource under dispute for the dictator. Even if the value of the resource is extremely important for the dictator, the dictator cannot justify a share of the resource larger than 3/4 of the total. An allocation proposing more than this share of the resource cannot reach social consensus. On the other extreme, if the value of the resource is sufficiently unimportant for the society, an equal split of the resource emerges in the limit. Keyword: Dictator Game; Allocation Rules; Altruism; Self-interest; Conflict Resolution. JEL classifi cation: C91, D03, D63, D74.
    Keywords: Disseny d'experiments, Economia del benestar, Decisió de grup, 33 - Economia,
    Date: 2018
  13. By: Elvira Caloiero; Massimo Guidolin
    Abstract: We investigate the potential role of Exchange Traded Products (Notes) as vehicles to trade volatility (here proxied by the VIX index) as an asset class in a fully optimizing asset allocation framework, subject to long-only constraints. In back-testing, recursive exercises based on an expanding window of data from February 2010 to February 2016, we find evidence that VIX should enter with non-negligible weight most portfolio strategies and that under many circumstances, long VIX positions may generate positive risk-adjusted performance benefits. However, the volatility positions that can be managed and traded through (one of) the most popular US exchange-traded notes (VXX) fails to deliver such realized, out-of-sample benefits under all utility functions and for a range of assumptions on investors’ risk aversion. Even though the turnover implied by VXX does not appear excessive, taking into account transaction costs worsens considerably its performance and even casts doubts as to whether volatility ought to be considered as an alternative asset class altogether. Direct strategies that trade appropriate futures on the VIX improve somewhat realized performance, but not enough to tilt over the balance of our conclusions.
    Keywords: Volatility, VIX, Exchange-Traded Products, Exchange
    JEL: G11 G12
    Date: 2017
  14. By: Creedy, John; Gemmell, Norman; Hérault, Nicolas; Mok, Penny
    Abstract: This paper examines the optimal direction of marginal income tax reform in the context of New Zealand, which recently reduced its top marginal income tax rate to one of the lowest in the OECD. A behavioural microsimulation model is used, in which social welfare functions are defined in terms of either money metric utility or net income. The model allows for labour supply responses to tax changes, in which a high degree of population heterogeneity is represented along with all the details of the highly complex income tax and transfer system. The implications of the results for specific combinations of tax rate or threshold changes, that are both revenue neutral and welfare improving, are explored in detail, recognising the role of distributional value judgements in determining an optimal reform.The potential impact of additional income responses is also examined, using the concept of the elasticity of taxable income. Results suggest, under a wide range of parameter values and assumptions, that raising the highest income tax rate and/or threshold, would be part of an optimal reform package.
    Keywords: Optimal taxation,tax reform,behavioural microsimulation,social welfare function,money metric utility
    JEL: D63 H21 H31 I31 J22
    Date: 2018

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