nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2018‒06‒25
thirteen papers chosen by

  1. Present Bias in Renewable Resources Management Reduces Agent’s Welfare By Persichina, Marco
  2. Weakening Transferable Utility: the Case of Non-intersecting Pareto Curves By Thomas Demuynck; Tom Potoms
  3. Three layers of uncertainty: an experiment By Ilke Aydogan; Loic Berger; Valentina Bosetti; Ning Liu
  4. Status maximization as a source of fairness in a networked dictator game By Jan E. Snellman; Gerardo I\~niguez; J\'anos Kert\'esz; R. A. Barrio; Kimmo K. Kaski
  5. Rational Inattention with Sequential Information Sampling By Hebert, Benjamin; Woodford, Michael
  6. Domain-Specific Risk and Public Policy By Kanninen, Ohto; Böckerman, Petri; Suoniemi, Ilpo
  7. Equilibrium with Differential Information and Exogenous Beliefs: A Basic Model of Full Existence By Lionel DE BOISDEFFRE
  8. A Macroscopic Portfolio Model: From Rational Agents to Bounded Rationality By Torsten Trimborn
  9. The Term Structure of Currency Carry Trade Risk Premia By Lustig, Hanno; Stathopoulos, Andreas; Verdelhan, Adrien
  10. Willingness to take risk: The role of risk conception and optimism By Thomas Dohmen; Simone Quercia; Jana Willrodt
  11. Role of Symmetry in Irrational Choice By Ivan Kozic
  12. Manipulating Reliance on Intuition Reduces Risk and Ambiguity Aversion By Luigi Guiso; Tullio Jappelli
  13. Monetary Policy Analysis when Planning Horizons are Finite By Woodford, Michael

  1. By: Persichina, Marco
    Abstract: This study investigates the effects generated by myopic and present-biased preferences in the context of resource harvesting, specifically on the impact that the present bias has on the agent’s welfare when the agent is engaged in an intertemporal harvesting activity from a stock of renewable resources. The harvesting activity, in this context, poses a conflict between the long-run benefit of the agent and the short-run desire. The paper assumes there is evidence of the existence of a dual system of response to short and long-term stimuli. Thus, the study shows and argues that in the decision-making that involves intertemporal choices in renewable resources management, the naive behavior, strongly influenced by the emotional-affective system, leads to a reduction in the lifetime utility enjoyed by the individual because of the present bias.
    Keywords: Present bias, naive agent, intertemporal resource management, dual system discounting, agent’s welfare, instant utility.
    JEL: D03 D90 Q20
    Date: 2016–07–20
  2. By: Thomas Demuynck; Tom Potoms
    Abstract: Transferable utility (TU) is a widely used assumption in economics. In this paper, we weaken the TU property to the setting where distinct Pareto frontiers have empty intersections. We call this the no-intersection property (NIP). We show that the NIP is strictly weaker than TU, but still maintains several desirable properties. We discuss the NIP property in relation to several models where TU has turned out to be a key assumption: models of assortative matching, the Coase theorem and Becker's Rotten Kid theorem. We also investigate classes of utility functions for which theNIP holds uniformly.
    Keywords: Pareto effciency, Transferable utility, Kaldor-Hicks compensation crite- rion, Assortative matching, Coase theorem, Rotten Kid theorem
    Date: 2018–06
  3. By: Ilke Aydogan; Loic Berger; Valentina Bosetti; Ning Liu
    Abstract: We experimentally explore decision-making under uncertainty using a framework that decomposes uncertainty into three distinct layers: (1) physical uncertainty, entailing inherent randomness within a given probability model, (2) model uncertainty, entailing subjective uncertainty about the probability model to be used and (3) model misspecification, entailing uncertainty about the presence of the true probability model among the set of models considered. Using a new experimental design, we measure individual attitudes towards these different layers of uncertainty and study the distinct role of each of them in characterizing ambiguity attitudes. In addition to providing new insights into the underlying processes behind ambiguity aversion -failure to reduce compound probabilities or distinct attitudes towards unknown probabilities- our study provides the first empirical evidence for the intermediate role of model misspecification between model uncertainty and Ellsberg in decision-making under uncertainty.Keywords: Ambiguity aversion, reduction of compound lotteries, non-expected utility, model uncertainty, model misspecification JEL Classification: D81
    Date: 2018
  4. By: Jan E. Snellman; Gerardo I\~niguez; J\'anos Kert\'esz; R. A. Barrio; Kimmo K. Kaski
    Abstract: Human behavioural patterns exhibit selfish or competitive, as well as selfless or altruistic tendencies, both of which have demonstrable effects on human social and economic activity. In behavioural economics, such effects have traditionally been illustrated experimentally via simple games like the dictator and ultimatum games. Experiments with these games suggest that, beyond rational economic thinking, human decision-making processes are influenced by social preferences, such as an inclination to fairness. In this study we suggest that the apparent gap between competitive and altruistic human tendencies can be bridged by assuming that people are primarily maximising their status, i.e., a utility function different from simple profit maximisation. To this end we analyse a simple agent-based model, where individuals play the repeated dictator game in a social network they can modify. As model parameters we consider the living costs and the rate at which agents forget infractions by others. We find that individual strategies used in the game vary greatly, from selfish to selfless, and that both of the above parameters determine when individuals form complex and cohesive social networks.
    Date: 2018–06
  5. By: Hebert, Benjamin (Stanford University); Woodford, Michael (Columbia University)
    Abstract: We propose a new principle for measuring the cost of information structures in rational inattention problems, based on the cost of generating the information used to make a decision through a dynamic evidence accumulation process. We introduce a continuous-time model of sequential information sampling, and show that, in a broad class of cases, the choice frequencies resulting from optimal information accumulation are the same as those implied by a static rational inattention problem with a particular static information-cost function. Among the static cost functions that can be justified in this way is the mutual information cost function proposed by Sims [2010], but we show that other cost functions can be justified in this way as well. We introduce a class of "neighborhood-based" cost functions, which also summarize the results of dynamic evidence accumulation, and (unlike mutual information) incorporate a conception of the similarity of states to one another, making it more costly to undertake experiments that can produce different results in similar but non-identical states. With this alternative cost function, optimal information accumulation results in choice frequencies that are similar in similar states; in a continuous-state extension of the model, optimality implies choice frequencies that vary continuously with the state, even when the choice payoffs jump discontinuously with variation in the state. This feature of our version of the rational inattention model conforms with evidence from perceptual discrimination experiments.
    Date: 2017–09
  6. By: Kanninen, Ohto (Labour Institute for Economic Research); Böckerman, Petri (Labour Institute for Economic Research); Suoniemi, Ilpo (Labour Institute for Economic Research)
    Abstract: We develop a method to estimate domain-specific risk. We apply the method to sickness insurance by fitting a utility function at the individual level, using European survey data on life satisfaction. Three results stand out. First, relative risk aversion increases with income. Second, marginal utility is higher in the sick state conditional on income, due to an observed fixed cost of sickness. Third, the domain-specificity of risk shifts the focus on the smoothing of utility, not consumption. The optimal policy rule implies that the replacement rates should be non-linear and decrease with income.
    Keywords: risk, risk aversion, state-dependence, social insurance, sickness absence
    JEL: D02 H55 I13
    Date: 2018–05
  7. By: Lionel DE BOISDEFFRE
    Abstract: We consider a pure exchange economy, where agents, typically asymmetrically informed, exchange securities, on financial markets, and commodities, on spot markets. Consumers have private characteristics, anticipations and beliefs, and no model to forecast prices. They are dispensed with rational expectation and bounded rationality assumptions, such as Radner's (1972, 1979), Kurz' (1994) or Koutsougeras-Yannelis' (1999). We show that they face an incompressible uncertainty, represented by a so-called "minimum uncertainty set". This uncertainty typically adds to the exogenous one, on the state of nature, an 'endogenous uncertainty' over future spot prices. At equilibrium, all agents expect the 'true' price on every spot market as a possible outcome, and elect optimal strategies, ex ante, which clear on all markets, ex post. We show this sequential equilibrium exists whenever agents' prior anticipations embed the minimum uncertainty set. This outcome differs from the standard generic existence results of Hart (1975), Radner (1979), and Duffie-Shaffer (1985), among others, based on the rational expectations of prices.
    Keywords: Sequential equilibrium, Temporary equilibrium, Perfect foresight, Existence, Rational expectations, Financial markets, Asymmetric Information, Arbitrage
    JEL: D52
    Date: 2018–06
  8. By: Torsten Trimborn
    Abstract: We present a macroscopic portfolio model which considers the time evolution of the stock price and the investments in bonds and stocks. The asset allocation between bonds and stocks is determined by an combination of a fundamentalist or chartist strategy. The stock price is determined by the inflow or outflow of stock investments. The model is able to replicate the most prominent features of financial markets, namely booms and crashes. In the case of random fundamental prices the model is even able to reproduce fat tails in logarithmic stock price return data. We want to point out that we derive the model from microscopic agent dynamics. On the microscopic level each financial agent is faced with an optimization problem, where each agent seeks to find a Nash equilibrium solution. We use model predictive control to approximate the control problem. This allows us to give a precise mathematical definition of rational and bounded rational financial agents. Moreover the approximation scheme of the microscopic optimal control problem gives a natural connections between rational and bounded rational agents. In fact the model can be regarded as the result of the simplest approximation of the optimal control problem and thus considers financial agents of maximum boundedness. Mathematically, the model can be regarded as the moment model of the recently introduced mesoscopic kinetic portfolio model(Trimborn, Pareschi, Frank: Portfolio Optimization and Model Predictive Control: A Kinetic Approach, arXiv:1711.03291).
    Date: 2018–05
  9. By: Lustig, Hanno (Stanford University); Stathopoulos, Andreas (University of Washington); Verdelhan, Adrien (Massachusetts Institute of Technology)
    Abstract: Fixing the investment horizon, the returns to currency carry trades decrease as the maturity of the foreign bonds increases, because the local currency term premia offset the currency risk premia. The time series predictability of foreign bond returns in dollars similarly declines as the maturity of the bonds increases. Leading no-arbitrage models in international finance cannot match the downward term structure of currency carry trade risk premia. While currency risk premia on short-term bonds reflect differences in transitory and permanent risk, we show that the premia on long-term bonds only reflect differences in the risk of permanent shocks to investors' marginal utility.
    Date: 2017–10
  10. By: Thomas Dohmen; Simone Quercia; Jana Willrodt
    Abstract: We show that the disposition to focus on favorable or unfavorable outcomes of risky situations affects willingness to take risk as measured by the general risk question. We demonstrate that this disposition, which we call risk conception, is strongly associated with optimism, a stable facet of personality and that it predicts real-life risk taking. The general risk question captures this disposition alongside pure risk preference. This enlightens why the general risk question is a better predictor of behavior under risk across different domains than measures of pure risk preference. Our results also rationalize why risk taking is related to optimism.
    Keywords: risk taking behavior, optimism, preference measures, risk conception
    JEL: D91 C91 D81 D01
    Date: 2018–06
  11. By: Ivan Kozic
    Abstract: Symmetry is a fundamental concept in modern physics and other related sciences. Being such a powerful tool, almost all physical theories can be derived from symmetry, and the effectiveness of such an approach is astonishing. Since many physicists do not actually believe that symmetry is a fundamental feature of nature, it seems more likely it is a fundamental feature of human cognition. According to evolutionary psychologists, humans have a sensory bias for symmetry. The unconscious quest for symmetrical patterns has developed as a solution to specific adaptive problems related to survival and reproduction. Therefore, it comes as no surprise that some fundamental concepts in psychology and behavioral economics necessarily involve symmetry. The purpose of this paper is to draw attention to the role of symmetry in decision-making and to illustrate how it can be algebraically operationalized through the use of mathematical group theory.
    Date: 2018–06
  12. By: Luigi Guiso (Einaudi Institute for Economics and Finance (EIEF) and CEPR); Tullio Jappelli (University of Naples Federico II, CSEF, and CEPR)
    Abstract: Rational investors perceive correctly the value of financial information. Investment in information is therefore associated with a higher expected portfolio return and Sharpe ratio. Overconfident investo rs overstate the quality of their own information, and thus investment in information is associated with a lower expected Sharpe ratio despite they realize higher average returns. We contrast the implications of these two models using two unique surveys of customers of a leading Italian bank with portfolio data and measures of financial information. We find that the investment in information is positively associated with returns to financial wealth and negatively to Sharpe ratio. The latter falls with proxies for overconfidence. We relate these findings to the wealth inequality debate.
    Keywords: Portfolio Choice, Information, Overconfidence
    JEL: E2 D8 G1
    Date: 2018–06–14
  13. By: Woodford, Michael
    Abstract: It is common to analyze the effects of alternative monetary policy commitments under the assumption of fully model-consistent expectations. This implicitly assumes unrealistic cognitive abilities on the part of economic decision makers. The relevant question, however, is not whether the assumption can be literally correct, but how much it would matter to model decision making in a more realistic way. A model is proposed, based on the architecture of artificial intelligence programs for problems such as chess or go, in which decision makers look ahead only a finite distance into the future, and use a value function learned from experience to evaluate situations that may be reached after a finite sequence of actions by themselves and others. Conditions are discussed under which the predictions of a model with finite-horizon forward planning are similar to those of a rational expectations equilibrium, and under which they are instead quite different. The model is used to re-examine the consequences that should be expected from a central-bank commitment to maintain a fixed nominal interest rate for a substantial period of time. "Neo-Fisherian" predictions are shown to depend on using rational expectations equilibrium analysis under circumstances in which it should be expected to be unreliable.
    Keywords: bounded rationality; forward guidance; neo-Fisherianism
    JEL: E52
    Date: 2018–06

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