nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2018‒07‒30
eighteen papers chosen by

  1. Ambiguity preferences for health By Arthur E. Attema; Han Bleichrodt; Olivier L'Haridon
  2. On Time-Consistent Collective Choice with Heterogeneous Quasi- Hyperbolic Discounting By Jean-Pierre Drugeon; Bertrand Wigniolle
  3. The Conjunction Fallacy in Quantum Decision Theory By Tatyana Kovalenko; Didier Sornette
  4. A Structural Model of The Demand For Telecare By Kevin Momanyi
  5. Sequential equilibrium without rational expectations of prices: A theorem of full existence By Lionel de Boisdeffre
  6. Conditional Davis Pricing By Kasper Larsen; Halil Mete Soner; Gordan Zitkovic
  7. Rationalizations and mistakes: optimal policy with normative ambiguity By Goldin, Jacob; Reck, Daniel
  8. Monetary Policy Analysis when Planning Horizons are Finite By Michael Woodford
  9. Multiple Misbehaving: Loss Averse and Inattentive to Monetary Incentives By Engström, Per; Nordblom, Katarina; Stefánsson, Arnaldur
  10. Pay Level Comparisons in Job Satisfaction Research and Mainstream Economic Methodology By Stavros, Drakopoulos
  11. Dynamic decisions under subjective expectations: a structural analysis By Yonghong An; Yingyao Hu; Ruli Xiao
  12. The Preference for Monotone Decision Problems By Bernard Sinclair-Desgagné
  13. Sorting or Steering: Experimental Evidence on the Economic Effects of Housing Discrimination By Peter Christensen; Christopher Timmins
  14. The Evolution of Self-Control in the Brain By David Jiménez-Gómez
  15. 'Discrete beliefs space and equilibrium: a cautionary note' By Michele Berardi
  16. Preparation for old age in France: The roles of preferences and expectations By Bénédicte H. Apouey
  17. Technological progress, the supply of hours worked, and the consumption-leisure complementarity By Andreas Irmen
  18. "Timing Games with Irrational Types: Leverage-Driven Bubbles and Crash-Contingent Claims" By Hitoshi Matsushima

  1. By: Arthur E. Attema (Erasmus School of Economics - Erasmus University Rotterdam); Han Bleichrodt (Erasmus School of Economics - Erasmus University Rotterdam); Olivier L'Haridon (CREM - Centre de recherche en économie et management - UNICAEN - Université de Caen Normandie - NU - Normandie Université - UR1 - Université de Rennes 1 - UNIV-RENNES - Université de Rennes - CNRS - Centre National de la Recherche Scientifique)
    Abstract: In most medical decisions probabilities are ambiguous and not objectively known.Empirical evidence suggests that people's preferences are affected by ambiguity. Health economic analyses generally ignore ambiguity preferences and assume that they are the same as preferences under risk. We show how health preferences can be measured under ambiguity and we compare them with health preferences under risk. We assume a general ambiguity model that includes many of the ambiguity models that have been proposed in the literature. For health gains, ambiguity preferences and risk preferences were indeed the same. For health losses they differed with subjects being more pessimistic in decision under ambiguity. Utility and loss aversion were the same for risk and ambiguity .
    Keywords: ambiguity, health
    Date: 2018
  2. By: Jean-Pierre Drugeon (PSE - Paris School of Economics, PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique); Bertrand Wigniolle (PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique)
    Abstract: A general setup is considered where agents are characterised by quasi-hyperbolic discounting and by heterogeneous bias for the present and heterogenous discounting parameters. Consumptions are moreover subject to a standard feasibility constraint. A collective utility function is defined as a function of the intertemporal utilities of the selves of the different agents, the elementary unit being thus the self of a given period for a given agent. The analysis is further specialized to time-independent collective utility functions. Such a framework generating a tension between Pareto-optimality and time-consistency for the optimal allocations, two approaches are suggested in order to tackle this issue. The first one imposes restrictions on the collective utility function that ensure the timeconsistency of the optimal decisions. The second one builds from an a priori time-inconsistent collective utility function. The benevolent planner is then to be considered as a sequence of successive incarnations, any of these incarnations being endowed with its own objective. The associated optimal policy is the equilibrium of a game between the successive incarnations of the planner when the players follow Markovian strategies. The results obtained for both solution concepts are compared through an example that also shows how they can be recovered through a competitive equilibrium.
    Keywords: Heterogeneities,hyperbolic discounting,collective choice
    Date: 2017–12
  3. By: Tatyana Kovalenko (ETH Zurich); Didier Sornette (ETH Zürich and Swiss Finance Institute)
    Abstract: The conjunction fallacy is a renowned violation of classical probability laws, which is persistently observed among decision makers. Within Quantum decision theory (QDT), such deviations are the manifestation of interference between decision modes of a given prospect. We propose a novel QDT interpretation of the conjunction fallacy, which cures some inconsistencies of a previous treatment, and incorporates the latest developments of QDT, in particular the representation of a decision-maker's state of mind with a statistical operator. Rather than focusing on the interference between choice options, our new interpretation identifies the origin of uncertainty and interference between decision modes to an entangled state of mind, whose structure determines the representation of prospects. On par with prospects, the state of mind can be a source of uncertainty and lead to interference effects, resulting in characteristic behavioral patterns. We present the first in-depth QDT-based analysis of an empirical study (the touchstone experimental investigations of Shafir et al. (1990)), which enables a data-driven exploration of its underlying theoretical construct. We link typicality judgements to probability amplitudes of the decision modes in the state of mind, and quantify the level of uncertainty and the relative contributions of prospect's interfering modes to its probability judgement. This enables inferences about the key QDT interference "attraction'' q-factor with respect to different types of prospects - compatible versus incompatible. We propose a novel empirically motivated "QDT indeterminacy (or uncertainty) principle,'' as a fundamental limit of the precision with which certain sets of prospects can be simultaneously known (or assessed) by a decision maker, or elicited by an experimental procedure. For any type of prospects, we observe a general tendency for the q-factor to converge to the same negative range q > (−0.3,−0.1) in the presence of high uncertainty, which motivates the hypothesis of an universal "aversion'' q. The "aversion'' q is independent of the (un-)attractiveness of a prospect under more certain conditions, which is the main difference with the previously considered "QDT quarter law''. The universal "aversion'' q substantiates the previously proposed "QDT uncertainty aversion principle'' and clarifies its domain of application. The universal "aversion'' q provides a theoretical basis for modelling different risk attitudes, such as aversions to uncertainty, to risk or to losses.
    Keywords: Quantum decision theory, conjunction fallacy, interference, indeterminacy (uncertainty) principle, universal aversion
    JEL: C02 C44 D80 D81
    Date: 2018–03
  4. By: Kevin Momanyi
    Abstract: In this paper, we formulate a structural model of the demand for telecare. We show how the Andersen's Behavioral Model of Health Services Use, the Almost Ideal Demand System and the Revealed Preference theory can be combined with microeconomic principles of health production to reason about individuals' utility maximizing behavior. We then estimate the model using a strategy that controls for the effects of both observable and unobservable factors, and later conduct a simulation exercise by way of a decomposition analysis.
    JEL: C32 C36 D13
    Date: 2018–07–20
  5. By: Lionel de Boisdeffre (Centre d'Economie de la Sorbonne)
    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: 2017–07
  6. By: Kasper Larsen (Rutgers, The State University of New Jersey); Halil Mete Soner (ETH Zürich and Swiss Finance Institute); Gordan Zitkovic (University of Texas at Austin)
    Abstract: We introduce the notion of a conditional Davis price and study its properties. Our ultimate goal is to use utility theory to price non-replicable contingent claims in the case when the investor's portfolio already contains a non-replicable component. We show that even in the simplest of settings - such as Samuelson's model - conditional Davis prices are typically not unique and form a non-trivial subinterval of the set of all no-arbitrage prices. Our main result characterizes this set and provides simple conditions under which its two endpoints can be effectively computed. We illustrate the theory with several examples.
    Keywords: Incomplete markets, utility-maximization, unspanned endowment, local martingales, linearization, directional derivative
    JEL: C61 G11
    Date: 2018–05
  7. By: Goldin, Jacob; Reck, Daniel
    Abstract: Behavior that appears to violate neoclassical assumptions can often be rationalized by incorporating an optimization cost into decision-makers' utility functions. Depending on the setting, these costs may reflect either an actual welfare loss for the decision-maker who incurs them or a convenient (but welfare irrelevant) modeling device. We consider how the resolution of this normative ambiguity shapes optimal policy in a number of contexts, including default options, inertia in health plan selection, take-up of social programs, programs that encourage moving to a new neighborhood, and tax salience.
    JEL: J1
    Date: 2018–05
  8. By: Michael Woodford
    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: forward guidance, neo-Fisherianism, Fisher equation, bounded rationality
    JEL: E52
    Date: 2018
  9. By: Engström, Per (Department of Economics and UCFS, Uppsala University, Sweden); Nordblom, Katarina (Department of Economics and CeCAR, University of Gothenburg, Sweden, and UCFS, Uppsala University); Stefánsson, Arnaldur (Department of Economics, UCFS and UCLS, Uppsala University)
    Abstract: We study what determines taxpayers’ deduction behavior when filing tax returns. Preliminary 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 empirical 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: 2018–05–03
  10. By: Stavros, Drakopoulos
    Abstract: Although social scientists have been investigating the nature and impact of job satisfaction for many decades, economists only started to investigate job satisfaction systematically in the late 1980’s. Almost from the first systematic studies of job satisfaction by economists, the research potential of the notion of pay level comparisons was realized. The idea of pay level comparisons in job satisfaction has proven particularly useful also because it has important implications for a number of standard theoretical and economic policy results. However, the inclusion of the variable of comparison wage in job satisfaction and the resulting supporting empirical findings, are in sharp contrast to the orthodox approach, given that in mainstream economic theory an individuals’ utility is assumed to be a function of absolute income only. Despite the important theoretical and policy implications, mainstream economic theory has not paid much heed to the job satisfaction conceptual formulations and empirical findings. The paper argues that there are methodological reasons for this state of affairs which seem to be linked to the subjective well-being research in general, and to the job satisfaction literature in particular. A strong mistrust against the method of stated preferences and the inherent methodological bias against the integration of psychological findings, are suggested as the two prime reasons. Although a few prominent figures in job satisfaction research have realized the mainstream methodological attitude, it is necessary that job satisfaction specialists should consider more seriously the basic components of mainstream economic methodology that relate to their research field.
    Keywords: job satisfaction; pay level comparisons; wages; economic methodology
    JEL: B41 I31 J28 J30
    Date: 2018–07–03
  11. By: Yonghong An (Institute for Fiscal Studies); Yingyao Hu (Institute for Fiscal Studies and Johns Hopkins University); Ruli Xiao (Institute for Fiscal Studies and Indiana University)
    Abstract: This paper studies dynamic discrete choices by relaxing the assumption of rational expectations. That is, agents' subjective expectations about the state transition are unknown and allowed to differ from their objectively estimable counterparts. We show that agents' subjective expectations and preferences can be identi ed and estimated from the observed conditional choice probabilities in both finite and infi nite horizon cases. Our identi cation of subjective expectations is nonparametric and can be expressed as a closed-form function of the observed conditional choice probabilities. We estimate the model primitives using maximum likelihood estimation and illustrate the good performance of estimators using Monte Carlo experiments. We apply our model to Panel Study of Income Dynamics (PSID) data and analyze women's labor participation. We find systematic differences between agents' subjective expectations about their income transition from those under rational expectations. A counterfactual analysis suggests that women with low and medium incomes would increase the probability of working under rational expectations, and that the probability would decrease for women with high income.
    Keywords: Dynamic discrete choice models, subjective expectations, rational expectations, nonparametric identi cation, estimation.
    Date: 2018–02–05
  12. By: Bernard Sinclair-Desgagné
    Abstract: This paper spells out conditions under which a rational decisionmaker will commit ex ante to certain choice restrictions, in order to get extra information about an uncertain state of nature. We show that the envisioned limitations will then bring the decision-maker to solve a monotone decision problem. This provides a first rationale for the observed recurrence of this type of problem in economic life. From another angle, the analysis also explains why individuals and organizations resort to automatic responses and routines in some circumstances, and how this contributes to shape their environment.
    Keywords: Monotone decision problems; Rational inattention; Design attributes; Routines
    JEL: D01 D02 D89
    Date: 2018
  13. By: Peter Christensen; Christopher Timmins
    Abstract: Housing discrimination is illegal. However, paired-tester audit experiments have revealed evidence of discrimination in the interactions between potential buyers and realtors, raising concern about whether certain groups are systematically excluded from the beneficial effects of healthy neighborhoods. Using data from HUD's most recent Housing Discrimination Study and micro-level data on key attributes of neighborhoods in 28 US cities, we find strong evidence of discrimination in the characteristics of neighborhoods towards which individuals are steered. Conditional upon the characteristics of the house suggested by the audit tester, minorities are significantly more likely to be steered towards neighborhoods with less economic opportunity and greater exposures to crime and local pollutants. We find that holding locational preferences or income constant, discriminatory steering alone may contribute substantially to the disproportionate number of minority house- holds found in high poverty neighborhoods in the United States. The steering effect is also large enough to fully explain the differential in proximity to Superfund sites among African American mothers. These results have important implications for studies of “neighborhood effects” and confirm an important mechanism underlying observed correlations between race and pollution in the environmental justice literature. Our results also suggest that the basic utility maximization assumptions underlying hedonic and residential sorting models may often be violated, resulting in an important distortion in the provision of local public goods.
    JEL: Q51 Q53 R31
    Date: 2018–07
  14. By: David Jiménez-Gómez (Dpto. Fundamentos del Análisis Económico)
    Abstract: Temptation and self-control evolved as single mechanism to make humans behave against their own self-interest. I analyze the evolution of self-control in a principal-agent framework, in which the agent has access to private information but his utility cannot depend on all rel-evant variables. The principal can obtain the first best asymptotically by biasing the utility of the agent (from which an endogenous conflict emerges) and simultaneously endowing the agent with a limited amount of self-control.Several empirical properties of self-control, observed in psychological experiments, are explained in terms of the model: 1) self-control grows over time as it is exercised; 2) self-control is lower when the level of glucose in the blood is low, but does not depend on a physical resource; 3) as the environment becomes more tempting, individuals exhibit less self-control. The model sheds light on the di¿erence between self-control and hyperbolic discounting and provides a framework for understanding the recent surge of chronic non-communicable diseases, suggesting that the current environment could be welfare-reducing.
    Keywords: neuroeconomics, evolution of preferences, self-control
    JEL: D60 D90 C72 D81
    Date: 2018–07
  15. By: Michele Berardi
    Abstract: Bounded rationality requires assumptions about ways in which rationality is constrained and agents form their expectations. Evolutionary schemes have been used to model beliefs dynamics, with agents choosing endogenously among a limited number of beliefs heuristics according to their relative performance. This work shows that arbitrarily constraining the beliefs space to a ?nite (small) set of possibilities can generate arti?cial equilibria that can be stable under evolutionary dynamics. Only when "enough" heuristics are available, beliefs in equilibrium are not arti?cially constrained. I discuss these ?ndings in light of an alternative approach to modelling beliefs dynamics, namely adaptive learning.
    Date: 2018
  16. By: Bénédicte H. Apouey (PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics)
    Abstract: This article assesses the roles of preferences and expectations on preparation for old age, employing unique data on French individuals aged 50+. The data do not only contain information on the general feeling to prepare for old age and on specific preparation activities in various domains, but also on risk and time attitudes, family and social altruism, and expected disability and longevity. Half of the sample reports preparing for old age. Future orientation emerges as an important predictor of preparation. While risk attitudes and altruism also matter for preparation, their effect may be less systematic across outcomes than that of general future orientation. Individuals who expect to become disabled or to live longer are more likely to prepare for old age. Policies promoting healthy aging should include messages targeting present-oriented individuals and try to make people more future-oriented.
    Keywords: expected longevity,altruism,Preparation for old age,risk aversion,time preference
    Date: 2017–11
  17. By: Andreas Irmen ( - Université du Luxembourg, PSE - Paris School of Economics, CESifo - CESifo - Munich, PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique)
    Abstract: At least since 1870 hours worked per worker declined and real wages increased in many of today's industrialized countries. The dual nature of technological progress in conjunction with a consumption-leisure complementarity explains these stylized facts. Technological progress drives real wages up and expands the amount of available consumption goods. Enjoying consumption goods increases the value of leisure. Therefore, individuals demand more leisure and supply less labor. This mechanism appears in an OLG-model with two-period lived individuals equipped with per-period utility functions of the generalized log-log type proposed by Boppart-Krusell (2016). The optimal plan is piecewise defined and hinges on the wage level. Technological progress moves a poor economy out of a regime with low wages and an inelastic supply of hours worked into a regime where wages increase further and hours worked continuously decline.
    Keywords: Technological Change,Capital Accumulation,Endogenous Labor Supply,OLG-model
    Date: 2017–12
  18. By: Hitoshi Matsushima (Faculty of Economics, The University of Tokyo)
    Abstract: This study investigates a timing game with irrational types; each player selects a time in a fixed time interval, and the player who selects the earliest time wins the game. We assume the possibility of irrational types in that each player is irrational with a positive probability, thus selecting the terminal time. We show that there exists the unique Nash equilibrium; according to it, every player never selects the initial time. As an application, we analyze a strategic aspect of leverage-driven bubbles; even if a company is unproductive, its stock price grows up according to an exogenous reinforcement pattern. During the bubble, this company is willing to raise huge funds by issuing new shares. We regard players as arbitrageurs, who decide whether to ride the bubble or burst it. We demonstrate two models, which are distinguished by whether crash-contingent claim, i.e., contractual agreement such that the purchaser of this claim receives a promised monetary amount from its seller if and only if the bubble crashes, is available. The availability of this claim deters the bubble; without crash-contingent claim, the bubble emerges and persists even if the degree of reinforcement is insufficient. Without crash-contingent claim, high leverage ratio fosters the bubble, while with crash-contingent claim, it rather deters the bubble.
    Date: 2018–06

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