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on Utility Models and Prospect Theory |
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Issue of 2018‒09‒03
twenty-six papers chosen by |
| By: | Robert Becker (Indiana University); Juan Pablo Rincon-Zapatero (Universidad Carlos III de Madrid) |
| Abstract: | We reconsider the theory of Thompson aggregators proposed by Mari-nacci and Montrucchio [30]. We demonstrate the Koopmans equation has a unique utility function solution given a Thompson aggregator. Uniqueness holds only on the interior of the commodity spaces positive cone. Our proof veri es the Koopmans operator is a u0 concave operator. We verify this using general sufficient conditions due to Liang, et al [28]. Previous published results apply variants of the contraction mapping theorem to the space of possibly utility functions endowed with the Thompson metric. Concave operator methods work on the possible utility function space with its norm topology. Our approach combines order and metric structures to demonstrate uniqueness differently than in the existing literature. |
| Keywords: | Recursive Utility, Thompson Aggregators, Koopmans Equation, u0 Concave Operator Theory |
| Date: | 2018–08 |
| URL: | http://d.repec.org/n?u=RePEc:inu:caeprp:2018008&r=upt |
| By: | Gilboa, Itzhak; Minardi, Stefania; Samuelson, Larry |
| Abstract: | We offer a model that combines and generalizes case-based decision theory and expected utility maximization. It is based on the premise that an agent looks ahead and assesses possible future scenarios, but may not know how to evaluate their likelihood and may not be sure that the set of scenarios is exhaustive. Consequently, she also looks back at her memory for past cases, and makes decisions so as to maximize a combined function, taking into account both scenarios and cases. We allow for non-additive set functions, both over future scenarios and over past cases, to capture (i) incompletely specified or unforeseen scenarios, (ii) ambiguity, (iii) the absence of information about counterfactuals, and (iv) some forms of case-to-rule induction ("abduction") and statistical inference. We axiomatize this model. Learning in this model takes several forms, and, in particular, changes the relative weights of the two forms of reasoning. |
| Keywords: | Decisions Under Uncertainty; decision theory |
| JEL: | A10 |
| Date: | 2017–03–17 |
| URL: | http://d.repec.org/n?u=RePEc:ebg:heccah:1200&r=upt |
| By: | Christian Tarsney |
| Abstract: | The principle that rational agents should maximize expectations is intuitively plausible with respect to many ordinary cases of decision-making under uncertainty. But it becomes increasingly implausible as we consider cases of more extreme, low-probability risk (like Pascal's Mugging), and intolerably paradoxical in cases like the St. Petersburg Lottery and the Pasadena Game. In this paper I show that, under certain assumptions, stochastic dominance reasoning can capture many of the plausible implications of expectational reasoning while avoiding its implausible implications. More specifically, when an agent starts from a condition of background uncertainty about the choiceworthiness of her options representable by a probability distribution over possible degrees of choiceworthiness with exponential or heavier tails and a sufficiently large scale parameter, many expectation-maximizing gambles that would not stochastically dominate their alternatives "in a vacuum" turn out to do so in virtue of that background uncertainty. Nonetheless, even under these conditions, stochastic dominance will generally not require agents to accept extreme gambles like Pascal's Mugging or the St. Petersburg Lottery. I argue that the sort of background uncertainty on which these results depend is appropriate for any agent who assigns normative weight to aggregative consequentialist considerations, i.e., who measures the choiceworthiness of an option in part by the total amount of value in the resulting world. At least for such agents, then, stochastic dominance offers a plausible general principle of choice under uncertainty that can explain more of the apparent rational constraints on such choices than has previously been recognized. |
| Date: | 2018–07 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1807.10895&r=upt |
| By: | Luis Ballesteros; Howard Kunreuther |
| Abstract: | In line with the fallacy of riskification of uncertainty by which decision makers believe that the effects of unpredictable phenomena can be captured accurately by probability distributions, organizational scholars commonly treat the organizational inefficiency in dealing with uncertainty shocks—exogenous hazards whose welfare effects spread across industries and markets, such as natural disasters, terrorist attacks, and financial crises—as a problem of risk management. This is problematic because the consequences of uncertainty shocks outstrip the predictability capacity for the average manager and entail a greater complexity of internal and external factors. Moreover, their uniqueness makes translating experience into learning far more difficult. We seek to address this inadequate approach with a theoretical framework that captures the multidimensional complexity of organizations preparing for, coping with, and recovering from exogenous uncertain disruption. We bring together the literatures on cognitive psychology that suggest that biases and heuristics drive behavior under uncertainty, a Neo-Carnegie perspective that indicates that organizational structure and strategy regulate these behavioral factors, and institutional theory that points to stakeholder and institutional dynamics affecting economic incentives to invest in prevention and business continuity. Taken together, this article offers the foundation for a behaviorally plausible, decision-centered perspective on organizational decision-making under uncertainty. |
| JEL: | D01 D03 D81 F23 L2 L22 |
| Date: | 2018–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:24924&r=upt |
| By: | Bonein, Aurélie; Turolla, Stéphane |
| Abstract: | Motivated by recent research on product differentiation, we conduct laboratory experiments to study how (aggregate) demand uncertainty influences location choices and price competition in the original Hotelling (1929)’s model. We provide new predictions on the effect of risk attitudes on both decisions under demand uncertainty and confront them with the data. Our experimental results support the predictions that demand uncertainty acts as a differentiation force for risk-neutral and risk-lover subjects. By contrast, we do not verify that demand uncertainty leads risk-averse subjects to agglomerate. This is explained primarily by learning effects and heterogeneous behaviors within this risk profile. Finally, we observe various price-setting behaviors, ranging from an attempt to collude to a price war, depending on the level of differentiation. |
| Keywords: | International Relations/Trade |
| Date: | 2017–12–20 |
| URL: | http://d.repec.org/n?u=RePEc:ags:inrasl:266260&r=upt |
| By: | Peyman Khezr (School of Economics, University of Queensland, Brisbane, Australia); Shabbir Ahmad (UQ Business School, University of Queensland, Brisbane, Australia) |
| Abstract: | This paper investigates the behavior of ‘buyers’ in the Sydney housing market when they purchase homes. The literature suggests that when individuals evaluate their utilities in an uncertain situation, they may use a reference point as an anchor. We suggest that asking prices in the housing market could act as reference points or anchors and affect the utility buyers receive from buying properties. We note that the other role of the asking price is to signal unobserved characteristics of properties to buyers. In this study, we separate these two effects and empirically investigate the implications on the final price of properties with data on the Sydney housing market. We found strong evidence of anchoring behavior by buyers in this market. |
| Keywords: | Reference dependence; anchoring; asking price; housing market. |
| JEL: | D80 R30 D12 |
| URL: | http://d.repec.org/n?u=RePEc:qld:uq2004:596&r=upt |
| By: | Nicholas C. Barberis |
| Abstract: | Behavioral finance tries to make sense of financial data using models that are based on psychologically accurate assumptions about people's beliefs, preferences, and cognitive limits. I review behavioral finance approaches to understanding asset prices and trading volume, with particular emphasis on three types of models: extrapolation-based models, models of overconfident beliefs, and models of gain-loss utility inspired by prospect theory. The research to date shows that a few simple assumptions about investor psychology capture a wide range of facts about prices and volume and lead to concrete new predictions. I end by speculating about the form that a unified psychology-based model of investor behavior might take. |
| JEL: | G11 G12 |
| Date: | 2018–06 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:24723&r=upt |
| By: | Kaylen, Michael S.; Preckel, Paul; Loehman, Edna |
| Keywords: | Risk and Uncertainty |
| URL: | http://d.repec.org/n?u=RePEc:ags:umcowp:256562&r=upt |
| By: | De Sousa, José; Disdier, Anne-Célia; Gaigné, Carl |
| Abstract: | Using firm and industry data, we unveil two empirical regularities: (i) Demand uncertainty not only reduces export probabilities but also decreases export quantities and increases export prices; (ii) The most productive exporters are more affected by higher industry-wide expenditure volatility than are the least productive exporters. We rationalize these regularities by developing a new firm-based trade model wherein managers are risk averse. Higher volatility induces the reallocation of export shares from the most to the least productive incumbents. Greater skewness of the demand distribution and/or higher trade costs weaken this effect. Our results hold for a large class of consumer utility functions. |
| Keywords: | International Relations/Trade |
| Date: | 2017–12–11 |
| URL: | http://d.repec.org/n?u=RePEc:ags:inrasl:265728&r=upt |
| By: | Martin Klein; Marc Deissenroth |
| Abstract: | While investments in renewable energy sources (RES) are incentivized around the world, the policy tools that do so are still poorly understood, leading to costly misadjustments in many cases. As a case study, the deployment dynamics of residential solar photovoltaics (PV) invoked by the German feed-in tariff legislation are investigated. Here we report a model showing that the question of when people invest in residential PV systems is found to be not only determined by profitability, but also by profitability's change compared to the status quo. This finding is interpreted in the light of loss aversion, a concept developed in Kahneman and Tversky's Prospect Theory. The model is able to reproduce most of the dynamics of the uptake with only a few financial and behavioral assumptions |
| Date: | 2018–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1808.05572&r=upt |
| By: | Jung, Seeun (Inha University, Department of Economics); Vranceanu, Radu (ESSEC Research Center, ESSEC Business School) |
| Abstract: | In a classical experiment, Niederle and Vesterlund (2007) used the dichotomous choice of individuals between a piece rate and a tournament payment scheme as an indication of their propensity to compete. This paper reports results from a two person interaction of a similar type to analyze whether the preference for competition is dependent on the gender of the partner. It introduces a Becker–DeGroot–Marschak mechanism to elicit individual willingness to compete (WTC), defined as the amount of money that makes an individual indifferent between the two compensation schemes. Even when controlling for risk aversion, past performance and overconfidence, the male WTC is e3.30 larger than the female WTC. The WTC instrument allows for a more precise analysis of the impact of the partner's gender on the taste for competition. |
| Keywords: | willingness-to-compete; experiments; gender effect; BDM mechanism |
| JEL: | C91 D03 |
| Date: | 2017–01 |
| URL: | http://d.repec.org/n?u=RePEc:ebg:essewp:dr-17001&r=upt |
| By: | Hitoshi Matsushima (Faculty of Economics, 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 |
| URL: | http://d.repec.org/n?u=RePEc:cfi:fseres:cf439&r=upt |
| 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, Money metric utility, |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:vuw:vuwcpf:7626&r=upt |
| By: | Weinem, Michael |
| Abstract: | Pascal's wager game showed that the atheistic view is always inferior compared to the theistic. The reason is that an infinitely high reward for the theist is always opposed to a finite payoff for the atheist, given that the existence of God cannot be excluded. However, an atheist can also obtain the infinite reward just by choosing strategy "believe", i.e. by pretending faith, but without really believing. As God may be demanding and grants the reward only those in firm faith, the inspection of faith by God is needed, which is included in the present analysis, i.e. God tests the faith. In addition, the infinitely high reward is removed from the payoffs, i.e. the believer goes out empty, and is even charged cost of faith. It shows that believing in God and worshipping is still the best option regardless, even if we believe that praying is in vain and has absolutely no value. The analysis also shows that the faith should even be so strong that we give our entire life to God and retain nothing for us since this is not only the safe rescue, but the rationally optimal choice of the extent of worship, and thus the unique salvation. Finally, all common criticisms to the wager game have been reinvestigated in detail; logic and mathematical analysis showed that they fail against the consideration of eternal punishment. |
| Keywords: | Theism, atheism, proof, faith, God, prayer, decision theory |
| JEL: | C00 |
| Date: | 2018–04–12 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:87458&r=upt |
| By: | Oded Stark, Grzegorz Kosiorowski, and Marcin Jakubek |
| Abstract: | A transfer from a richer individual to a poorer one seems to be the most intuitive and straightforward way of reducing income inequality in a society. However, can such a transfer reduce the welfare of the society? We show that a rich-to-poor transfer can induce a response in the individuals’ behaviors which actually exacerbates, rather than reduces, income inequality as measured by the Gini index. We use this result as an input in assessing the social welfare consequence of the transfer. Measuring social welfare by Sen’s social welfare function, we show that the transfer reduces social welfare. These two results are possible even for individuals whose utility functions are relatively simple (namely, at most quadratic in all terms) and incorporate a distaste for low relative income. We first present the two results for a population of two individuals. We subsequently provide several generalizations. We show that our argument holds for a population of any size, and that the choice of utility functions which trigger this response is not singular - the results obtain for an open set of the space of admissible utility functions. In addition, we show that a rich-to-poor transfer can exacerbate inequality when we employ Lorenz-domination, and that it can decrease social welfare when we draw on any increasing, Schur-concave welfare function. |
| Keywords: | Public Economics |
| Date: | 2017–09–29 |
| URL: | http://d.repec.org/n?u=RePEc:ags:ubzefd:264176&r=upt |
| By: | Ori Heffetz |
| Abstract: | What explains the mixed evidence from laboratory tests of Kőszegi and Rabin’s (2006 and later) model of expectations-based reference-dependent preferences? We investigate one hypothesis: to become (behavior-affecting) reference points, probability beliefs have to sink in—being merely lagged, as the theory requires, is not sufficient. Past experiments with conflicting findings exogenously endowed subjects with beliefs that were equally lagged, but possibly unequally sunk-in. In four experiments, whose designs replicate past KR-nonsupporting experiments, we add new sink-in manipulations that endow individuals with additional, visual/physical probability impressions. Our findings are more KR-supporting in an endowment-effect setting but not in an effort-provision setting. |
| JEL: | D12 D84 D91 J22 |
| Date: | 2018–06 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:24721&r=upt |
| By: | Creedy, John; Gemmell, Norman |
| Abstract: | This paper examines the effect on the elasticity of taxable income for individuals in couples, where there is no income splitting for tax purposes but joint decisions are taken regarding taxable incomes. Two approaches are considered. First, the effects of minimising the total tax increase arising from a marginal rate increase are examines. Second, the paper considers the effects of joint utility maximisation. |
| Keywords: | Income taxation, Taxable income, Elasticity of taxable income, |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:vuw:vuwcpf:7615&r=upt |
| By: | Stark, Oded |
| Abstract: | We study the relative risk aversion of an individual with particular social preferences: his wellbeing is influenced by his relative wealth, and by how concerned he is about having low relative wealth. Holding constant the individual’s absolute wealth, we obtain two results. First, if the individual’s level of concern about low relative wealth does not change, the individual becomes more risk averse when he rises in the wealth hierarchy. Second, if the individual’s level of concern about low relative wealth intensifies when he rises in the wealth hierarchy and if, in precise sense, this intensification is strong enough, then the individual becomes less risk averse: the individual’s desire to advance further in the wealth hierarchy is more important to him than possibly missing out on a better rank. |
| Keywords: | Financial Economics, Risk and Uncertainty |
| Date: | 2018–05–29 |
| URL: | http://d.repec.org/n?u=RePEc:ags:ubzefd:273146&r=upt |
| By: | Calisto Guambe; Rodwell Kufakunesu; Gusti Van Zyl; Conrad Beyers |
| Abstract: | We study an asset allocation stochastic problem with restriction for a defined-contribution pension plan during the accumulation phase. We consider a financial market with stochastic interest rate, composed of a risk-free asset, a real zero coupon bond price, the inflation-linked bond and the risky asset. A plan member aims to maximize the expected power utility derived from the terminal wealth. In order to protect the rights of a member who dies before retirement, we introduce a clause which allows to withdraw his premiums and the difference is distributed among the survival members. Besides the mortality risk, the fund manager takes into account the salary and the inflation risks. We then obtain closed form solutions for the asset allocation problem using a sufficient maximum principle approach for the problem with partial information. Finally, we give a numerical example. |
| Date: | 2018–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1808.06337&r=upt |
| By: | Costanigro, Marco; Onozaka, Yuko |
| Abstract: | We develop a methodology addressing the issue of confounded beliefs and preferences in models of discrete choice. First, we formalize the theoretical framework and logical underpinnings of a belief-preference model of choice for experience and credence goods, where subjective beliefs relate to uncertain product quality. Then, we present the experimental procedure within the context of an online choice experiment studying consumer food preferences. The empirical strategy leverages information from a quality sorting task to identify and estimate beliefs, while choice data are used to recover preferences. By conditioning product choices on predicted quality perceptions, the issue of endogenous beliefs is resolved. |
| Keywords: | Institutional and Behavioral Economics |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:ags:csdawp:276053&r=upt |
| By: | Audrey Hu (Department of Economics, City University of Hong Kong); Steven Matthews (Department of Economics, University of Pennsylvania); Liang Zou (Department of Economics, University of Amsterdam) |
| Abstract: | Received auction theory prescribes that a reserve price which maximizes expected profit should be no less than the seller's own value for the auctioned object. In contrast, a common empirical observation is that many auctions have reserve prices set below seller's values, even at zero. This paper revisits the theory to find a potential resolution of the puzzle for second-price auctions. The main result is that an optimal reserve price may be less than the seller's value if bidders are risk averse and have interdependent values. Moreover, the resulting outcome may be arbitrarily close to that of an auction that has no reserve price, an absolute auction. |
| Keywords: | reserve price, risk aversion, interdependent values, second-price auction |
| JEL: | D44 D82 |
| Date: | 2017–03–13 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:17-004&r=upt |
| By: | Blacklow, Paul (Tasmanian School of Business & Economics, University of Tasmania); Corman, Amy Beth (Deparment of Economics, University of Melbourne); Sibly, Hugh (Tasmanian School of Business & Economics, University of Tasmania) |
| Abstract: | People enjoy judging and receiving the approval of others. They may modify their behaviour in costly ways to obtain such approval. This paper presents an experiment in which some participants can, at a cost, appear to others to have a better performance on a real effort task than they really do. The only motivation for such an action is esteem seeking. The provision of esteem is also recorded. We measure esteem seeking when participants are facing both high and low performing partners. We model our experiment theoretically: individuals generate income party to undertake consumption but also partly to gain esteem. Our results are consistent with theory: those with low marginal utility of consumption engage in esteem seeking. |
| Keywords: | Esteem, Image, Laboratory Experiment |
| JEL: | C92 D91 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:tas:wpaper:27693&r=upt |
| By: | Sproul, Thomas W.; Michaud, Clayton P. |
| Keywords: | Risk and Uncertainty |
| Date: | 2017–04–01 |
| URL: | http://d.repec.org/n?u=RePEc:ags:scc017:256333&r=upt |
| By: | Phillips,Yvonne |
| Abstract: | Beach recreation value is an important consideration in a cost-benefit analysis of coastal development or conservation. A destination choice-based travel cost analysis is often used to quantify recreation values but the destination choice only partially reflects the intrinsic characteristics of that site. Visitors are influenced by opportunities available at other sites and can visit multiple sites resulting in spatially correlated errors. For this study about the recreation value of beaches on the Coromandel Peninsula we draw on the theory of cumulative attraction to analyse the compatibility of different beaches for the multiple-destination visitors who comprise more than half our sample. We investigate different random utility model formulations to explain destination choice and find that a cross-nested logit with sites nested by availability of amenities explains the observed patterns of visitation well and is more computationally efficient that non-closed-form models such as mixed logit. We also include inverse distance variables to the nearest amenity of each type and their significance supports the tenet of cumulative attraction that the importance of other spaces is greater when the attributes differ. Overall beach recreation values are maximised when sites are diverse in terms of development level and type. |
| Keywords: | Community/Rural/Urban Development, Consumer/Household Economics, Environmental Economics and Policy, Research Methods/ Statistical Methods, Risk and Uncertainty |
| Date: | 2016–08–25 |
| URL: | http://d.repec.org/n?u=RePEc:ags:nzar16:261840&r=upt |
| By: | Giovanni Dosi; Marco Faillo; Luigi Marengo |
| Abstract: | This work challenges the very notion of bounded rationality as dangerously too near to some "unbounded rationality" used as a benchmark. Should we assume that there is an "unbounded" rationality as a benchmark? Should one start, in order to describe and interpret human behaviour, from a model which assumes that we, human beings, have complete and well-defined knowledge of our preferences, all possible states of the world, all possible actions (our "technologies"), the mappings among them, and then look for possible "bounds" and "biases"? Our answer is negative. Rather, the question should be: how do human agents and organizations thereof actually behave in complex and changing environments? Answering this question, we suggest, entails also a significant departure from what is now accepted as behavioural economics, often meant as the analysis of more or less significant deviations from the "Olympic rationality". On the contrary, we suggest, human beings and human organizations behave quite distinctively from the prescriptive model derived from the axioms of rationality. |
| Keywords: | bounded rationality, heuristics, cognition, memory |
| Date: | 2018–08–26 |
| URL: | http://d.repec.org/n?u=RePEc:ssa:lemwps:2018/26&r=upt |
| By: | Christoph Engel (Max Planck Institute for Research on Collective Goods) |
| Abstract: | Behavioral law and economics applies the conceptual tools of behavioral economics to the analysis of legal problems and legal intervention. These models, and the experiments to test them, assume an institution free state of nature. In modern societies, the law’s subjects never see this state of nature. However a rich arrangement of informal and formal institutions creates generalized trust. If individuals are sufficiently confident that nothing too bad will happen, they are freed up to interact with strangers as if they were in a state of nature. This willingness dramatically reduces transaction cost and enables division of labor. If generalized trust can be assumed, simple economic models are appropriate. But they must be behavioral, since otherwise individuals would not want to run the risk of interaction. |
| Date: | 2018–01 |
| URL: | http://d.repec.org/n?u=RePEc:mpg:wpaper:2018_02&r=upt |