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on Utility Models and Prospect Theory |
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Issue of 2018‒10‒22
fifteen papers chosen by |
| By: | William Barnett (Department of Economics, The University of Kansas; Center for Financial Stability, New York City; IC2 Institute, University of Texas at Austin); Qing Han (Department of Economics, University of Kansas); Jianbo Zhang (Department of Economics, University of Kansas) |
| Abstract: | A central tenet of behavioral economics is that the axioms producing expected utility maximization by consumers are too strong to be descriptive of rational behavior. The existing theory of monetary services aggregation under risk assume expected utility maximization. We extend those results to uncertainty under weaker axiomatic assumptions by using Choquet expectations. Choquet integration reduces to Riemann integration as a special case under the stronger assumption of additive probability measure, not accepted in the literature on behavioral economics. Our theoretical results on monetary services aggregation are generalizations of prior results, nested as special cases of our results under stronger behavioral assumptions. |
| Keywords: | Uncertainty Aversion, User Cost, Choquet Expectation, Monetary Aggregation. |
| JEL: | E41 G12 C43 |
| Date: | 2018–08 |
| URL: | http://d.repec.org/n?u=RePEc:kan:wpaper:201806&r=upt |
| By: | Victor H. Aguiar; Nail Kashaev |
| Abstract: | A long-standing question about consumer behavior is whether individuals' observed purchase decisions satisfy the revealed preference (RP) axioms of the utility maximization theory (UMT). Researchers using survey or experimental panel data sets on prices and consumption to answer this question face the well-known problem of measurement error. We show that ignoring measurement error in the RP approach may lead to overrejection of the UMT. To solve this problem, this paper proposes a new statistical RP framework for consumption panel data sets that allows for testing the UMT in the presence of measurement error. Our test is applicable to all consumer models that can be characterized by their first-order conditions. Our approach is nonparametric, allows for unrestricted heterogeneity in preferences, and requires only a centering condition on measurement error. We develop two applications that provide new evidence about the UMT. First, we find support in a survey dataset for the dynamic and time-consistent UMT in single-individual households, in the presence of \emph{nonclassical} measurement error in consumption. In the second application, we cannot reject the static UMT in a widely used experimental dataset where measurement error in prices is assumed to be the result of price misperception due to the experimental design. The first finding stands in contrast to the conclusions drawn from the deterministic RP test of Browning (1989). The second finding reverses the conclusions drawn from the deterministic RP test of Afriat (1967) and Varian (1982) |
| Date: | 2018–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1810.05287&r=upt |
| By: | Emmanuelle Gabillon |
| Abstract: | This paper is a contribution to regret theory, which we generalize in two ways. Since the intensity of regret depends on the information the decision-maker has about the results of the foregone strategies, we build a model of choice which accommodates any feedback structure. We also show that the reference point, which characterizes the regret utility function introduced by Quiggin (1994), does not always represent a feeling of regret. It corresponds to a broader concept, which we call psychological opportunity cost (POC), of which regret is no more than a specific expression. We find behavioral deviations from the predictions of the Expected Utility Theory. We obtain correlation loving, greater reluctance to take on risk and we highlight some harmful effects of information. Our model equally offers a theoretical framework for experimental studies about inaction inertia. |
| Keywords: | choice, correlation loving, emotion, inaction inertia, information, regret. |
| JEL: | D03 D81 D82 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:grt:wpegrt:2018-18&r=upt |
| By: | Anand, Mohit; Miao, Ruiqing; Khanna, Madhu |
| Abstract: | This paper investigates farmers’ willingness to grow bio-energy crops (namely, miscanthus and switchgrass) while accounting for their preferences toward loss. We model a representative farmer’s optimal land allocation problem between conventional crops and bio-energy crops by employing the prospect theory. Numerical simulation is conducted for 1,919 U.S. counties east of the 100th Meridian that have yield data for corn and for at least one bio-energy crop. Results show that all else equal, if farmers are credit constrained then accounting for loss aversion will decrease the miscanthus production but increase switchgrass production. If farmers are not credit constrained, however, then accounting for loss aversion only has small impact on bio-energy crop production, indicating that the availability of credit mitigates the effect of farmers’ loss preferences. We also find that biomass production on marginal land is less sensitive to farmers’ loss aversion than production on high quality land is, which underscores the importance of marginal land in providing biomass for the bio-energy and bio-product sector. Moreover, results show that impact of loss aversion is smaller when interest rate is low as compare to scenarios under which interest rate is high. Geographical configuration of biomass production under various loss aversion, credit constraint, and interest rate scenarios are examined as well. |
| Keywords: | Production Economics, Risk and Uncertainty |
| Date: | 2018–01–04 |
| URL: | http://d.repec.org/n?u=RePEc:ags:saea18:266326&r=upt |
| By: | Eran Hanany (Faculty of Engineering, Tel Aviv University); Peter Klibanoff (Department of Managerial Economics and Decision Sciences, Kellogg School of Management, North-western University); Sujoy Mukerji (Queen Mary University of London) |
| Abstract: | We study incomplete information games with ambiguity averse players. Our focus is on equilibrium concepts satisfying sequential optimality each player's strategy is optimal at each information set given opponents' strategies. We show sequential optimality, which does not make any explicit assumption on updating, is equivalent to sequential optimality with respect to beliefs updated using a particular generalization of Bayesian updating. Ambiguity aversion expands the set of equilibria compatible with players sharing common ambiguous beliefs. We connect ambiguity aversion with belief robustness. Examples illustrate new strategic behavior, including strategic use of ambiguity, under ambiguity aversion. |
| Keywords: | Ambiguity aversion, dynamic games, incomplete information, multi-stage games, sequential optimality, sequential equilibrium with ambiguity, ambiguous strategies, smooth ambiguity model |
| JEL: | C72 D82 D81 |
| Date: | 2018–09–13 |
| URL: | http://d.repec.org/n?u=RePEc:qmw:qmwecw:868&r=upt |
| By: | Wiktor Budziński (University of Warsaw, Faculty of Economic Sciences); Mikołaj Czajkowski (University of Warsaw, Faculty of Economic Sciences) |
| Abstract: | We investigate the problem of endogeneity in the context of hybrid choice (integrated choice and latent variable) models. We first provide a thorough analysis of potential causes of endogeneity and propose a working taxonomy. We demonstrate that although it is widely believed that the hybrid choice framework is devoid of the endogeneity problem, there is no theoretical reason to expect that this is the case. We then demonstrate empirically that the problem exists in the hybrid choice framework too. By conducting a Monte Carlo experiment, we display the extent of the bias resulting from measurement and endogeneity biases. Finally, we propose two novel solutions to address the problem: by explicitly accounting for correlation between structural and discrete choice component error terms (or with random parameters in a utility function), or by introducing additional latent variables. Using simulated data, we demonstrate that these approaches work as expected, that is, they result in unbiased estimates of all model parameters. |
| Keywords: | hybrid choice models, endogeneity, measurement bias, attitudinal variables, indicators |
| JEL: | C35 C51 Q51 R41 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:war:wpaper:2018-20&r=upt |
| By: | Anna Conte; John D. Hey |
| Abstract: | The Random Utility Model (RUM) and the Random Preference Model (RPM) are important tools in the economist’s toolbox when estimating preference functionals from experimental data. In an important recent paper in this journal, Apesteguia and Ballester (2018) cautioned decision theorists against using the RUM, suggesting that the RPM may be preferable. This short note comments on this paper, and concludes that RUM does not suffer from the drawbacks suggested in their paper. |
| Date: | 2018–10 |
| URL: | http://d.repec.org/n?u=RePEc:yor:yorken:18/12&r=upt |
| By: | Quainoo, Ruth; Petrolia, Daniel |
| Abstract: | Hypothetical bias continues to be a challenge for practitioners of stated preference methods, and various remedies have been proposed to mitigate the problem. This paper presents the background, theory, and experimental design for testing two novel hypothetical bias mitigation treatments in the context of a contingent-valuation survey focused on a beach conditions monitoring service for Gulf Coast beachgoers. The two treatments proposed are: 1) a multiple-question budget and substitutes treatment, and 2) a cheap talk with confirmation treatment, to be tested both independently and in tandem. We present a theoretically-consistent model of budget-constrained utility maximization which accounts for the respondents’ subjective probability of a good beach trip with and without the beach conditions information. Data are to be collected via an online referendum-style valuation questionnaire sent to a randomly-selected sample of Gulf Coast households. Along with referendum responses and subjective probabilities, other information elicited from the respondents will include beach visit frequency, beach activities engaged in, knowledge of existing monitoring services, and specific beach conditions of interest. |
| Keywords: | Environmental Economics and Policy |
| Date: | 2018–01–16 |
| URL: | http://d.repec.org/n?u=RePEc:ags:saea18:266715&r=upt |
| By: | Thibault Fally |
| Abstract: | This paper examines demand systems where the demand for a good depends only on its own price, consumer income, and a single aggregator synthesizing information on all other prices. This generalizes directly-separable preferences where the Lagrange multiplier provides such an aggregator. As indicated by Gorman (1972), symmetry of the Slutsky substitution terms implies that such demand can take only one of two simple forms. Conversely, here we show that only weak conditions ensure that such demand systems are integrable, i.e. can be derived from the maximization of a well-behaved utility function. This paper further studies useful properties and applications of these demand systems. |
| JEL: | D11 D40 L13 |
| Date: | 2018–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:25025&r=upt |
| By: | Bloedel, Alex (Stanford University); Krishna, R. Vijay (Florida State University); Leukhina, Oksana (Federal Reserve Bank of St. Louis) |
| Abstract: | We study optimal insurance contracts for an agent with Markovian private information. Our main results characterize the implications of constrained efficiency for long-run welfare and inequality. Under minimal technical conditions, there is Absolute Immiseration: in the long run, the agent’s consumption and utility converge to their lower bounds. When types are persistent and utility is unbounded below, there is Relative Immiseration: low-type agents are immiserated at a faster rate than high-type agents, and “pathwise welfare inequality” grows without bound. These results extend and substantially generalize the hallmark findings from the classic literature with iid types, suggesting that the underlying forces are robust to a broad class of private information processes. The proofs rely on novel recursive techniques and martingale arguments. When the agent has CARA utility, we also analytically and numerically characterize the short-run properties of the optimal contract. Persistence gives rise to qualitatively novel short-run dynamics and allocative distortions (or “wedges”) and, quantitatively, induces less efficient risk-sharing. We compare properties of the wedges to their counterparts in the dynamic taxation literature. |
| Keywords: | Absolute immiseration; relative immiseration; dynamic contracting; recursive contracts; principal-agent problem; persistent private information. |
| JEL: | C73 D30 D31 D80 D82 E61 |
| Date: | 2018–09–07 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2018-020&r=upt |
| By: | Chavez, Daniel E.; Palma, Marco A.; Nayga Jr., Rodolfo M. |
| Abstract: | The proneness of stated preference choice experiments to hypothetical bias has increased the popularity of incentivized or real discrete choice experiments (RDCE). One challenge that practitioners face when designing RDCE is that some of the product alternatives may not be available for the study. To avoid deception, researchers should truthfully inform respondents that only a certain percentage of the product alternatives is available for the experiment. But would the proportion of available products influence the results of the RDCE? Using an induced value choice experiment, we varied the number of potentially binding alternatives in four treatments: 0%, 33%, 66%, and 100% to assess the effect of availability of product alternatives on choice behavior. We designed the induced value experiment with a profit maximization optimal strategy for agents (i.e., with a unique known profit-maximizing alternative). Our results suggest that incentives matter in that the percentage of optimal choices was lowest in the 0% treatment. Interestingly, however, we did not find statistically significant differences in amount of optimal choices in the 33%, 66%, and 100% treatments, suggesting that one could conduct an incentivized RDCE without the need to have all the product alternatives be made available in the study. |
| Keywords: | Institutional and Behavioral Economics, Marketing |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:ags:saea18:266327&r=upt |
| By: | Nathaniel T. Wilcox (Economics Science Institute, Chapman University) |
| Abstract: | Experimental and behavioral economists, as well as psychologists, commonly assume conditional independence of choices when constructing likelihood functions for structural estimation. I test this assumption using data from a new experiment designed for this purpose. Within the limits of the experiment’s identifying restriction and designed power to detect deviations from conditional independence, conditional independence is not rejected. In naturally occurring data, concerns about violations of conditional independence are certainly proper and well-taken (for well-known reasons). However, when an experimenter employs contemporary state-of-the-art experimental mechanisms and designs, the current evidence suggests that conditional independence is an acceptable assumption for analyzing data so generated. |
| Keywords: | Alternation, Conditional Independence, Choice Under Risk, Discrete Choice, Persistence, Random Lottery Incentive, Random Lottery Selection, Random Problem Selection, Random Round Payoff |
| JEL: | C22 C25 C91 D81 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:chu:wpaper:18-08&r=upt |
| By: | Bansal, Avijit; Jacob, Joshy |
| Abstract: | Recent studies, in experimental markets, have illustrated the incremental influence of price path on investor decisions. We empirically demonstrate that the nature of price path significantly impacts the degree of disposition bias, after controlling for the level of returns and volatility, with investor-level high-frequency trade data from the commodities futures market. We find that following the experience of a favourable (unfavourable) price path, disposition bias among traders with Prospect Theory preferences declines (increases). Disposition bias in the market declines (increases) as an outcome of the decline (increase) in the propensity for gain realization, accompanied by a concurrent increase (decline) in the propensity for loss realization among traders. Our findings imply that the investor preferences, as well as their beliefs about the future price movements, inferred from the experienced price path, jointly influence their trading decisions. |
| Date: | 2018–10–15 |
| URL: | http://d.repec.org/n?u=RePEc:iim:iimawp:14593&r=upt |
| By: | Griffin, Bretford; Hartarska, Valentina; Nadolnyak, Denis |
| Abstract: | One of the major demographic trends in the US is the aging of farm operators and landlords suggesting transition of farm ownership in the form of exit and disinvestment. This coincides with economic pressures on farmers’ incomes due to recent market volatility. We model retirement age farmers’ exit/disinvestment as the outcome of intertemporal utility maximization and identify the extent to which economic and demographic factors affect these choices using the Census of Agriculture farm-level data for the 1992-2012 period. Regression results highlight the role of demographic factors. Minority and female farmers are more likely to exit but female operators are less likely to disinvest, while family farms are less likely to exit. High sales farms are less likely to exit but more likely to disinvest possibly targeting a smaller production scale before retirement. The relative size of the non-agricultural economy is negatively associated with exit but positively with disinvestment, while off-farm work reduces exit probability only a little. However, flow economic variables such as return-on-assets and government payments do not seem to impact exit and disinvestment. These findings are largely consistent with the view that mainly demographic factors and size determine farmers’ decisions to retire, which has important policy implications. |
| Date: | 2018–01–01 |
| URL: | http://d.repec.org/n?u=RePEc:ags:saea18:266616&r=upt |
| By: | Rachappa Shette (Indian Institute of Management Kozhikode) |
| Abstract: | The present study examine whether Indian corporates undertake earnings management methods to avoid earnings losses. First, this paper provides evidence that firms manage reported earnings to avoid losses in India. Second, the results indicate that two components of earnings, cash from operations and changes in working capital, are used to achieve increases in earnings. The robustness of the results is examined under various scenarios. The results are consists with existing literature. The present study support two theories based on stakeholder’s use of informationprocessing heuristics and prospect theory about the motivation for avoidance of earnings losses. The results are useful to regulators, investors and financial analysts |
| Keywords: | Social enterprises, |
| Date: | 2018–02 |
| URL: | http://d.repec.org/n?u=RePEc:iik:wpaper:255&r=upt |