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on Utility Models and Prospect Theory |
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Issue of 2018‒12‒10
thirteen papers chosen by |
| By: | Alós-Ferrer, Carlos (University of Konstanz); Fehr, Ernst (University of Zurich); Netzer, Nick (University of Zurich) |
| Abstract: | The ability to uncover preferences from choices is fundamental for both positive economics and welfare analysis. Overwhelming evidence shows that choice is stochastic, which has given rise to random utility models as the dominant paradigm in applied microeconomics. However, as is well known, it is not possible to infer the structure of preferences in the absence of assumptions on the structure of noise. This makes it impossible to empirically test the structure of noise independently from the structure of preferences. Here, we show that the difficulty can be bypassed if data sets are enlarged to include response times. A simple condition on response time distributions (a weaker version of first-order stochastic dominance) ensures that choices reveal preferences without assumptions on the structure of utility noise. Sharper results are obtained if the analysis is restricted to specific classes of models. Under symmetric noise, response times allow to uncover preferences for choice pairs outside the data set, and if noise is Fechnerian, even choice probabilities can be forecast out of sample. We conclude by showing that standard random utility models from economics and standard drift-diffusion models from psychology necessarily generate data sets fulfilling our sufficient condition on response time distributions. |
| Keywords: | revealed preference, random utility models, response times |
| JEL: | D11 D81 D83 D87 |
| Date: | 2018–10 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp11918&r=upt |
| By: | Harin, Alexander |
| Abstract: | A theorem, mathematical method and model are introduced in the present article. Inequalities, allowed and forbidden zones, their relations, consequences, and applications are considered for the expectations of random variables. The method and model are based on the inequalities and zones of the theorem. The article is motivated by the need for theoretical support for the practical analysis performed for the purposes of behavioral economics. |
| Keywords: | probability; variance; noise; bias; measurement; utility theory; prospect theory; behavioral economics; psychology; social sciences; |
| JEL: | C02 C1 D8 D81 D84 |
| Date: | 2018–12–01 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:90326&r=upt |
| By: | Natalya Ayzenberg (Melentiev Energy Systems Institute SB RAS); Igor Bykadorov (Sobolev Institute of Mathematics SB RAS); Sergey Kokovin (National Research University Higher School of Economics) |
| Abstract: | We explore the impact of reciprocal, specific or ad valorem, import tariffs on welfare among N symmetric countries (a free-trade agreement)—using the standard Krugman’s one-sector trade model, with unspecified variable-elasticity preferences (mostly under decreasing elasticity of utility). Without transport costs, any tariff is harmful, a specific import subsidy (export tariff) can be welfare-improving, whereas ad valorem tariffs or subsidies are always harmful. Under transport costs, a small ad valorem tariff can be beneficial; moreover, under sufficiently high transport costs, both kinds of tariffs can be become beneficial. The reason is mitigated distortion: excessive entry under decreasingly elastic utility. |
| Keywords: | transport, tariff |
| JEL: | Z |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:hig:wpaper:204/ec/2018&r=upt |
| By: | Hubert Janos Kiss (Momentum (LD-004/2010) Game Theory Research Group Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences and Department of Economics, Eötvös Loránd University, Budapest, Hungary); Ismael Rodriguez-Lara (Departamento de Teoría e Historia Económica Universidad de Granada); Alfonso Rosa-Garcia (Facultad de Ciencias Jurídicas y de la Empresa, Universidad Católica San Antonio, Murcia, Spain) |
| Abstract: | We study how lines form endogenously in front of banks when depositors differ in their liquidity needs. Our model has two stages. In the first one, depositors choose the level of costly effort they want to exert to arrive early at the bank which determines the order of decisions. In the second stage, depositors decide whether to withdraw or to keep the funds deposited. We consider two different informational environments (simultaneous and sequential) that differ in whether or not depositors can observe the decision of others during the second stage of the game. We show theoretically that the informational environment affects the emergence of bank runs and thus should influence the willingness to rush to the bank. We test the predictions in the lab, where we gather extensive data on individual traits to account for depositors' heterogeneity; e.g. socio-demographics, uncertainty attitudes or personality traits. We find no significant differences in the costly effort to arrive early at the bank neither across the informational environments, nor according to the liquidity needs of the depositors. In the sequential environment, some depositors rush to the bank because they are irrational and do not recognize the benefits of observability in fostering the coordination on the no-bank run outcome. There is also evidence that some depositors rush to keep their funds deposited and to facilitate coordination on the efficient outcome. Finally, we document that loss aversion is an important factor in the formation of the line. |
| Keywords: | bank runs, coordination problems, endogenous formation of lines, loss aversion, risk aversion, experimental economics, game theory, sequential games, simultaneous games |
| JEL: | C91 D03 D8 G02 J16 |
| Date: | 2018–10 |
| URL: | http://d.repec.org/n?u=RePEc:has:discpr:1826&r=upt |
| By: | Douadia Bougherara (LAMETA - Laboratoire Montpelliérain d'Économie Théorique et Appliquée - UM1 - Université Montpellier 1 - UM3 - Université Paul-Valéry - Montpellier 3 - Montpellier SupAgro - Centre international d'études supérieures en sciences agronomiques - INRA Montpellier - Institut national de la recherche agronomique [Montpellier] - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique - Montpellier SupAgro - Institut national d’études supérieures agronomiques de Montpellier); Laurent Piet (SMART - Structures et Marché Agricoles, Ressources et Territoires - INRA - Institut National de la Recherche Agronomique - AGROCAMPUS OUEST) |
| Abstract: | A growing number of studies in finance and economics seek to explain insurance choices us- ing the assumptions advanced by behavioral economics. One recent example in agricultural economics is the use of cumulative prospect theory (CPT) to explain farmer choices regarding crop insurance coverage levels (Babcock, 2015). We build upon this framework by deriving willingness to pay (WTP) for insurance programs under alternative assumptions, thus extend- ing the model to incorporate farmer decisions regarding whether or not to purchase insurance. Our contribution is twofold. First, we study the sensitivity of farmer WTP for crop insurance to the inclusion of CPT parameters. We find that loss aversion and probability distortion in- crease WTP for insurance while risk aversion decreases it. Probability distortion in losses plays a particularly important role. Second, we study the impact of yield distribution skewness on farmer WTP assuming CPT preferences. We find that WTP decreases when the distribution of yields moves from negatively- to positively-skewed and that the combined effect of proba- bility weighting in losses and skewness has a large negative impact on farmer WTP for crop insurance. |
| Abstract: | Un nombre croissant d'études en finance et en économie cherchent à expliquer les choix d'assu- rance à partir des hypothèses formulées par l'économie comportementale. Un exemple ré- cent en économie agricole utilise la théorie des perspectives cumulées (ou CPT pour "cu- mulative prospect theory") pour expliquer les choix des agriculteurs en matière de niveau de franchise d'une assurance récolte (Babcock, 2015). Nous étendons cette étude en dérivant le consentement à payer pour le contrat d'assurance proposé sous différentes hypothèses alter- natives, enrichissant ainsi le modèle en y intégrant la décision des agriculteurs d'acheter ou non l'assurance. Notre contribution est double. Premièrement, nous étudions la sensibilité du consentement à payer des agriculteurs vis-à-vis des différents paramètres définissant le cadre théorique CPT. Nous trouvons que l'aversion à la perte et la distorsion des probabilités aug- mentent le consentement à payer alors que l'aversion au risque le fait baisser. En particulier, la distorsion des probabilités dans le domaine des pertes joue un rôle prépondérant. Deuxième- ment, nous étudions l'impact de l'asymétrie de la distribution des rendements sur le consente- ment à payer d'agriculteurs dont les préférences sont supposées être CPT. Nous trouvons que le consentement à payer diminue lorsque l'asymétrie de la distribution passe de négative à pos- itive, et que l'effet combiné de la pondération des probabilités dans le domaine des pertes et de l'asymétrie des rendements fait fortement baisser le consentement à payer des agriculteurs pour l'assurance récolte. |
| Keywords: | crop insurance,cumulative prospect theory,premium subsidy,Skewness,théorie des perspectives cumulées,subvention de la prime d’assurance,assurance récolte |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-01911611&r=upt |
| By: | Salamanca, Andrés (Department of Business and Economics) |
| Abstract: | In this paper, we introduce a solution concept generalizing the Harsanyi non-transferable utility (NTU) value to cooperative games with incomplete information. The so-defined S-solution is characterized by virtual utility scales that extend the Harsanyi-Shapley fictitious weighted utility transfer procedure. We construct a three-player cooperative game in which Myerson’s [Cooperative games with incomplete information. Int. J. Game Theory, 13, 1984, pp. 69-96] generalization of the Shapley NTU value does not capture some “negative” externality generated by the adverse selection. However, when we explicitly compute the S-solution in this game, it turns out that it prescribes a more intuitive outcome which takes into account the above mentioned informational externality. |
| Keywords: | Cooperative games; incomplete information; virtual utility |
| JEL: | C71 C78 D82 |
| Date: | 2018–11–25 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:sdueko:2018_005&r=upt |
| By: | Pierlauro Lopez; David Lopez-Salido; Francisco Vazquez-Grande o |
| Abstract: | We propose a simple risk-adjusted linear approximation to solve a large class of dynamic models with time-varying and non-Gaussian risk. Our approach generalizes lognormal affine approximations commonly used in the macro-finance literature and can be seen as a first-order perturbation around the risky steady state. Therefore, we unify coexisting theories of risk-adjusted linearizations. We provide a formal foundation for approximation methods that remained so far heuristic, and offer explicit formulas for approximate equilibrium objects and conditions for their local existence and uniqueness. Affine approximations are not nested in conventional perturbations of arbitrary order. We apply this technique to models featuring Campbell-Cochrane habits, recursive preferences, and time-varying disaster risk. The proposed affine approximation performs similarly to global solution methods in many applications; risk pricing is accurate at all investment horizons, thereby capturing the main properties of investors’ marginal utility of wealth and measures of welfare costs of fluctuations. |
| Keywords: | Perturbation methods, Risky steady state, Macroeconomic uncertainty, Intertemporal risk prices, Risk-return tradeoff. |
| JEL: | C63 G12 E32 E44 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:bfr:banfra:702&r=upt |
| By: | Hlouskova, Jaroslava (Institute for Advanced Studies, Vienna, Austria and Department of Economics, Thompson Rivers University, Kamloops, BC, Canada); Fortin, Ines (Institute for Advanced Studies, Vienna, Austria); Tsigaris, Panagiotis (Department of Economics, Thompson Rivers University, Kamloops, BC, Canada) |
| Abstract: | In this paper we analyze the two-period consumption-investment decision of a household with prospect theory preferences and an endogenous second period reference level which captures habit persistence in consumption and in the current consumption reference level. In particular, we examine three types of household depending on how the household’s current consumption reference level relates to a given threshold which is equal to the average discounted endowment income. The first type of household has a relatively low reference level (less ambitious household) and can avoid relative consumption losses in both periods. The second type of household (balanced household) always consumes exactly its reference levels. The third type of household has a relatively high reference level (more ambitious household) and cannot avoid to incur relative consumption losses, either now or in the future. Note that these households may act very differently from one another and thus there will often be a diversity of behavior. For all three types we examine how the household reacts to changes in: income (e.g., income fall caused by recession or taxation of endowment income), persistence to consumption, the first period reference level and the degree of loss aversion. Among others we find that the household increases its exposure to risky assets in good economic times if it is less ambitious and in bad economic times if it is more ambitious. We also find that in some cases more income can lead to less happiness. In addition, the less ambitious household and the more ambitious household with a higher time preference will be less happy with a rising persistence in consumption while the more ambitious household with a lower time preference will be happier if it sticks more to its consumption habits. Finally, the household will be happiest for the lowest possible current consumption reference level, i.e., not comparing at all will lead to the highest level of happiness. |
| Keywords: | prospect theory, loss aversion, consumption-savings decision, portfolio allocation, happiness, income effects |
| JEL: | G02 G11 E20 |
| Date: | 2018–11 |
| URL: | http://d.repec.org/n?u=RePEc:ihs:ihsesp:344&r=upt |
| By: | Ulrik W. Nash |
| Abstract: | We suggest that one individual holds multiple degrees of belief about an outcome, given the evidence. We then investigate the implications of such noisy probabilities for a buyer and a seller of binary options and find the odds agreed upon to ensure zero-expectation betting, differ from those consistent with the relative frequency of outcomes. More precisely, the buyer and the seller agree to odds that are higher (lower) than the reciprocal of their averaged unbiased probabilities when this average indicates the outcome is more (less) likely to occur than chance. The favorite-longshot bias thereby emerges to establish the foundation of an equitable market. As corollaries, our work suggests the old-established way of revealing someone's degree of belief through wagers may be more problematic than previously thought, and implies that betting markets cannot generally promise to support rational decisions. |
| Date: | 2018–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1811.12516&r=upt |
| By: | Radványi, Anna |
| Abstract: | In this paper sharing the cost of emission in supply chains are considered. We focus on allocation problems that can be described by rooted trees, called cost-tree problems, and on the induced transferable utility cooperative games, called upstream responsibility games (Gopalakrishnan et al., 2017). The formal notion of upstream responsibility games is introduced, and the characterization of the class of these games is provided. The Shapley value (Shapley, 1953) is probably the most popular value for transferable utility cooperative games. Dubey (1982) and Moulin and Shenker (1992) show respectively, that Shapley (1953)’s and Young (1985)’s axiomatizations of the Shapley value are valid on the class of airport games. We extend Dubey's and Moulin and Shenker's results onto the class of upstream responsibility games, that is, we provide two characterizations of the Shapley value for upstream responsibility games. |
| Keywords: | upstream responsibility games, cost sharing, emission, supply chain, shapley value, rooted tree, axiomatization of the shapley value |
| JEL: | C71 |
| Date: | 2018–11–18 |
| URL: | http://d.repec.org/n?u=RePEc:cvh:coecwp:2018/06&r=upt |
| By: | Salamanca, Andrés (Department of Business and Economics) |
| Abstract: | Several value-like solution concepts are computed and compared in a cooperative game with incomplete information and non-transferable utility. |
| Keywords: | Cooperative games; incomplete information; non-transferable utility |
| JEL: | C71 C78 D82 |
| Date: | 2018–11–27 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:sdueko:2018_007&r=upt |
| By: | Salamanca, Andrés (Department of Business and Economics) |
| Abstract: | In this paper we explore the relationship between several value-like solution concepts for cooperative games with incomplete information and utility transfers in the form of sidepayments. In our model, state-contingent contracts are required to be incentive compatible, and thus utility might not be not fully transferable (as it would be in the complete information case). When we restrict our attention to games with orthogonal coalitions (i.e., which do not involve strategic externalities), our first main result states that Myerson’s [Cooperative games with incomplete information. Int. J. Game Theory. (1984), 13, 69-96] generalization of the Shapley NTU value and Salamanca’s [A generalization of the Harsanyi NTU value to games with incomplete information. (2016), HAL 01579898] extension of the Harsanyi NTU value are interim utility equivalent. If we allow for arbitrary informational and strategic externalities, our second main result establishes that the ex-ante evaluation of Myerson’s solution equals Kalai and Kalai’s [Cooperation in strategic games revisited. Q. J. Econ. (2013) 128, 917-966] cooperative-competitive value in two-player games with verifiable types. |
| Keywords: | Cooperative games; incomplete information; sidepayments |
| JEL: | C71 C78 D82 |
| Date: | 2018–11–26 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:sdueko:2018_006&r=upt |
| By: | Alain Venditti (Aix-Marseille Univ., CNRS, EHESS, Centrale Marseille, AMSE & EDHEC Business School) |
| Abstract: | We study the existence of endogenous competitive equilibrium cycles under small discounting in a two-sector discrete-time optimal growth model. We provide precise concavity conditions on the indirect utility function leading to the existence of period-two cycles with a critical value for the discount factor that can be arbitrarily close to one. Contrary to the continuous-time case where the existence of periodic-cycles is obtained if the degree of concavity is close to zero, we show that in a discrete-time setting the driving condition does not require a close to zero degree of concavity but a symmetry of the indirect utility function’s concavity properties with respect to its two arguments. |
| Keywords: | two-sector optimal growth model, small discounting, period-two cycles, strong and weak concavity |
| JEL: | C62 E32 O41 |
| Date: | 2018–11 |
| URL: | http://d.repec.org/n?u=RePEc:aim:wpaimx:1830&r=upt |