nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2019‒01‒14
nineteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Indecisiveness, preference for exibility, and a unique subjective state space By Nobuo Koida
  2. Consequentialism and Dynamic Consistency in Updating Ambiguous Beliefs By Takao Asano; Hiroyuki Kojima
  3. Costly Self-Control and Limited Willpower By Simon Grant; Meng-Yu Liang; Sung-Lin Hsieh
  4. Intertemporal Choice By Keith Marzilli Ericson; David Laibson
  5. On a Simple Equilibrium with Heterogeneous Quasi-Hyperbolic Discounting Agents By Jean-Pierre Drugeon; Bertrand Wigniolle
  6. A model of social welfare improving transfers By Brice Magdalou
  7. Endogenous worst-case beliefs in first-price auctions By Gretschko, Vitali; Mass, Helene
  8. Do farmers follow the herd? The influence of social norms in the participation to agri-environmental schemes. By Philippe Le Coent; Raphaële Preget; Sophie Thoyer
  9. The robust superreplication problem: a dynamic approach By Laurence Carassus; Jan Obloj; Johannes Wiesel
  10. Elementary Microeconomics of the Talmudic Rule By Anton Salikhmetov
  11. On temperance and risks spreading By Christophe Courbage; Béatrice Rey
  12. Giving Once, Giving Twice: A Two-Period Field Experiment On Intertemporal Crowding in Charitable Giving By Adena, Maja; Huck, Steffen
  13. Equitable Solutions in Game Representations and the Shapley Value By Pradeep Dubey
  14. A Model of Competing Narratives By Kfir Eliaz; Ran Spiegler
  15. Dynamic Models with Robust Decision Makers: Identification and Estimation By Timothy M. Christensen
  16. Seqential competition and the strategic origins of preferential attachment By Antoine Mandel; Xavier Venel
  17. Incentive-Compatibility, Limited Liability and Costly Liquidation in Financial Contracting By Zhengqing Gui; Ernst-Ludwig von Thadden; Xiaojian Zhao
  18. Timing the market: the economic value of price extremes By Haibin Xie; Shouyang Wang
  19. Growth, Industrial Externality, Prospect Dynamics and Well-being on Markets By Emmanuel Chauvet

  1. By: Nobuo Koida (Faculty of Policy Studies, Iwate Prefectural University)
    Abstract: The objective of this study is to unify two major approaches for addressing uncertainty, namely, indecisiveness and preference for flexibility. Specifically, we assume preferences over alternatives and over menus as primitives, and axiomatize a joint representation of expected multi-utility (Dubra et al. 2004) and ordinal expected utility (Dekel et al. 2001), wherein the set of utility functions in the former is equivalent to the subjective state space in the latter. This result indicates that indecisiveness and preference for flexibility arise from the common underlying uncertainty about ex post tastes, that is, the subjective state space, albeit they may appear differently. Our key axiom is dominance consistency, which requires that the addition of an alternative to a menu strictly improves the menu evaluation if and only if the alternative is undominated by the menu. The main result can be extended to a specific class of ordinal expected utility, such as the additive representation. The relationship between the preference over alternatives and the commitment ranking, and the one-directional implications of dominance consistency, are also discussed.
    Keywords: uncertainty, indecisiveness, preference for flexibility, subjective state space, dominance consistency
    JEL: D81
    Date: 2018–04
  2. By: Takao Asano (Okayama University); Hiroyuki Kojima (Teikyo University)
    Abstract: By proposing the notions of upper-constrained dynamic consistency and lower-constrained dynamic consistency that are weaker axioms than dynamic consistency, this paper axiomatizes the Dempster-Shafer updating rule and naive Bayes' updating rule within the framework of Choquet expected utility. Based on the notion of conditional comonotonicity, this paper also provides an axiomatization of consequentialism under Choquet expected utility. Fur- thermore, based on the idea of the mean preserving rule, this paper provides a unified approach for distinguishing capacity updating rules (the Dempster- Shafer updating rule, naive Bayes' updating rule, and Fagin-Halpern updating rule) according to the degree of dynamic consistency.
    Keywords: Dynamic Consistency, Consequentialism, Choquet Expected Utility, Conditional Comonotonicity, Conditional Preferences, Dempster-Shafer Updating Rule, Naive Bayes' Updating Rule, Fagin-Halpern Updating Rule
    JEL: C71 D81 D90
    Date: 2018–03
  3. By: Simon Grant (Australian National University); Meng-Yu Liang (Institute of Economics, Academia Sinica, Taipei, Taiwan); Sung-Lin Hsieh (Department of Economics, University of Michigan)
    Abstract: In Gul and Pesendorfer (2001), a decision-maker, when facing a choice among menus, evaluates each menu in terms of the maximum value of its normative utility net of self-control costs. This paper extends the model such that this maximum is constrained by the condition that the cost of self-control cannot exceed the decision-makerís stock of willpower w. In our characterization, choices within menus that satisfy the weak axiom of revealed preferences (WARP) reveal a constant trade-off between normative and temptation utilities. However, it is the discontinuity of preferences over menus (along with violations of WARP for choices within menus) that reveals w (measured in units of temptation utility), allowing for a behaviorally meaningful comparative measure of self-control across individuals.
    Keywords: : temptation, self-control, willpower
    JEL: D81 D91 D11
    Date: 2018–12
  4. By: Keith Marzilli Ericson; David Laibson
    Abstract: Intertemporal tradeoffs play a key role in many personal decisions and policy questions. We describe models of intertemporal choice, identify empirical regularities in choice, and pose new questions for research. The focus for intertemporal choice research is no longer whether the exponential discounted utility model is empirically accurate, but, instead, what models best explain the robust behavioral deviations we observe. We introduce the term “present-focused preferences” to describe the large class of models that prioritize present flows of experienced utility. Present-focused preferences need not coincide with a preference for commitment or dynamically inconsistent preferences. Present-bias is a special case of present-focused preferences.
    JEL: C90 D14 D60 D91
    Date: 2018–12
  5. 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 (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)
    Abstract: This article considers the long-run equilibrium distribution of an economy populated by heterogenous and present biased quasi-hyperbolic discounting agents. In a first configuration with logarithmic utility functions and Cobb-Douglas production technologies, this article establishes the existence and the uniqueness of the equilibrium: only one agent, determined by the highest value of a coefficient building from both the degree of present bias and the rate of discount, will have a positive long-run consumption and a positive long-run wealth. A second configuration with constant elasticities of substitution utilities and linear production technologies is then considered. This article similarly establishes the existence and the uniqueness of the equilibrium. There is generically a unique agent with the highest growth rate for his consumption and his wealth. This agent is determined by both preferences and technology parameters and may change following a technological shock.
    Keywords: Heterogeneities,quasi-hyperbolic discounting,linear decision rules
    Date: 2018–12
  6. By: Brice Magdalou
    Abstract: We establish an equivalence theorem between (i) dominance of one society by another, according to a finite sequence of social welfare improving transfers and (ii) dominance according to a class of social welfare functions, in the following framework: individual outcomes are multidimensional but finitely divisible in each dimension, a distribution simply counts the number of individuals having each possible outcome, and the considered set of transfers has the structure of a discrete cone. This framework encompasses most of the social welfare improving transfers investigated in the literature such as, for instance, Pigou-Dalton progressive transfers. As by-products, our model sheds new light on some surprising results in the literature on social deprivation, and provides new arguments on the key role of the expected utility model in decision-making under risk..
    Keywords: social welfare, inequality, welfare-improving transfers, stochastic dominance
    JEL: C02 D63 D81
    Date: 2018–09
  7. By: Gretschko, Vitali; Mass, Helene
    Abstract: Bidding in first-price auctions crucially depends on the beliefs of the bidders about their competitors' willingness to pay. We analyze bidding behavior in a first-price auction in which the knowledge of the bidders about the distribution of their competitors' valuations is restricted to the support and the mean. To model this situation, we assume that under such uncertainty a bidder will expect to face the distribution of valuations that minimizes her expected utility, given her bid is an optimal reaction to the bids of her competitors induced by this distribution. This introduces a novel way to endogenize beliefs in games of incomplete information. We find that for a bidder with a given valuation her worst-case belief just puts sufficient probability weight on lower valuations of her competitors to induce a high bid. At the same time the worst-case belief puts as much as possible probability weight on the same valuation in order to minimize the bidder's winning probability. This implies that even though the worst-case beliefs are type dependent in a non-monotonic way, an efficient equilibrium of the first-price auction exists.
    Keywords: auctions,mechanism design,beliefs,uncertainty
    JEL: D44 D81 D82
    Date: 2018
  8. By: Philippe Le Coent (CEE-M - Centre d'Economie de l'Environnement - Montpellier - FRE2010 - INRA - Institut National de la Recherche Agronomique - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique - Montpellier SupAgro - Institut national d’études supérieures agronomiques de Montpellier); Raphaële Preget (CEE-M - Centre d'Economie de l'Environnement - Montpellier - FRE2010 - INRA - Institut National de la Recherche Agronomique - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique - Montpellier SupAgro - Institut national d’études supérieures agronomiques de Montpellier); Sophie Thoyer (CEE-M - Centre d'Economie de l'Environnement - Montpellier - FRE2010 - INRA - Institut National de la Recherche Agronomique - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique - Montpellier SupAgro - Institut national d’études supérieures agronomiques de Montpellier)
    Abstract: This article analyses the role played by social norms in farmers' decisions to enroll into an agri-environmental scheme (AES). First, it develops a simple theoretical model highlighting the interplay of descriptive and injunctive norms in farmers' utility functions. Second, an empirical valuation of the effect of social norms is provided based on the results of a stated preference survey conducted with 98 wine-growers in the South of France. Proxies are proposed to capture and measure the weight of social norms in farmers' decision to sign an agri-environmental contract. Our empirical results indicate that the injunctive norm seems to play a stronger role than the descriptive norm.
    Keywords: agri-environmental contracts,behaviour,social norms
    Date: 2018
  9. By: Laurence Carassus; Jan Obloj; Johannes Wiesel
    Abstract: In the frictionless discrete time financial market of Bouchard et al.(2015) we consider a trader who, due to regulatory requirements or internal risk management reasons, is required to hedge a claim $\xi$ in a risk-conservative way relative to a family of probability measures $\mathcal{P}$. We first describe the evolution of $\pi_t(\xi)$ - the superhedging price at time $t$ of the liability $\xi$ at maturity $T$ - via a dynamic programming principle and show that $\pi_t(\xi)$ can be seen as a concave envelope of $\pi_{t+1}(\xi)$ evaluated at today's prices. Then we consider an optimal investment problem for a trader who is rolling over her robust superhedge and phrase this as a robust maximisation problem, where the expected utility of inter-temporal consumption is optimised subject to a robust superhedging constraint. This utility maximisation is carrried out under a new family of measures $\mathcal{P}^u$, which no longer have to capture regulatory or institutional risk views but rather represent trader's subjective views on market dynamics. Under suitable assumptions on the trader's utility functions, we show that optimal investment and consumption strategies exist and further specify when, and in what sense, these may be unique.
    Date: 2018–12
  10. By: Anton Salikhmetov
    Abstract: This paper takes a look at the Talmudic rule aka the 1/N rule aka the uniform investment strategy from the viewpoint of elementary microeconomics. Specifically, we derive the cardinal utility function for a Talmud-obeying agent which happens to have the Cobb-Douglas form. Further, we investigate individual supply and demand due to rebalancing and compare them to market depth of an exchange. Finally, we discuss how operating as a liquidity provider can benefit the Talmud-obeying agent with every exchange transaction in terms of the identified utility function.
    Date: 2018–11
  11. By: Christophe Courbage (Geneva School of Business Administration - University of Applied Sciences Western Switzerland); Béatrice Rey (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - ENS Lyon - École normale supérieure - Lyon - UL2 - Université Lumière - Lyon 2 - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon - UJM - Université Jean Monnet [Saint-Étienne] - Université de Lyon - CNRS - Centre National de la Recherche Scientifique)
    Abstract: This paper investigates the conditions for which spreading N independent and unfair risks provides the highest level of welfare than any other possible allocations of risks. It shows that such preferences do not require a higher order property than temperance. Results are also interpreted in terms of the property of superadditivity of the utility premium.
    Keywords: temperance,risk spreading,superadditivity,utility premium
    Date: 2018
  12. By: Adena, Maja (WZB Berlin); Huck, Steffen (WZB Berlin and University College London)
    Abstract: We study intertemporal crowding between two fundraising campaigns for the same charitable organization by manipulating donors\' beliefs about the likelihood of future campaigns in two subsequent field experiments. The data shows that initial giving is decreasing in the likelihood of a future campaign while subsequent giving increases in initial giving. While this refutes the predictions of a simple expected utility model, the pattern is in line with a model that allows for (anticipated or unanticipated) habit formation provided that donations in the two periods are substitutes.
    Keywords: charitable giving; field experiments; intertemporal crowding;
    JEL: C93 D64 D12
    Date: 2018–12–20
  13. By: Pradeep Dubey
    Abstract: We show that any transferable utility game can be represented by an assignment of costly facilities to players, in which it is intuitively obvious how to allocate the total cost of all facilities amongst the players in an equitable manner. The equitable solution in the representation turns out to be the Shapley value of the game, and thus serves as an alternative justification of the value. We show that this approach extends also to the case when not all coalitions can form, provided those that can constitute a semi-algebra of sets (i.e., contain the grand coalition, and are closed under complements).
    Date: 2018
  14. By: Kfir Eliaz; Ran Spiegler
    Abstract: We formalize the argument that political disagreements can be traced to a "clash of narratives". Drawing on the "Bayesian Networks" literature, we model a narrative as a causal model that maps actions into consequences, weaving a selection of other random variables into the story. An equilibrium is defined as a probability distribution over narrative-policy pairs that maximizes a representative agent's anticipatory utility, capturing the idea that public opinion favors hopeful narratives. Our equilibrium analysis sheds light on the structure of prevailing narratives, the variables they involve, the policies they sustain and their contribution to political polarization.
    Date: 2018–11
  15. By: Timothy M. Christensen
    Abstract: This paper studies identification and estimation of a class of dynamic models in which the decision maker (DM) is uncertain about the data-generating process. The DM maximizes his or her continuation value under a worst-case model which lies within a nonparametric neighborhood of a benchmark model. The DM's benchmark model and preference parameters are jointly underidentified. With the DM's benchmark model fixed, primitive conditions are established for nonparametric identification of the worst-case model and local identification of the DM's preference parameters. The key step in the identification analysis is to establish existence and uniqueness of the DM's continuation value function allowing for unbounded statespace and unbounded utilities, both of which are important in applications. To do so, we derive new fixed-point results which use monotonicity and convexity of the value function recursion and which are embedded within a Banach space of "thin-tailed" functions that arises naturally from the structure of recursion. The fixed-point results are quite general and are also applied to models where the DM learns about a hidden state and Rust-type dynamic discrete choice models. A perturbation result is derived which provides a necessary and sufficient condition for consistent estimation of continuation values and the worst-case model. A robust consumption-investment problem is studied as an empirical application and some connections are drawn with the literature on macroeconomic uncertainty.
    Date: 2018–12
  16. By: Antoine Mandel (Paris School of Economics - Centre d'Economie de la Sorbonne); Xavier Venel (Paris School of Economics - Centre d'Economie de la Sorbonne)
    Abstract: There exists a wide gap between the predictions of strategic models of network formation and empirical observations of the characteristics of socio-economic networks. Empirical observations underline a complex structure characterized by fat-tailed degree distribution, short average distance, large clustering coefficient and positive assortativity. Game theoretic models offer a detailed representation of individuals' incentives but they predict the emergence of much simpler structures than these observed empirically. Random network formation processes, such as preferential attachment, provide a much better fit to empirical observations but generally lack micro-foundations. in order to bridge this gap, we propose to model network formation as extensive games and investigate under which conditions equilibria of these games are observationally equivalent with random network formation process. In particular, we introduce a class of games in which players compete with their predecessors and their successors for the utility induced by the links they form with another node in the network. Such sequential competition games can represent a number of strategic economic interactions such as oligopolistic competition in supply networks or diffusion of influence in opinion networks. we show that the focal equilibrium that emerge in this setting is one where players use probability distributions with full support and target the whole network with probabilities inversely proportional to the utility of each node. Notably, when the utility of a node is inversely proportional to its degree, equilibrium play induces a preferential attachment process
    Keywords: Socio-economic networks; endogenous network formation; game theory
    JEL: C71 D85
    Date: 2018–10
  17. By: Zhengqing Gui; Ernst-Ludwig von Thadden; Xiaojian Zhao
    Abstract: We characterize an optimal financial contract when the firm’s realized cash flow is unobservable to the investor and the firm’s collateral can only be liquidated partially by resorting to the services of a costly third party. An optimal contract may exhibit a piecewise structure and vary with the liquidation cost and the firm’s actual liquidity shortage. Partial liquidation and wholesale transfers of collateral can coexist in an optimal contract. In contrast to part of the literature, the incentive-compatibility constraint incorporates the firm’s limited liability, and may be slack at the optimum. Allowing the firm to overcome an ex-post liquidity shortage by borrowing surreptitiously from a third party may reduce the firm’s ex-ante expected utility.
    Keywords: Financial contracting, incentive-compatibility, limited liability, indivisible collateral, costly liquidation
    JEL: D86 G33
    Date: 2018–12
  18. By: Haibin Xie; Shouyang Wang
    Abstract: By decomposing asset returns into potential maximum gain (PMG) and potential maximum loss (PML) with price extremes, this study empirically investigated the relationships between PMG and PML. We found significant asymmetry between PMG and PML. PML significantly contributed to forecasting PMG but not vice versa. We further explored the power of this asymmetry for predicting asset returns and found it could significantly improve asset return predictability in both in-sample and out-of-sample forecasting. Investors who incorporate this asymmetry into their investment decisions can get substantial utility gains. This asymmetry remains significant even when controlling for macroeconomic variables, technical indicators, market sentiment, and skewness. Moreover, this asymmetry was found to be quite general across different countries.
    Date: 2019–01
  19. By: Emmanuel Chauvet
    Abstract: Functions or 'functionnings' enable to give a structure to any economic activity whether they are used to describe a good or a service that is exchanged on a market or they constitute the capability of an agent to provide the labor market with specific work and skills. That structure encompasses the basic law of supply and demand and the conditions of growth within a transaction and of the inflation control. Functional requirements can be followed from the design of a product to the delivery of a solution to a customer needs with different levels of externalities while value is created integrating organizational and technical constraints whereas a budget is allocated to the various entities of the firm involved in the production. Entering the market through that structure leads to designing basic equations of its dynamics and to finding canonical solutions out of particular equilibria. This approach enables to tackle behavioral foundations of Prospect Theory within a generalization of its probability weighting function turned into an operator which applies to Western, Educated, Industrialized, Rich, and Democratic societies as well as to the poorest ones. The nature of reality and well-being appears then as closely related to the relative satisfaction reached on the market, as it can be conceived by an agent, according to business cycles. This reality being the result of the complementary systems that govern human mind as structured by rational psychologists.
    Date: 2018–11

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