nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2019‒04‒22
twelve papers chosen by

  1. New Results for Additive and Multiplicative Risk Apportionment By Henri Loubergé; Yannick Malevergne; Béatrice Rey
  2. A general theory of risk apportionment By Gollier, Christian
  3. Asset Integration, Risk Taking and Loss Aversion in the Laboratory By Morrison, William G.; Oxoby, Robert J.
  4. A Generalized Continuous-Multinomial Response Model with a t-distributed Error Kernel By Subodh Dubey; Prateek Bansal; Ricardo A. Daziano; Erick Guerra
  5. Rational Inattention and Retirement Puzzles By Jamie Hentall MacCuish
  6. Choosing between Hail Insurance and Anti-Hail Nets: A Simple Model and a Simulation among Apples Producers in South Tyrol By Marco Rogna; Günter Schamel; Alex Weissensteiner
  7. Beyond quantified ignorance: Rebuilding rationality without the bias bias By Brighton, Henry
  8. Animal spirits, risk premia and monetary policy at the zero lower bound By Proaño Acosta, Christian; Lojak, Benjamin
  9. Escape from model-land By Thompson, Erica L.; Smith, Leonard A.
  10. Decision-making under environmental uncertainty By Gawlik, Remigiusz
  11. Reducing the anchoring bias in multiple question CV surveys By Victor Champonnois; Olivier Chanel; Khaled Makhloufi
  12. P\'olygamma Data Augmentation to address Non-conjugacy in the Bayesian Estimation of Mixed Multinomial Logit Models By Prateek Bansal; Rico Krueger; Michel Bierlaire; Ricardo A. Daziano; Taha H. Rashidi

  1. By: Henri Loubergé (Geneva School of Economics and Management, University of Geneva, Uni Mail, Pont d'Arve 40, 1211 Geneva 4); Yannick Malevergne (Université Paris 1 Panthéon Sorbonne, PRISM Sorbonne EA 4101 and LabEx ReFi, F-75005 Paris, France); Béatrice Rey (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824, F-69130 Ecully, France)
    Abstract: We start by pointing out a simple property of risk apportionment with additive risks in the general stochastic dominance context defined by Eeckhoudt et al. (2009b). Quite generally, an observed preference for risk apportionment with additive risks in a specific risk environment is preserved when the decision-maker is confronted to other risk situations, so long as the total order of stochastic dominance relationships among pairs of risks remains the same. Our objective is to check whether this simple property also holds for multiplicative risk environments. We show that this is not the case, in general, but that the property holds and more strongly for the case of CRRA utility functions. This is due to a particular feature of CRRA functions that we unveil.
    Keywords: Additive risks, Constant relative risk aversion, Multiplicative risks, Preserved preference ranking, Risk apportionment
    JEL: D81
    Date: 2019
  2. By: Gollier, Christian
    Abstract: Suppose that the conditional distributions of ˜x (resp. ˜y) can be ranked according to the m-th (resp. n-th) risk order. Increasing their statistical concordance increases the (m, n) degree riskiness of (˜x, ˜y), i.e., it reduces expected utility for all bivariate utility functions whose sign of the (m, n) cross-derivative is (−1)m+n+1. This means in particular that this increase in concordance of risks induces a m + n degree risk increase in ˜x + ˜y. On the basis of these general results, I provide different recursive methods to generate high degrees of univariate and bivariate risk increases. In the reverse-or-translate (resp.reverse-or-spread) univariate procedure, a m degree risk increase is either reversed or translated downward (resp. spread) with equal probabilities to generate a m + 1 (resp.m + 2) degree risk increase. These results are useful for example in asset pricing theory when the trend and the volatility of consumption growth are stochastic or statistically linked.
    Keywords: Stochastic dominance; risk orders; prudence; temperance; concordance.
    JEL: D81
    Date: 2019–04–08
  3. By: Morrison, William G. (Wilfrid Laurier University); Oxoby, Robert J. (University of Calgary)
    Abstract: We report on a laboratory experiment testing for the presence of loss aversion, as separate from risk aversion, utilizing an asset integration protocol designed to ensure that a loss of cash provided by the experimenter is viewed as a real loss by experimental participants. Our experimental design augments the Holt-Laury risk preference elicitation methodology to assess how individuals choose between a safe option and a riskier lottery. When the money at stake is viewed as the individual's own money, one of the lottery outcomes is in the domain of losses. Our results confirm that individuals display an additional reluctance to participate in a mixed domain lottery beyond that predicted by risk aversion. We show that only preference functions incorporating loss aversion are able to generate predicted behaviour that matches our results.
    Keywords: risk taking, experiments
    JEL: C91 D81
    Date: 2019–03
  4. By: Subodh Dubey; Prateek Bansal; Ricardo A. Daziano; Erick Guerra
    Abstract: In multinomial response models, idiosyncratic variations in the indirect utility are generally modeled using Gumbel or normal distributions. This study makes a strong case to substitute these thin-tailed distributions with a t-distribution. First, we demonstrate that a model with a t-distributed error kernel better estimates and predicts preferences, especially in class-imbalanced datasets. Our proposed specification also implicitly accounts for decision-uncertainty behavior, i.e. the degree of certainty that decision-makers hold in their choices relative to the variation in the indirect utility of any alternative. Second, after applying a t-distributed error kernel in a multinomial response model for the first time, we extend this specification to a generalized continuous-multinomial (GCM) model and derive its full-information maximum likelihood estimator. The likelihood involves an open-form expression of the cumulative density function of the multivariate t-distribution, which we propose to compute using a combination of the composite marginal likelihood method and the separation-of-variables approach. Third, we establish finite sample properties of the GCM model with a t-distributed error kernel (GCM-t) and highlight its superiority over the GCM model with a normally-distributed error kernel (GCM-N) in a Monte Carlo study. Finally, we compare GCM-t and GCM-N in an empirical setting related to preferences for electric vehicles (EVs). We observe that accounting for decision-uncertainty behavior in GCM-t results in lower elasticity estimates and a higher willingness to pay for improving the EV attributes than those of the GCM-N model. These differences are relevant in making policies to expedite the adoption of EVs.
    Date: 2019–04
  5. By: Jamie Hentall MacCuish
    Abstract: I present evidence incorporating costly thought solves three puzzles in the retirement literature. The first puzzle is, given incentives, the extent of bunching of labour market exits at legislated state pension ages (SPA) seems incompatible with rational expectations. Adding to the evidence for this puzzle, I include an empirical analysis focusing on whether liquidity constraints can explain this bunching and find they cannot. The nature of this puzzle is clarified by exploring a life-cycle model with rational agents that matches aggregate profiles. This model succeeds in matching aggregates by overestimating the impact of the SPA on poorer individuals whilst underestimating its impact on wealthier people. The second puzzle is people are often mistaken about their own pension provisions. Concerning the second puzzle, I incorporate rational inattention to the SPA into the aforementioned life-cycle model, allowing for mistaken beliefs. To the best of my knowledge, this paper is the first not only to incorporate rational inattention into a life-cycle model but also to assess a rationally inattentive model against non-experimental individual choice data. This facilitates another important contribution: discipling the cost of attention with subjective belief data. Preliminary results indicate rational inattention improves the aggregate fit and better matches the response of participation to the SPA across the wealth distribution, hence offering a resolution to the first puzzle. The third puzzle is despite actuarially advantageous options to defer receipt of pension benefits, take up is extremely low. An extension of the model generates an explanation of this last puzzle: the actuarial calculations implying deferral is preferable ignore the utility cost of tracking your pension which can be avoided by claiming. These puzzles are researched in the context of the reform to the UK female SPA.
    Date: 2019–04
  6. By: Marco Rogna (Free University of Bolzano‐Bozen, Faculty of Economics and Management, Italy); Günter Schamel (Free University of Bolzano‐Bozen, Faculty of Economics and Management, Italy); Alex Weissensteiner (Free University of Bolzano‐Bozen, Faculty of Economics and Management, Italy)
    Abstract: There is a growing interest in analysing the diffusion of agricultural insurance, seen as an effective tool for managing farm risks. Much atten- tion has been dedicated to understanding the scarce adoption rate despite high levels of subsidization and policy support. In this paper, we analyse an aspect that seems to have been partially overlooked: the potential competing nature between insurance and other risk management tools. We consider hail as a single source weather shock and analyse the potential competing effect of anti-hail nets over insurance as instruments to cope with this shock by presenting a simple theoretical model that is rooted into expected utility theory. After describing the basic model, we perform some comparative static analysis to identify the role of individual elements that are shaping farmers' decisions. From this exercise it results that the worth of anti-hail nets compared to insurance is an increasing function of the overall risk of hail damages, of the farmers' level of risk aversion and of the worth of the agricultural output. Finally, we develop a simulation model using data related to apple production in South Tyrol, a Northern-Italian province with a relatively high risk of hail. The model generally confirms the results of the comparative static analysis and it shows that, in this region, anti-hail nets are often superior than insurance in expected utility terms.
    Keywords: Actuarial soundness, Agricultural insurance markets, Antihail nets, Hail, Expected utility
    JEL: Q12 Q18
    Date: 2019–04
  7. By: Brighton, Henry
    Abstract: If we reassess the rationality question under the assumption that the uncertainty of the natural world is largely unquantifiable, where do we end up? In this article the author argues that we arrive at a statistical, normative, and cognitive theory of ecological rationality. The main casualty of this rebuilding process is optimality. Once we view optimality as a formal implication of quantified uncertainty rather than an ecologically meaningful objective, the rationality question shifts from being axiomatic/probabilistic in nature to being algorithmic/ predictive in nature. These distinct views on rationalitymirror fundamental and longstanding divisions in statistics.
    Keywords: cognitive science,rationality,ecological rationality,bounded rationality,bias bias,bias/variance dilemma,Bayesianism,machine learning,pattern recognition,decision making under uncertainty,unquantifiable uncertainty
    JEL: A12 B4 C1 C44 C52 C53 C63 D18
    Date: 2019
  8. By: Proaño Acosta, Christian; Lojak, Benjamin
    Abstract: In this paper we investigate the risk-related effects of monetary policy both in normal times, as well as in periods where the zero lower bound (ZLB) binds, in a stylized macroeconomic model with boundedly rational beliefs. In our model, financial market participants use heuristics to assess the risk premium over the policy rate in accordance to an "implicit Taylor rule" that measures the stance of conventional monetary policy and which serves as an informative instrument during times when the funds rate is constrained by the ZLB. In such a case, conventional monetary policy is exhausted so that the central bank is forced to use unconventional types of policy. We propose alternative monetary policy measures to help the economy out of the liquidity trap which take into account this assumed form of bounded rationality.
    Keywords: Behavioral Macroeconomics,Monetary Policy,Zero Lower Bound,Bounded Rationality
    Date: 2019
  9. By: Thompson, Erica L.; Smith, Leonard A.
    Abstract: Both mathematical modelling and simulation methods in general have contributed greatly to understanding, insight and forecasting in many fields including macroeconomics. Never-theless, we must remain careful to distinguish model-land and model-land quantities from the real world. Decisions taken in the real world are more robust when informed by our best estimate of real-world quantities, than when "optimal" model-land quantities obtained from imperfect simulations are employed. The authors present a short guide to some of the temptations and pitfalls of model-land, some directions towards the exit, and two ways to escape.
    Keywords: modelling and simulation,decision-making,model evaluation,uncertainty,structural model error,dynamical systems,radical uncertainty
    JEL: C52 C53 C6 D8 D81
    Date: 2019
  10. By: Gawlik, Remigiusz
    Abstract: Goal of the paper: proposal of a model for decision-making enhancement that includes qualitative and quantitative elements influencing managerial decision-making processes under geopolitical uncertainty. Methods: primary: Analytic Hierarchy Process – for assessment of individual and collective utility of indexes describing the functioning of enterprises; secondary: Delphi questionnaires, Pareto-Lorenz diagram, stratified random sampling; AHP evaluations came from six professional managers Results: a mixed qualitative and quantitative instrument bringing geopolitical occurrences into managerial decision-making under turbulent environmental conditions; Practical implications: increased efficiency of managerial decision-making processes, with managerial decisions closer to the possible optimum, under given environmental conditions. Added value: the application of multicriteria models for enhancement of managerial decision-making provides a larger perspective on environmental threats and lowers the decision-making uncertainty.
    Keywords: decision-making; management; Analytic Hierarchy Process; geopolitical environment; uncertainty;
    JEL: C44 D81 F00
    Date: 2018–10–20
  11. By: Victor Champonnois (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - Ecole Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique); Olivier Chanel (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - ECM - Ecole Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique - AMU - Aix Marseille Université - EHESS - École des hautes études en sciences sociales, AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - Ecole Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique); Khaled Makhloufi (SESSTIM - U1252 INSERM - Aix Marseille Univ - UMR 259 IRD - Sciences Economiques et Sociales de la Santé & Traitement de l'Information Médicale - IRD - Institut de Recherche pour le Développement - AMU - Aix Marseille Université - INSERM - Institut National de la Santé et de la Recherche Médicale)
    Abstract: The elicitation format is a crucial aspect of Contingent Valuation (CV) surveys and can impact their reliability. This paper contributes to the extensive debate on WTP (Willingness To Pay) elicitation formats by assessing whether the Circular Payment Card (CPC) can reduce anchoring on respondents' previous answers under multiple elicitation questions. This new format uses a visual pie-chart representation without start or end points: respondents spin the circular card in any direction until they find the section that best matches their WTP. We used a CV survey based on two ways of reducing risks associated with flooding, each randomly presented first to half of the respondents, to test the absolute performance of CPC. We presented a second survey on two social insurance schemes for subjects currently uninsured to respondents randomly split into three subgroups. Each group's WTP was elicited using one of three formats: Open-Ended (OE), standard Payment Card (PC) and the new CPC. The two insurance schemes were always proposed in the same order, and we assessed the relative performance of CPC by comparing anchoring across respondents. Our results provide evidence that CPC is likely to reduce anchoring in multiple elicitation questions and that respondents may rely on different heuristic decisions when giving WTP in the OE and in the two PC formats.
    Keywords: Willingness to pay,Elicitation format,Payment card,Circular payment card,Social insurance,Flood
    Date: 2018–09
  12. By: Prateek Bansal; Rico Krueger; Michel Bierlaire; Ricardo A. Daziano; Taha H. Rashidi
    Abstract: The standard Gibbs sampler of Mixed Multinomial Logit (MMNL) models involves sampling from conditional densities of utility parameters using Metropolis-Hastings (MH) algorithm due to unavailability of conjugate prior for logit kernel. To address this non-conjugacy concern, we propose the application of P\'olygamma data augmentation (PG-DA) technique for the MMNL estimation. The posterior estimates of the augmented and the default Gibbs sampler are similar for two-alternative scenario (binary choice), but we encounter empirical identification issues in the case of more alternatives ($J \geq 3$).
    Date: 2019–04

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