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on Utility Models and Prospect Theory |
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Issue of 2019‒04‒29
ten papers chosen by |
| By: | Christian A. Vossler (Department of Economics, University of Tennessee); Dong Yan (Department of Economics, University of Tennessee) |
| Abstract: | We formulate new hypotheses that take advantage of information updating in order to discriminate between the two major specifications of multi-prior ambiguity models: ``kinked'' and ``smooth''. In particular, across comparable decision settings, we examine the effects of adding or trimming out certain priors, updating the weight on particular beliefs, changing the payoff for a single potential state, and modifying the distribution within certain priors. Our results show that the kinked specification does well in consistently predicting choices from 68% of participants, and the smooth specification predicts well for just 10%. We find evidence that people may use a compound lottery as one of their priors, subjects are insensitive to information that the best prior is more likely, and people place lower values on ambiguous lotteries that are relatively more complex. Our experimental methods are likely to be useful in other contexts, as they allow for simple tests of decision-making under ambiguity without placing restrictions on the weights participants place on priors, or reliance on comparisons to decision-making under risk. |
| Keywords: | uncertainty; ambiguity; updating; multiple priors models; alpha-maxmin expected utility; recursive expected utility; lab experiment; self-protection; subjective expected utility |
| JEL: | C91 D81 D83 |
| Date: | 2019–04 |
| URL: | http://d.repec.org/n?u=RePEc:ten:wpaper:2019-02&r=all |
| By: | Qian Lin; Xianming Sun; Chao Zhou |
| Abstract: | In the presence of ambiguity on the driving force of market randomness, we consider the dynamic portfolio choice without any predetermined investment horizon. The investment criteria is formulated as a robust forward performance process, reflecting an investor's dynamic preference. We show that the market risk premium and the utility risk premium jointly determine the investors' trading direction and the worst-case scenarios of the risky asset's mean return and volatility. The closed-form formulas for the optimal investment strategies are given in the special settings of the CRRA preference. |
| Date: | 2019–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1904.09379&r=all |
| By: | Birgit Rudloff; Firdevs Ulus |
| Abstract: | For incomplete preference relations that are represented by multiple priors and/or multiple -- possibly multivariate -- utility functions, we define a certainty equivalent as well as the utility buy and sell prices and indifference price bounds as set-valued functions of the claim. Furthermore, we motivate and introduce the notion of a weak and a strong certainty equivalent. We will show that our definitions contain as special cases some definitions found in the literature so far on complete or special incomplete preferences. We prove monotonicity and convexity properties of utility buy and sell prices that hold in total analogy to the properties of the scalar indifference prices for complete preferences. We show how the (weak and strong) set-valued certainty equivalent as well as the indifference price bounds can be computed or approximated by solving convex vector optimization problems. Numerical examples and their economic interpretations are given for the univariate as well as for the multivariate case. |
| Date: | 2019–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1904.09456&r=all |
| By: | Panizza, Folco (university of trento); Vostroknutov, Alexander (General Economics 1 (Micro)); Coricelli, Giorgio (university of southern california) |
| Abstract: | Knowing that some action is possible in principle, even if not available, could affect behaviour. This may happen because a game is perceived as part of a larger game or ‘metacontext’ that includes its outcomes as a proper subset. In an experiment we test the effects of meta-context and specific choice sets on pro-social behaviour in a series of binary mini-Dictator games by eliciting participants’ normative evaluations, fitting a norm-dependent utility, and analysing the residuals. We find that participants’ normative evaluations in mini-Dictator games derive from the meta-context (a standard Dictator game) and explain a sizeable portion of variance in choices. Restricted choice sets of mini-Dictator games also influence participants’ decisions: they take into account dictator’s losses and recipient’s gains from choosing the prosocial action as fractions of their respective maximum payoffs. This choice-set effect correlates with individual measures of rule-following propensity supporting the idea that it is also normative. Thus, there are two types of normative reasoning that contribute to pro-social behaviour: a meta-context and a choice-set effect. |
| Keywords: | mini-Dictator games, meta-context, choice-set effects, norms, norm-dependent utility |
| JEL: | C91 C92 D91 |
| Date: | 2019–04–16 |
| URL: | http://d.repec.org/n?u=RePEc:unm:umagsb:2019010&r=all |
| By: | John Creedy (Victoria Business School, Victoria University of Wellington, Wellington, New Zealand); Norman Gemmell (Victoria Business School, Victoria University of Wellington, Wellington, New Zealand); Nicolas Hérault (Melbourne Institute: Applied Economic & Social Research, The University of Melbourne); Penny Mok (Ministry of Business, Innovation and Employment (MBIE), Wellington, New Zealand) |
| 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, social welfare function, money metric utility |
| JEL: | D63 H21 H31 I31 J22 |
| Date: | 2018–05 |
| URL: | http://d.repec.org/n?u=RePEc:iae:iaewps:wp2018n07&r=all |
| By: | Yongjie Wang |
| Abstract: | This paper studies an optimal portfolio problem for a DC pension plan considering both interest rate risk and longevity risk. In the accumulation phase, plan members pay constant contributions continuously into the pension fund. We assume that the evolution of mortality rate of all the plan members can be described by the same stochastic process and a representative member is chosen to study the problem. At retirement time, the pension fund is used to purchase a lifetime annuity and a minimum guarantee is required by the representative member. To hedge the longevity risk, we introduce a mortality-linked security, i.e. a longevity bond, into the financial market. The pension manager makes investment decisions for the benefit and on behalf of the representative pension member whose objective is to maximize his expected utility of the terminal surplus between the final fund level and the minimum guarantee. To solve the initial constrained non-self-financing optimization problem, we transform it to an unconstrained self-financing problem by replicating the future contributions and the minimum guarantee. By applying dynamic programming method, analytical solutions to the equivalent optimization problem are derived and optimal investment strategies to the original problem are obtained by simple calculations. The numerical applications reveal that the longevity risk has an important impact on the investment strategies and show evidence that mortality-linked securities could provide an efficient way to hedge the longevity risk. |
| Date: | 2019–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1904.10229&r=all |
| By: | Eric T. Swanson |
| Abstract: | A flexible labor margin allows households to absorb shocks to asset values with changes in hours worked as well as changes in consumption. This ability to partially offset wealth shocks by varying hours of work can significantly alter the household’s attitudes toward risk, as shown in Swanson (2012). In this paper, I analyze how frictional labor markets affect that analysis. Household risk aversion (as measured by willingness to pay to avoid a wealth shock) is higher: 1) in countries with more frictional labor markets, 2) in recessions, and 3) for households that have more difficulty finding a job. These predictions are consistent with empirical evidence from a variety of sources. Quantitatively, I show that labor market frictions in Europe are large enough to play a substantial contributing role to risk aversion in those countries. Nevertheless, labor markets in the U.S. and Europe are sufficiently flexible that risk aversion is much closer to the frictionless benchmark in Swanson (2012) than to traditional measures that assume labor is fixed. |
| JEL: | D81 E24 E44 G12 |
| Date: | 2019–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:25764&r=all |
| By: | Aronsson, Thomas (Department of Economics, Umeå University); Johansson-Stenman, Olof (Department of Economics, School of Business, Economics and Law, University of Gothenburg); Wendner, Ronald (Institute of Economics, University of Graz) |
| Abstract: | This paper deals with tax policy responses to charitable giving, defined in terms of voluntary contributions to a public good, to which the government also contributes through public revenue; the set of tax instruments contains general, nonlinear taxes on income and charitable giving. In addition to consumption, leisure and a public good, individuals obtain utility from the warm glow of giving and social status generated by their relative contributions to charity as well as their relative consumption compared with others. We analyze the conditions under which it is optimal to tax or subsidize charitable giving and derive corresponding optimal policy rules. Another aim of the paper is to compare the optimal tax policy and public good provision by a conventional welfarist government with those by two kinds of paternalist governments: The first kind does not respect the consumer preferences for status in terms of relative giving and relative consumption, while the second kind in addition does not respect preferences for warm glow of giving. The optimal policy rules for marginal taxation and public good provision are similar across governments, except for the stronger incentive to tax charitable giving at the margin under the more extensive kind of paternalism. Numerical simulations supplement the theoretical results. |
| Keywords: | Conspicuous consumption; conspicuous charitable giving; optimal taxation; warm glow |
| JEL: | D03 D62 H21 H23 |
| Date: | 2019–04–16 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:umnees:0959&r=all |
| By: | Olkhov, Victor |
| Abstract: | This paper presents further development of our economic model. We describe economic and financial transactions between agents as factors that define evolution of economic variables. We show that change of risk ratings of agents as their coordinates on economic space due to economic activity or due to other reasons induce flows of economic transactions that contribute significantly to macroeconomic evolution. Transactions are made under numerous expectations of agents and agents establish their expectations on base of economic variables, transactions, other factors that impact economic evolution. We argue that economic value of expectations should be regarded proportionally to economic value of transactions made under these expectations. We describe transition from modeling transactions and expectations of separate agents to description of density functions of transactions and expectations on economic space. We derive systems of equations that describe density functions of transactions, expectations and their flows. We explain how transactions and expectations determine asset pricing and derive price equations. We use our model equations on economic variables, transactions, expectations and their flows for description of particular economic problems in Part III. |
| Keywords: | Economic Theory, Risk Ratings, Economic Space, Economic Transactions, Expectations, Asset Pricing |
| JEL: | C4 C5 E0 E1 E3 G0 |
| Date: | 2019–04–20 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:93428&r=all |
| By: | Nicolás Salamanca (Melbourne Institute: Applied Economic & Social Research, The University of Melbourne) |
| Abstract: | The time-stability of preferences is a crucial and ubiquitous assumption in economics, yet to date there is no method to test its validity. Based on a model of the dynamics of individual preferences, I develop a simple method to test this assumption. Time-persistance in preferences is captured via an autoregressive parameter that accounts for observable characteristics and is unattenuated by measurement error, which forms the basis of the test. The method also estimates the variance of persistent shocks to latent preferences, which measures unobserved heterogeneity, and preference measurement error. I illustrate the use of this method by testing the stability of risk aversion and patience using micro-level data, and find that patience is time-stable but risk aversion is not. However, change very slowly over time. This method provides researchers with a simple tool to properly test the assumption on preference stability, and to measure the degree of preference changes due to observable and unobservable factors. |
| Keywords: | stability of preferences, risk aversion, patience, shock persistence, measurement error |
| JEL: | D01 D03 C18 |
| Date: | 2018–04 |
| URL: | http://d.repec.org/n?u=RePEc:iae:iaewps:wp2018n04&r=all |