nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2019‒05‒20
sixteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Fair Utilitarianism By Marc Fleurbaey; Stéphane Zuber
  2. Static use of options in dynamic portfolio optimization under transaction costs and solvency constraints By Stefano Baccarin
  3. Extreme inflation and time-varying consumption growth By Dergunov, Ilya; Meinerding, Christoph; Schlag, Christian
  4. A Proof of Blackwell's Theorem By Eduardo Perez
  5. The Maturity of Sovereign Debt Issuance in the Euro Area By Beetsma, Roel; de Jong, Frank; Giuliodori, Massimo; Hanson, Jesper
  6. Feasible best-response correspondences and quadratic scoring rules By Norde, Henk; Voorneveld, Mark
  7. Optimal multi-asset trading with linear costs: a mean-field approach By Matt Emschwiller; Benjamin Petit; Jean-Philippe Bouchaud
  8. Identifying Present-Bias from the Timing of Choices By Paul Heidhues; Philipp Strack
  9. Using multiple reference levels in Multi-Criteria Decision Aid: the Generalized-Additive Independence model and the Choquet integral approaches By Christophe Labreuche; Michel Grabisch
  10. Optimal Stopping Time, Consumption, Labour, and Portfolio Decision for a Pension Scheme By Menoncin, Francesco; Vergalli, Sergio
  11. Inconsistent Time Preferences and On-the-job Search - When it Pays to be Naive By Matthias Fahn; Regina Seibel
  12. Guilt Aversion in Economics and Psychology By Bellemare, Charles; Sebald, A.; Suetens, Sigrid
  13. Risk attitudes with state-dependent indivisibilities in consumption By Fels, Markus
  14. The Devil is in the Details: Risk Preferences, Choice List Design, and Measurement Error By Holden , Stein T.; Tilahun , Mesfin
  15. Is there a loyalty-enhancing effect of retroactive price-reduction schemes? By Lisa Bruttel
  16. Approval voting and Shapley ranking. By Pierre Dehez; Victor Ginsburgh

  1. By: Marc Fleurbaey (Woodrow Wilson School and Center for Human Values - Princeton University); Stéphane Zuber (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics)
    Abstract: Utilitarianism is a prominent approach to social justice that has played a central role in economic theory. A key issue for utilitarianism is to define how utilities should be measured and compared. This paper draws on Harsanyi's approach (Harsanyi, 1955) to derive utilities from choices in risky situations. We introduce a new normalization of utilities that ensures that: 1) a transfer from a rich to a poor is welfare enhancing, and 2) populations with more risk averse people have lower welfare. We propose normative principles that reflect these fairness requirements and characterize fair utilitarianism. We also study some implications of fair utilitarianism for risk sharing and collective risk aversion.
    Keywords: Fairness,social risk,utilitarianism
    Date: 2017–07
  2. By: Stefano Baccarin (Department of Economics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino, Italy)
    Abstract: We study a dynamic portfolio optimization problem where it is possible to invest in a risk-free bond, in a risky stock modeled by a lognormal diffusion and in call options written on the stock. The use of the options is limited to static strategies at the beginning of the investment period. The investor faces transaction costs with a fixed component and solvency constraints and the objective is to maximize the expected utility of the final wealth. We characterize the value function as a constrained viscosity solution of the associated quasi-variational inequality and we prove the local uniform convergence of a Markov chain approximation scheme to compute numerically the optimal solution. Because of transaction costs and solvency constraints the options cannot be pefectly replicated and despite the restriction to static policies our numerical results show that in most cases the investor will keep a significant part of his portfolio invested in options.
    Keywords: Dynamic Portfolio Management, Incomplete Markets, Static Use of Options, Impulse Control, Viscosity Solutions, Markov Chain Approximations.
    JEL: C61 C63 G11 G13
    Date: 2019–05
  3. By: Dergunov, Ilya; Meinerding, Christoph; Schlag, Christian
    Abstract: In a parsimonious regime switching model, expected consumption growth varies over time. Adding in ation as a conditioning variable, we uncover two states in which expected consumption growth is low, one with high and one with negative expected in ation. Embedded in a general equilibrium asset pricing model with learning, these dynamics replicate the observed time variation in stock return volatilities and stock-bond return correlations. Furthermore, they provide an alternative way to come up with a measure of time-varying disaster risk in the spirit of Wachter (2013). Our findings imply that both the disaster and the long-run risk paradigm can be extended towards explaining movements in the stock-bond return correlation.
    Keywords: long-run risk,inflation,recursive utility,filtering,disaster risk
    JEL: E31 E44 G12
    Date: 2019
  4. By: Eduardo Perez (Département d'économie)
    Abstract: This note gives a new proof of Blackwell’s celebrated result. The result is a bit stronger than the classical version since the action set and the prior are fixed, and only the utility of the decision maker varies. I show directly that a decision maker has access to a larger set of joint distributions over actions and states of the world if and only if her information improves in the garbling order.
    Date: 2017–11
  5. By: Beetsma, Roel; de Jong, Frank; Giuliodori, Massimo; Hanson, Jesper
    Abstract: We use information on new sovereign debt issues in the euro area to explore the drivers behind the debt maturity decisions of governments. We set up a theoretical model for the maturity structure that trades off preference for liquidity services of short-term debt, roll-over risk and price risk. The average debt maturity is negatively related to both the level and the slope of the yield curve. A panel VAR analysis shows that positive shocks to risk aversion, the probability of non-repayment and the demand for the liquidity services of short-term debt all have a positive effect on the yield curve level and slope, and a negative effect on the average maturity of new debt issues. These results are partially in line with our theory. A forecast error variance decomposition suggests that changes in non-repayment risk as captured by credit default spreads are the most important source of shocks.
    Keywords: euro-area public debt auctions; expected repayment probability; liquidity services of short debt; Maturity; risk aversion; yield curve
    JEL: E62 G11 G12 G18
    Date: 2019–05
  6. By: Norde, Henk (CentER and Department of Econometrics and Operations Research, Tilburg University); Voorneveld, Mark (Dept. of Economics)
    Abstract: The rational choice paradigm in game theory and other fields of economics has agents best-responding to beliefs about factors that are outside their control. And making certain options a best response is a common problem in mechanism design and information elicitation. But not every correspondence can be made into a best-response correspondence. So what characterizes a feasible best-response correspondence? And once we know that, can we find some or even all utility functions that give rise to this best-response correspondence? We answer these three questions for an expected-utility maximizing agent with finitely many actions and probabilistic beliefs over finitely many states or opponents' strategies. We apply our results to information elicitation problems where contracts (scoring rules) are designed to financially reward an expected-payoff maximizing agent to truthfully reveal a property of her belief by sending a report from some finite set of messages. This leads to a number of new insights: firstly, we characterize exactly which properties can be elicited using scoring rules; secondly, we show that in this class of problems quadratic scoring rules are both necessary and sufficient methods of doing so.
    Keywords: best-response correspondence; best-response equivalence; information elicitation; scoring rule
    JEL: C72 D82 D83
    Date: 2019–04–25
  7. By: Matt Emschwiller; Benjamin Petit; Jean-Philippe Bouchaud
    Abstract: Optimal multi-asset trading with Markovian predictors is well understood in the case of quadratic transaction costs, but remains intractable when these costs are $L_1$. We present a mean-field approach that reduces the multi-asset problem to a single-asset problem, with an effective predictor that includes a risk averse component. We obtain a simple approximate solution in the case of Ornstein-Uhlenbeck predictors and maximum position constraints. The optimal strategy is of the "bang-bang" type similar to that obtained in [de Lataillade et al., 2012]. When the risk aversion parameter is small, we find that the trading threshold is an affine function of the instantaneous global position, with a slope coefficient that we compute exactly. We provide numerical simulations that support our analytical results.
    Date: 2019–05
  8. By: Paul Heidhues; Philipp Strack
    Abstract: Timing decisions are common: when to file your taxes, finish a referee report, or complete a task at work. We ask whether time preferences can be inferred when \textsl{only} task completion is observed. To answer this question, we analyze the following model: each period a decision maker faces the choice whether to complete the task today or to postpone it to later. Cost and benefits of task completion cannot be directly observed by the analyst, but the analyst knows that net benefits are drawn independently between periods from a time-invariant distribution and that the agent has time-separable utility. Furthermore, we suppose the analyst can observe the agent's exact stopping probability. We establish that for any agent with quasi-hyperbolic $\beta,\delta$-preferences and given level of partial naivete $\hat{\beta}$, the probability of completing the task conditional on not having done it earlier increases towards the deadline. And conversely, for any given preference parameters $\beta,\delta$ and (weakly increasing) profile of task completion probability, there exists a stationary payoff distribution that rationalizes her behavior as long as the agent is either sophisticated or fully naive. An immediate corollary being that, without parametric assumptions, it is impossible to rule out time-consistency even when imposing an a priori assumption on the permissible long-run discount factor. We also provide an exact partial identification result when the analyst can, in addition to the stopping probability, observe the agent's continuation value.
    Date: 2019–05
  9. By: Christophe Labreuche (Thales Research and Technology [Palaiseau] - THALES); Michel Grabisch (CES - Centre d'économie de la Sorbonne - CNRS - Centre National de la Recherche Scientifique - UP1 - Université Panthéon-Sorbonne, PSE - Paris School of Economics)
    Abstract: In many Multi-Criteria Decision problems, one can construct with the decision maker several reference levels on the attributes such that some decision strategies are conditional on the comparison with these reference levels. The classical models (such as the Choquet integral) cannot represent these preferences. We are then interested in two models. The first one is the Choquet with respect to a p-ary capacity combined with utility functions, where the p-ary capacity is obtained from the reference levels. The second one is a specialization of the Generalized-Additive Independence (GAI) model, which is discretized to fit with the presence of reference levels. These two models share common properties (monotonicity, continuity, properly weighted, …), but differ on the interpolation means (Lovász extension for the Choquet integral, and multi-linear extension for the GAI model). A drawback of the use of the Choquet integral with respect to a p-ary capacity is that it cannot satisfy decision strategies in each domain bounded by two successive reference levels that are completely independent of one another. We show that this is not the case with the GAI model.
    Abstract: Dans beaucoup de problème de décision multicritère, on peut construire avec le décideur plusieurs niveaux de référence sur les attributs de telle sorte que des stratégies de décision soient conditionnelles sur la comparaison avec les niveaux de référence. Les modèles classiques (Choquet) ne peuvent représenter ces préférences. Nous nous intéressons à deux modèles, le premier étant Choquet vs. une p-capacité qui est obtenue à partir des niveaux de référence. Le second est une spécialisation du modèle GAI (Generalized-Additive Independence). Ces deux modèles ont en commun des propriétés (monotonie, continuité), mais diffèrent sur le type d'interpolation (Lovász, multilinéaire). Un défaut de l'intégrale de Choquet est qu'elle ne satisfait pas les stratégies de décision dans chaque domaine borné par deux niveaux de références indépendants l'un de l'autre. Nous montrons que cela ne peut arriver avec le modèle GAI.
    Keywords: multiple criteria analysis,Generalized Additive Independence,Choquet integral,reference levels,intégrale de Choquet,niveau de références,interpolation,GAI,analyse multicritère
    Date: 2018–03
  10. By: Menoncin, Francesco; Vergalli, Sergio
    Abstract: In this work we solve in a closed form the problem of an agent who wants to optimise the inter-temporal utility of both his consumption and leisure by choosing: (i) the optimal inter-temporal consumption, (ii) the optimal inter-temporal labour supply, (iii) the optimal share of wealth to invest in a risky asset, and (iv) the optimal retirement age. The wage of the agent is assumed to be stochastic and correlated with the risky asset on the financial market. The problem is split into two sub-problems: the optimal consumption, labour, and portfolio problem is solved first, and then the optimal stopping time is approached. The martingale method is used for the first problem, and it allows to solve it for any value of the stopping time which is just considered as a stochastic variable. The problem of the agent is solved by assuming that after retirement he received a utility that is proportional to the remaining human capital. Finally, a numerical simulation is presented for showing the behaviour over time of the optimal solution.
    Keywords: Research Methods/ Statistical Methods
    Date: 2019–05–15
  11. By: Matthias Fahn; Regina Seibel (University of Zurich)
    Abstract: We study optimal employment contracts for present-biased employees who can conduct on-the-job search. Presuming that firms cannot offer long-term contracts, we find that individuals who are naive about their present bias will actually be better off than sophisticated or time-consistent individuals. Moreover, they search more, which partially counteracts the inefficiencies caused by their present bias.
    Keywords: Present bias, on-the-job search
    JEL: D21 D83 D90 J31 J32
    Date: 2019–04
  12. By: Bellemare, Charles; Sebald, A.; Suetens, Sigrid (Tilburg University, Center For Economic Research)
    Abstract: We investigate whether the concept of guilt aversion in economics is related to the psychological characterization of the same phenomenon. For trust games and dictator games we report correlations between the guilt sensitivity measured within a framework of psychological games most common in economics and the guilt sensitivity measured using a questionnaire common in psychology (TOSCA-3). We find that the two measures correlate well and significantly in the two settings.
    Keywords: guilt sensitivity; psychological game theory; TOSCA; laboratory experiment; guilt aversion
    JEL: A13 C91
    Date: 2019
  13. By: Fels, Markus
    Abstract: Some consumption opportunities are both indivisible and only valuable in particular tates of nature. The existence of such state-dependent indivisible consumption opportunities influences a person's risk attitudes. In general, people are not risk averse anymore even if utility from divisible consumption is concave. I propose a definition of insurance in the context of state-dependent preferences and investigate the different motives underlying insurance demand. The same reasons that rule out risk aversion turn out to be the basis of a desire to insure. This calls into question the standard approach that bases insurance demand on risk aversion with important implications for policy and research.
    Keywords: risk preferences,indivisible consumption,insurance,gambling
    JEL: D01 D81
    Date: 2019
  14. By: Holden , Stein T. (Centre for Land Tenure Studies, Norwegian University of Life Sciences); Tilahun , Mesfin (Centre for Land Tenure Studies, Norwegian University of Life Sciences)
    Abstract: We use a field experiment to estimate the risk preferences of 945 youth and young adult members of 116 rural business groups organized as primary cooperatives in a semi-arid risky environment in northern Ethiopia. Multiple Choice Lists with binary choices between risky prospects and varying safe amounts are used to identify the certainty equivalent for each risky prospect. Rank Dependent Utility Models with alternatively Wilcox’ (2011) Contextual Utility or Busemeyer and Townsend (1992, 1993) Decision Field Theory heteroskedastic error specifications are used to estimate risk preference parameters and parametrized model noise. The study aims to a) assess potential biases associated with Choice List design; b) assess a time-saving elicitation method; c) inspect the predictive power of the predicted risk preference parameters for respondents’ investment, income and endowment variables; d) assess how the predictive power is associated with model noise and the addition of two low probability high outcome risky prospects that may help to capture utility curvature more accurately. Substantial risk parameter sensitivity to Choice List design was detected. The rapid elicitation method appears attractive as it facilitates use of a larger number of Choice Lists with variable attributes although it is sensitive to bias due to random error associated with randomized starting points. The addition of the two Choice Lists with low probability high outcomes substantially enhanced the explanatory power of the predicted risk preference parameters and resulted in substantially higher estimates of the utility curvature parameter.
    Keywords: Risk preferences; rank dependent utility; probability weighting; measurement error; predictive power; field experiment; Ethiopia
    JEL: C90 C93 D14 D81 D90
    Date: 2019–05–01
  15. By: Lisa Bruttel (University of Potsdam)
    Abstract: This paper presents an experiment on the effect of retroactive price-reduction schemes on buyers’ repeated purchase decisions. Such schemes promise buyers a reduced price for all units that are bought in a certain time frame if the total quantity that is purchased passes a given threshold. This study finds a loyalty-enhancing effect of retroactive price-reduction schemes only if the buyers ex-ante expected that entering into the scheme would maximize their monetary gain, but later learn that they should leave the scheme. Furthermore, the effect crucially hinges on the framing of the price reduction.
    Keywords: rebate and discount, buyer behavior, risk aversion, loss aversion, regulation of dominant firms, experiment
    JEL: C91 D03 D81 L42
    Date: 2019–05
  16. By: Pierre Dehez; Victor Ginsburgh
    Abstract: Approval voting allows electors to list any number of candidates and their scores are obtained by summing the votes cast in their favor. Equal-and-even cumulative voting instead follows the One-person-one-vote principle by endowing electors with a single vote that they may evenly distribute among several candidates. It corresponds to satisfaction approval voting introduced by Brams and Kilgour (2014) as an extension of approval voting to a multiwinner election. It also corresponds to the concept of Shapley ranking introduced by Ginsburgh and Zang (2012) as the Shapley value of a cooperative game with transferable utility. In the present paper, we provide an axiomatic foundation of Shapley ranking and analyze the properties of the resulting social welfare function.
    Keywords: Search and matching models, Collective bargaining, Experience rating, Employment protection.
    JEL: D71 C71
    Date: 2019

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