nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2019‒06‒10
twenty papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Dispersed Behavior and Perceptions in Assortative Societies By Mira Frick; Ryota Iijima; Yves Le Yaouanq
  2. Preferences Over Rich Sets of Random Variables: Semicontinuity in Measure versus Convexity By Alexander Zimper; Hirbod Assa
  3. Portfolio optimisation beyond semimartingales: shadowprices and fractional Brownian motion By Czichowsky, Christoph; Schachermayer, Walter
  4. Mortality Options: the Point of View of an Insurer By Schmeck, Maren Diane; Schmidli, Hanspeter
  5. Can crop diversification of perennial crop by smallholder farmers explained by risk attitudes and time preferences? By Wening Sarwosri, Arieska; Mußhoff, Oliver
  6. Financial literacy and precautionary insurance By Kubitza, Christian; Hofmann, Annette; Steinorth, Petra
  7. How related are risk preferences and time preferences? By Holden, Stein T.; Tilahun, Mesfin
  8. Rejection prices and an auctioneer with non-monotonic utility By Zhonghao Shui
  9. Optimal pricing by a risk-averse seller By Tomer Siedner
  10. Adoption of e-commerce by individuals and digital divide: Evidence from Spain By Ángel Valarezo; Rafael López; Teodosio Pérez-Amaral
  11. Depression, Risk Preferences and Risk-Taking Behavior By Deborah A. Cobb-Clark; Sarah Dahmann; Nathan Kettlewell
  12. Equilibrium with Differential Information and Exogenous Beliefs: A Basic Model of Full Existence By Lionel de Boisdeffre
  13. The pure effect of social preferences on regional location choices: The evolving dynamics of convergence to a steady state population distribution By Stark, Oded; Budzinski, Wiktor; Kosiorowski, Grzegorz
  14. Resolving New Keynesian Anomalies with Wealth in the Utility Function By Pascal Michaillat; Emmanuel Saez
  15. Can the environment be an inferior good ? A theory with context-dependent substitutability and needs. By Marion Dupoux; Vincent Martinet
  16. An Experimental Test of the Under-Annuitization Puzzle with Smooth Ambiguity and Charitable Giving By Hippolyte d'Albis; Giuseppe Attanasi; Emmanuel Thibault
  17. Predicting the U.S. Stock Market Return: Evidence from the Improved Augmented Regression Method By Jurdi, Doureige; Kim, Jae
  18. Monopolar Concentration in Tokyo and Promotion of Urban-to-Rural Migration (Japanese) By KONDO Keisuke
  19. Experiments on matching markets: A survey By Hakimov, Rustamdjan; Kübler, Dorothea
  20. Promises, Expectations & Causation By Giovanni Di Bartolomeo; Martin Dufwenberg; Stefano Papa; Francesco Passarelli

  1. By: Mira Frick (Cowles Foundation, Yale University); Ryota Iijima (Cowles Foundation, Yale University); Yves Le Yaouanq (Harvard University)
    Abstract: We propose a multiple-prior model of preferences under ambiguity that provides a uni?ed lens through which to understand di?erent formalizations of ambiguity aversion, as well as context-dependent negative and positive ambiguity attitudes documented in experiments. This model, Boolean expected utility (BEU), represents the belief the decision-maker uses to evaluate any uncertain prospect as the outcome of a game between two conflicting forces, Pessimism and Optimism. We prove, ?rst, that BEU provides a novel representation of the class of invariant biseparable preferences (Ghirardato, Maccheroni, and Marinacci, 2004). Second, BEU accommodates rich patterns of ambiguity attitudes, which we characterize in terms of the relative power allocated to each force in the game.
    Keywords: Multiple priors, Ambiguity aversion
    JEL: D81
    Date: 2019–06
  2. By: Alexander Zimper (Department of Economics; University of Pretoria; postal address: Private Bag X20; Hat.eld 0028; South Africa); Hirbod Assa (Institute for Financial and Actuarial Mathematics and Institute for Risk and Uncertainty, University of Liverpool, Center for Doctoral Training, Chadwick Building, G62, Liverpool UK.)
    Abstract: The choice of a continuity concept in decision theoretic models has behavioral meaning because it pins down how the decision maker perceives the similarity of random variables. This paper analyzes the preferences of a decision maker who perceives similarity in accordance with the topology of convergence in measure. As our main insight we show that this decision maker cannot be globally risk or ambiguity averse whenever her preferences are lower-semicontinuous and complete on a rich set of random variables. Real life decision makers who perceive the similarity of random variables in accordance with convergence in measure might thus account for violations of global convexity as observed in empirical studies. Similarly, the non-convex risk measure value-at-risk might be popular among decision makers because it represents preferences that are lower-semicontinuous in measure.
    Keywords: Similarity Perceptions, Continuous Preferences, Uncertainty, Ambiguity, Utility Representations, Risk Measures
    JEL: D81
    Date: 2019–05
  3. By: Czichowsky, Christoph; Schachermayer, Walter
    Abstract: While absence of arbitrage in frictionlessfinancial markets requires price processes to be semimartingales, non-semimartingales can be used to model prices in an arbitrage-free way, if proportional transaction costs are taken into account. In this paper, we show, for a class of price processes which are not necessarily semimartingales, the existence of an optimal trading strategy for utility maximisation under transaction costs by establishing the existence of a so-called shadow price. This is a semimartingale price process, taking values in the bid ask spread, such that frictionless trading for that price process leads to the same optimal strategy and utility as the original problem under transaction costs. Our results combine arguments from convex duality with the stickiness condition introduced by P. Guasoni. They apply in particular to exponential utility and geometric fractional Brownian motion. In this case, the shadow price is an It^o process. As a consequence we obtain a rather surprising result on the pathwise behaviour of fractional Brownian motion: the trajectories may touch an It^o process in a one-sided manner without reflection.
    Keywords: portfolio choice; non-semimartingale price processes; fractional Brownian motion; proportional transaction costs; utilities on the whole real line; exponential utility; shadow price; convex duality; stickiness; optimal trading strategies
    JEL: C61 G11
    Date: 2017–06–01
  4. By: Schmeck, Maren Diane (Center for Mathematical Economics, Bielefeld University); Schmidli, Hanspeter (Center for Mathematical Economics, Bielefeld University)
    Abstract: We consider the surplus process of a life insurer who is able to buy a securitisation product to hedge mortality in a discrete time framework. Two cohorts are considered: one underlying the securitisation product and one for the portfolio of the insurer. In our main result we show that there exists a unique strategy that maximises the expected utility of the insurer. Our findings are illustrated by a tractable model for mortality catastrophe risk.
    Keywords: mortality option, optimal strategy, maximal utility, ex- ponential utility
    Date: 2019–05–28
  5. By: Wening Sarwosri, Arieska; Mußhoff, Oliver
    Abstract: This study examines whether the decision of crop diversification for perennial crops is based on underlying risk attitudes and time preferences. We conducted incentivised field experiments on Sumatra Island, Indonesia, involving farmers who cultivate rubber and farmers who cultivated rubber and oil palm trees, i.e., undertook crop diversification. We estimated risk attitudes and time preferences jointly. The results indicated that farmers who undertook crop diversification were statistically significantly more risk-averse than rubber farmers. However, the time preferences between the two groups were not statistically significantly different.
    Keywords: crop diversification,oil palms,risk attitudes,rubber,time preference
    Date: 2019
  6. By: Kubitza, Christian; Hofmann, Annette; Steinorth, Petra
    Abstract: This paper studies insurance demand for individuals with limited financial literacy. We propose uncertainty about insurance payouts, resulting from contract complexity, as a novel channel that affects decision-making of financially illiterate individuals. Then, a trade-off between second-order (risk aversion) and third-order (prudence) risk preferences drives insurance demand. Sufficiently prudent individuals raise insurance demand upon an increase in contract complexity, while the effect is reversed for less prudent individuals. We characterize competitive market equilibria that feature complex contracts since firms face costs to reduce complexity. Based on the equilibrium analysis, we propose a monetary measure for the welfare cost of financial illiteracy and show that it is mainly driven by individuals' risk aversion. Finally, we discuss implications for regulation and consumer protection.
    Keywords: financial literacy,insurance demand,prudence,precautionary insurance
    JEL: D11 D81 D91 G22
    Date: 2019
  7. 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: Risk and time preferences are fundamentally important for financial decisions. We study such preferences for business group members based on field experiments in Ethiopia. The relationship between risk preferences and time preferences has been subject to intensive research and debate among behavioral and experimental economists lately. We aim to contribute to this literature based on a Double Multiple Choice List approach used in an incentivized field experiment. First, we provide strong evidence of diminishing impatience in our data that cannot be explained by present bias. Next, we assess whether measures of diminishing impatience can be associated with measures of risk aversion and probabilistic sensitivity. We also assess whether measurement error in the risk experiment could be the culprit and create spurious correlations between measures of risk aversion and discount rate elasticities with respect to time horizon. Using a random coefficient model, we find strong evidence of diminishing impatience and large and highly significant individual variation in discount rate elasticities with respect to time horizon. We find only weak support for the idea that diminishing impatience is explained by probabilistic sensitivity due to uncertainty about delayed payouts in the discount rate experiments. Risk aversion and optimism/pessimism were unrelated to model noise. More pessimistic and more risk averse respondents had more hyperbolic time preferences and these results were not sensitive to measurement error. Surprisingly, more consistent responses in the risk experiments (lower measurement error) were found for respondents with more hyperbolic time preferences and respondents with higher probabilistic insensitivity.
    Keywords: Time preferences; risk preferences; diminishing impatience; probability weighting
    JEL: C93 D83
    Date: 2019–05–22
  8. By: Zhonghao Shui (Graduate School of Economics, Kyoto University)
    Abstract: This paper considers an auctioneer who has a non-monotonic utility function with a unique maximizer. The auctioneer is able to reject all bids over some amount by using rejection prices. We show that the optimal rejection price for such an auctioneer is lower than and equal to that maximizer in first-price and second-price sealed-bid auctions, respectively. Further, in each auction we characterize a necessary and sufficient condition that by using the optimal rejection price not only the auctioneer but also bidders can be better off, compared to a standard auction. Finally, we find that the auctioneer strictly prefers a first-price sealed-bid auction if he is risk-averse when his revenue is lower than the maximizer or if the distribution of revenues which are lower than the maximizer in a standard first-price sealed-bid auction is first-order stochastic dominant over the one in a standard second-price sealed-bid auction.
    Keywords: Auction, Rejection prices, Non-monotonic utility
    JEL: D44 D82
    Date: 2019–04
  9. By: Tomer Siedner
    Abstract: We consider the basic setup of one seller, one buyer, and one good, where the seller is risk averse, and characterize the mechanism that maximizes the seller's expected utility. In contrast to the risk-neutral case, where a single deterministic price is optimal, we show that in the risk averse case the optimal mechanism consists of a continuum of lotteries.
    Date: 2019–05
  10. By: Ángel Valarezo (Instituto Complutense de Análisis Económico (ICAE), Universidad Complutense de Madrid (UCM).); Rafael López (Instituto Complutense de Análisis Económico (ICAE), Universidad Complutense de Madrid (UCM).); Teodosio Pérez-Amaral (Instituto Complutense de Análisis Económico (ICAE), Universidad Complutense de Madrid (UCM).)
    Abstract: E-commerce penetration rates are distant among those groups of individuals with the lowest and the highest levels of online shopping adoption. This is an indicator of digital divide, having negative effects in terms of untapped opportunities for people, companies and the whole economy. Key socioeconomic and demographic determinants of adoption of ecommerce are explored, analyzing a dataset of 174,776 observations for the period 2008-2017 in Spain. The empirical analysis is based on a standard neoclassical utility maximization framework. Linear probability model, logistic regression, and Heckman’s sample selection correction model have been used. The results suggest that e-commerce adoption is positively related with being male, having higher levels of education, income and digital skills, being Spanish, and being employed; while being female, older and belonging to a household of two or more members have negative effects. An interaction between digital skills and age has been introduced in the model, where high digital skills seem to have a positive influence, partly counteracting the lower odds for some age groups. Policy recommendations related to demand and supply measures are suggested to foster the adoption of e-commerce.
    Keywords: E-commerce; Digital divide; Linear probability model; Logistic regression; Heckman’s sample selection correction; Polychoric correlation; Digital skills; Time and regional dummies; Pool data; Utility maximization framework.
    JEL: C25 D11 O33
    Date: 2019–03
  11. By: Deborah A. Cobb-Clark; Sarah Dahmann; Nathan Kettlewell
    Abstract: Depression affects the way that people process information and make decisions, including those involving risk and uncertainty. Our objective is to analyze the way that depressive episodes shape risk preferences and risk-taking behaviors. We are the first to address this issue using large-scale, representative panel data that include both behavioral and stated risk preference measures and a theoretical framework that accounts for the multiple pathways through which depression affects risk-taking. We find no disparity in the behavioral risk preferences of the mentally well vs. depressed; yet depression is related to people’s stated risk preferences and risk-taking behaviors in ways that are context-specific. Those who are likely to be experiencing a depressive episode report less willingness to take risks in general, but more willingness to take health risks, for example. We investigate these patterns by developing a conceptual model — informed by the psychological literature — that links depression to risk-taking behavior through the key elements of a standard intertemporal choice problem (e.g., time preferences, expectations, budget constraints). This motivates a mediation analysis in which we show that differences in risk-taking behavior are largely explained by depression-related disparities in behavioral traits such as locus of control, optimism and trust. Overall, we find that there is no overarching tendency for those who are depressive to engage in either more or less risk-taking. Instead, the decision-making context matters in ways that largely align with our theoretical expectations.
    Keywords: Risk preferences, depression, mental health, risk-taking
    JEL: D91 I12 D14
    Date: 2019
  12. By: Lionel de Boisdeffre (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, CATT - Centre d'Analyse Théorique et de Traitement des données économiques - UPPA - Université de Pau et des Pays de l'Adour)
    Abstract: We consider a pure exchange economy, where agents, typically asymmetrically informed, exchange securities, on financial markets, and commodities, on spot markets. Consumers have private characteristics, anticipations and beliefs, and no model to forecast prices. They are dispensed with rational expectation and bounded rationality assumptions, such as Radner's (1972, 1979), Kurz' (1994) or Koutsougeras-Yannelis' (1999). We show that they face an incompressible uncertainty, represented by a so-called "minimum uncertainty set". This uncertainty typically adds to the exogenous one, on the state of nature, an 'endogenous uncertainty' over future spot prices. At equilibrium, all agents expect the 'true' price on every spot market as a possible outcome, and elect optimal strategies, ex ante, which clear on all markets, ex post. We show this sequential equilibrium exists whenever agents' prior anticipations embed the minimum uncertainty set. This outcome differs from the standard generic existence results of Hart (1975), Radner (1979), and Duffie-Shaffer (1985), among others, based on the rational expectations of prices.
    Keywords: Sequential equilibrium,Temporary equilibrium,Perfect foresight,Existence,Rational expectations,Financial markets,Asymmetric Information,Arbitrage
    Date: 2018–06
  13. By: Stark, Oded; Budzinski, Wiktor; Kosiorowski, Grzegorz
    Abstract: This paper tracks the consequences of individuals' desire to align their location with their social preferences. The social preference studied in the paper is distaste for relative deprivation, measured in a cardinal manner. Location is conceived as social space, with individuals choosing to relocate if, as a result, their relative deprivation will be reduced, holding their incomes constant. Conditions are provided under which the associated dynamics reaches a spatial steady state, the number of periods it takes to reach a steady state is specified, and light is shed on the robustness of the steady state outcome. By way of simulation it is shown that for large populations, a steady state of the relocation dynamics is almost always reached, typically in one period, and that cycles are more likely to occur when the populations' income distributions are more equal.
    Keywords: Social preferences,Distaste for low relative income,A cardinal measure of income relative deprivation,Interregional locational choices,Relocation dynamics,Steady-state spatial distribution
    JEL: C62 C63 R12 R13 Z13
    Date: 2019
  14. By: Pascal Michaillat; Emmanuel Saez
    Abstract: The New Keynesian model makes several anomalous predictions at the zero lower bound: collapse of output and inflation, and implausibly large effects of forward guidance and government spending. To resolve these anomalies, we introduce wealth into the utility function. The justification is that wealth is a marker of social status, and people value social status. Since people save not only for future consumption but also to accrue social status, the Euler equation is modified. As a result, when the marginal utility of wealth is sufficiently large, the dynamical system representing the equilibrium at the zero lower bound becomes a source instead of a saddle---which resolves all the anomalies.
    Date: 2019–05
  15. By: Marion Dupoux (University of Gothenburg); Vincent Martinet (INRA, Economie Publique, Paris-Grignon, France)
    Abstract: Empirical evidence and theoretical frameworks mostly suggest normality of public environmental goods. In this paper, we argue there is no reason an environmental good should be categorized as inferior, normal or luxury in all decision contexts. We develop a model that allows public environmental goods to switch from one category to another, depending on individual income and environmental quality levels (i.e., the context). Our model is based on needs within which private consumption and environmental goods may interact differently (substitutes/complements). We formalize utility functional forms that comply with our framework. We finally derive some policy implications for environmental benefit transfers.
    Keywords: substitutability, context, willingness to pay for the environment, inferior good, needs
    JEL: D11 H41 Q50
    Date: 2019–04
  16. By: Hippolyte d'Albis (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, PSE - Paris School of Economics); Giuseppe Attanasi (GREDEG - Groupe de Recherche en Droit, Economie et Gestion - UNS - Université Nice Sophia Antipolis - UCA - Université Côte d'Azur - CNRS - Centre National de la Recherche Scientifique); Emmanuel Thibault (TSE - Toulouse School of Economics - UT1 - Université Toulouse 1 Capitole - CNRS - Centre National de la Recherche Scientifique - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales)
    Keywords: Self-insurance,annuity,uncertain survival probabilities,smooth ambiguity aversion,charity,experiment
    Date: 2019–05
  17. By: Jurdi, Doureige; Kim, Jae
    Abstract: We examine whether the stock market return is predictable from a range of financial indicators and macroeconomic variables, using monthly U.S. data from 1926 to 2012. We adopt the improved augmented regression method for parameter estimation, statistical inference, and out-of-sample forecasting. By employing moving sub-sample windows, we evaluate the time-variation of predictability free from data snooping bias and report changes in predictability dynamics over time. Although we may find statistically significant in-sample predictability from time to time, the associated effect size estimates are fairly small in most cases. We also find weak predictability of the stock market return from multistep ahead (out-of-sample) forecasts. In addition, we find that mean-variance investors realize sporadic economic gains in utility based on predictive regression forecasts relative to naive model historic average forecasts
    Keywords: Bias-correction; Financial ratios; Forecasting; Return predictability; Utility gains
    JEL: G17
    Date: 2019–05–20
  18. By: KONDO Keisuke
    Abstract: This study analyzes interregional migration decision-making in terms of utility maximization. Given that indirect utility consists of real income and migration costs, migration decisions depend on whether additional benefits of real income by migration at least offset the costs of migration. To quantify migration costs from interregional migration flow data, this study constructs a structural model of migration decision by incorporating different migration costs based on different age ranges. This study further discusses whether current migration policy is effective based on the counterfactual results since the Japanese government currently promotes urban-to-rural migration policy measures for regional revitalization in order to correct monopolar concentration in Tokyo.
    Date: 2019–04
  19. By: Hakimov, Rustamdjan; Kübler, Dorothea
    Abstract: The paper surveys the experimental literature on matching markets. It covers house allocation, school choice, and two-sided matching markets such as college admissions. The main focus of the survey is on truth-telling and strategic manipulations by the agents, on the stability and efficiency of the matching outcome, as well as on the distribution of utility.
    Keywords: experiments,matching markets,survey
    JEL: C92 D83
    Date: 2019
  20. By: Giovanni Di Bartolomeo; Martin Dufwenberg; Stefano Papa; Francesco Passarelli
    Abstract: Why do people keep their promises? Vanberg (2008) and Ederer & Stremitzer (2017) provide causal evidence in favor of, respectively, an intrinsic preference for keeping one’s word and Charness & Dufwenberg’s (2006) expectations-based account based on guilt aversion. The overall picture is incomplete though, as no study disentangles effects in a design that provides exogenous variation of both (the key features of) promises and beliefs. We present an experimental design that does so.
    Keywords: Promises; Expectations; Guilt aversion; Moral commitment; Causation
    JEL: A13 C91 D03 D64
    Date: 2018–12

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