nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2019‒07‒08
fifteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. A portfolio choice problem in the framework of expected utility operators By Irina Georgescu; Louis Aim\'e Fono
  2. Testing for Risk Aversion in First-Price Sealed-Bid Auctions By Federico Zincenko
  3. Do Portfolio Investors Need To Consider The Asymmetry Of Returns On The Russian Stock Market? By Valeria V. Lakshina
  4. The welfare implications of addictive substances: a longitudinal study of life satisfaction of drug users By Moschion, Julie; Powdthavee, Nattavudh
  5. CONSISTENCY OF THE EQUAL SPLIT-OFF SET By Bas Dietzenbacher; Elena Yanovskaya
  6. The quasilinear quadratic utility model: an overview By Philippe Choné; Laurent Linnemer
  7. Anticipatory Anxiety and Wishful Thinking By Jan Engelmann; Maël Lebreton; Peter Schwardmann; Joël van der Weele; Li-Ang Chang
  8. Can loss aversion shed light on the deflation puzzle? By Jenny N. Lye; Ian M. McDonald
  9. The limitations of the representativeness heuristic: further evidence from choices between lottery tickets By Michał Wiktor Krawczyk; Joanna Rachubik
  10. Economic Uncertainty and Subjective Inflation Expectations By Rossmann, Tobias
  11. Do Measures of Risk Attitude in the Laboratory Predict Behavior under Risk in and outside of the Laboratory? By Charness, Gary; Garcia, Thomas; Offerman, Theo; Villeval, Marie Claire
  12. Constrained fixed sample search By Roberto Bonilla; Francis Kiraly
  13. On Capital Allocation under Time and Information Constraints By Christoph J. B\"orner; Ingo Hoffmann; Fabian Poetter; Tim Schmitz
  14. Magnitude Effect in Intertemporal Allocation Tasks By Sun, Chen; Potters, Jan
  15. Predictability concentrates in bad times. And so does disagreement By de Oliveira Souza, Thiago

  1. By: Irina Georgescu; Louis Aim\'e Fono
    Abstract: Possibilistic risk theory starts from the hypothesis that risk is modelled by fuzzy numbers. In particular, in a possibilistic portfolio choice problem, the return of a risky asset will be a fuzzy number. The expected utility operators have been introduced in a previous paper to build an abstract theory of possibilistic risk aversion. To each expected utility operator one can associate a notion of possibilistic expected utility. Using this notion, we will formulate in this very general context a possibilistic choice problem. The main results of the paper are two approximate calculation formulas for corresponding optimization problem. The first formula approximates the optimal allocation with respect to risk aversion and investor's prudence, as well as the first three possibilistic moments. Besides these parameters, in the second formula the temperance index of the utility function and the fourth possibilistic moment appear.
    Date: 2019–06
  2. By: Federico Zincenko
    Abstract: We consider testing for risk aversion in fi rst-price sealed-bid auctions with symmetricbidders and independent private values: the parameters are the bidders' utility function andvaluation distribution. First, we show that any test based on a sample of bids will generally beinconsistent and it will fail to detect any sequence of local alternatives converging to the null of riskneutrality. Second, we introduce restrictions on the parameter space, which are implied by Guerre,Perrigne, and Vuong (2009)'s exclusion restriction, and then we develop a consistent nonparametrictest that controls the limiting size and detects local alternatives at the parametric rate.
    Date: 2019–01
  3. By: Valeria V. Lakshina (National Research University Higher School of Economics)
    Abstract: This paper uses the parsimonious method of embedding skewness in asset allocation based on the Taylor expansion of the investor utility function up to the third term and maximizing it by portfolio weights. This approach also enables us to consider investor risk aversion. Time-dependent multivariate asset moments are obtained via the GOGARCH volatility model with a normal-inverse Gaussian distribution for the error term. We explore the performance of the usual 2 moment utility and its 3 moment counterpart for a portfolio consisted of twenty assets traded on the Russian stock market. The results demonstrate that the 3 moment utility significantly outperforms the 2 moment utility by SD, MAD and CVaR for low levels of absolute risk aversion and by portfolio returns and investor utility level during the whole forecast period.
    Keywords: portfolio optimization, asymmetry of returns, risk aversion, GO-GARCH, normal-inverse Gaussian distribution, utility approach.
    JEL: C13 C22 C58 G11 G17
    Date: 2019
  4. By: Moschion, Julie; Powdthavee, Nattavudh
    Abstract: This paper provides an empirical test of the rational addiction model, used in economics to model individuals’ consumption of addictive substances, versus the utility misprediction model, used in psychology to explain the discrepancy between people’s decision and their subsequent experiences. By exploiting a unique data set of disadvantaged Australians, we provide longitudinal evidence that a drop in life satisfaction tends to precede the use of illegal/street drugs. We also find that the abuse of alcohol, the daily use of cannabis and the weekly use of illegal/street drugs in the past 6 months relate to lower current levels of life satisfaction. This provides empirical support for the utility misprediction model. Further, we find that the decrease in life satisfaction following the consumption of illegal/street drugs persists 6 months to a year after use. In contrast, the consumption of cigarettes is unrelated to life satisfaction in the close past or the near future. Our results, though only illustrative, suggest that measures of individual’s subjective wellbeing should be examined together with data on revealed preferences when testing models of rational decision-making
    Keywords: Life satisfaction Rational addiction Drugs Homeless Australia Happiness
    JEL: I12 I18 I30
    Date: 2018–02–01
  5. By: Bas Dietzenbacher (National Research University Higher School of Economics); Elena Yanovskaya (National Research University Higher School of Economics)
    Abstract: This paper axiomatically studies the equal split-o set [Branzei, Dimitrov, Tijs 2006) as a solution for cooperative games with transferable utility. This solution extends the well-known [Dutta Ray 1989] solution for convex games to arbitrary games. By deriving several characterizations, we explore the relation of the equal split-o set with various consistency notions.
    Keywords: transferable utility games; egalitarianism; equal split-o set; consistency
    JEL: C71
    Date: 2019
  6. By: Philippe Choné; Laurent Linnemer
    Abstract: The quasi-linear quadratic utility model is widely used in economics. The knowledge of its exact origin is less widespread. A first contribution of the paper is to explain the genesis of this model. Next, we review the main properties of the general model, mainly following the previous literature. Finally, it is shown that all the tractable versions of the model used in practice are (almost) identical and have a mean variance structure. We provide ready-to-use formulae for this symmetric model.
    JEL: L13
    Date: 2019
  7. By: Jan Engelmann (University of Amsterdam); Maël Lebreton (University of Geneva); Peter Schwardmann (LMU Munich); Joël van der Weele (University of Amsterdam); Li-Ang Chang (CREED - University of Amsterdam)
    Abstract: It is widely hypothesized that anxiety and worry about an uncertain future lead to the adoption of comforting beliefs or "wishful thinking". However, there is little direct causal evidence for this effect. In our experiment, participants perform a visual pattern recognition task where some patterns may result in the delivery of an electric shock, a proven way of inducing anxiety. Participants engage in significant wishful thinking, as they are less likely to correctly identify patterns that they know may lead to a shock. Greater ambiguity of the pattern facilitates wishful thinking. Raising incentives for accuracy does not significantly decrease it.
    Keywords: confidence, beliefs, anticipatory utility, anxiety, motivated cognition
    JEL: D83 C91
    Date: 2019–06–21
  8. By: Jenny N. Lye; Ian M. McDonald
    Abstract: This paper argues that the application of loss aversion to wage determination can explain the deflation puzzle: the failure of persistently high unemployment to exert a persistent downward impact on the rate of inflation in money wages. This is an improvement on other theories of the deflation puzzle which simply assume downward wage rigidity; which are the hysteresis theory, the lubrication theory and the efficiency wage theory. The paper presents estimates that support the loss aversion explanation of the deflation puzzle for both the US and Australia. Furthermore, our estimation approach gives a more precise estimate of the potential rate of unemployment than does the natural rate approach and reveals a potential rate of unemployment for the US and Australia at the current time (end of 2017) of about 4% and 3.3% respectively.
    Keywords: unemployment, inflation, Phillips curve, hysteresis, loss aversion, behavioural macroeconomics
    JEL: E12 E24 E31
    Date: 2019–06
  9. By: Michał Wiktor Krawczyk (Faculty of Economic Sciences, University of Warsaw); Joanna Rachubik (Faculty of Economic Sciences, University of Warsaw)
    Abstract: The representativeness heuristic (RH) proposes that people expect even a small sample to have similar characteristics to the parent population. One domain in which it appears to operate is the preference for combinations of numbers on lottery tickets: most players seem to avoid very characteristic, “unrepresentative” combinations, e.g. only containing very low numbers. Likewise, most players may avoid betting on a combination that was drawn recently, because it would seem particularly improbable to be drawn again. We confirm both of these tendencies in two field experiments, building upon Krawczyk and Rachubik (2019, KR19). However, we find no link between these two choices: it is not the same people that show the two biases. In this sense, the RH does not organize the data well. Nevertheless, there are some links related to rationality across the two choices – people who are willing to forgo a monetary payment in order to get the preferred ticket in one task are also willing to do it in the other. We find such preference to be related with misperception of probabilities and providing intuitive, incorrect answers in the Cognitive Reflection Test.
    Keywords: Decision making under risk; Gambler’s fallacy; Lottery choice; Perception of randomness; Number preferences in lotteries; Representativeness heuristic
    JEL: C93 D01 D81 D91
    Date: 2019
  10. By: Rossmann, Tobias (LMU Munich)
    Abstract: Measuring economic uncertainty is crucial for understanding investment decisions by individuals and firms. Macroeconomists increasingly rely on survey data on subjective expectations. An innovative approach to measure aggregate uncertainty exploits the rounding patterns in individuals\' responses to survey questions on inflation expectations (Binder, 2017). This paper uses the panel dimension of household surveys to study individual-level heterogeneity in this measure of individual uncertainty. The results provide evidence for the existence of considerable heterogeneity in individuals\' response behavior and inflation expectations.
    Keywords: uncertainty; inflation; expectations; mixture models;
    JEL: C10 D80 D83 D84 E31
    Date: 2019–06–25
  11. By: Charness, Gary (University of California, Santa Barbara); Garcia, Thomas (GATE, University of Lyon); Offerman, Theo (University of Amsterdam); Villeval, Marie Claire (CNRS, GATE)
    Abstract: We consider the external validity of laboratory measures of risk attitude. Based on a large-scale experiment using a representative panel of the Dutch population, we test if these measures can explain two different types of behavior: (i) behavior in laboratory risky financial decisions, and (ii) behavior in naturally-occurring field behavior under risk (financial, health and employment decisions). We find that measures of risk attitude are related to behavior in laboratory financial decisions and the most complex measures are outperformed by simpler measures. However, measures of risk attitude are not related to risk-taking in the field, calling into question the methods currently used for the purpose of measuring actual risk preferences. We conclude that while the external validity of measures of risk attitude holds in closely related frameworks, this validity is compromised in more remote settings.
    Keywords: lab-in-the-field experiment, elicitation methods, risk preferences
    JEL: C91 C93 D81
    Date: 2019–06
  12. By: Roberto Bonilla; Francis Kiraly
    Abstract: We consider a version of the Stigler model of fixed sample price search, where consumer utility depends on whether or not at least one sampled price fulfils a pre-set target.
    Keywords: fixed sample search, constrained search
    JEL: D83
    Date: 2019
  13. By: Christoph J. B\"orner; Ingo Hoffmann; Fabian Poetter; Tim Schmitz
    Abstract: Attempts to allocate capital to a selection of different investment objects often face the problem that investors' decisions are made under limited information (no historical return data) and an extremely limited timeframe. Nevertheless, in some cases, rational investors with a certain level of experience are able to ordinally rank investment alternatives through relative assessments of the probability that an investment will be successful. However, to apply traditional portfolio optimization models, analysts must use historical (or simulated/expected) return data as the basis for their calculations. Our paper develops an alternative portfolio optimization framework that is able to handle this kind of information (given by the ordinal ranking of investment alternatives) and to calculate an optimal capital allocation based on a Cobb-Douglas function. Considering risk-neutral investors, we show that the results of this portfolio optimization model usually outperform the output generated by the (intuitive) Equally Weighted Portfolio (EWP) of the different investment alternatives, which is the result of optimization when one is unable to incorporate additional data (the ordinal ranking of the alternatives). In a further extension, we show that our model is also able to address risk-averse investors to capture diversification benefits.
    Date: 2019–06
  14. By: Sun, Chen (HU Berlin); Potters, Jan (Tilburg University)
    Abstract: We investigate how intertemporal allocation of monetary rewards is influenced by the size of total budget, with a particular interest in the channels of influence. We find a significant magnitude effect: the budget share allocated to the later date increases with the size of the budget. At the aggregate level as well as at the individual level, we find magnitude effects both on the discount rate and on intertemporal substitutability (i.e. utility curvature). The latter effect is consistent with theories in which the degree of asset integration is increasing in the stake.
    Keywords: time preference; magnitude effect; convex time budget method;
    JEL: C91 D12 D91
    Date: 2019–06–24
  15. By: de Oliveira Souza, Thiago (Department of Business and Economics)
    Abstract: Within a standard risk-based asset pricing framework with rational expectations, realized returns have two components: Predictable risk premiums and unpredictable shocks. In bad times, the price of risk increases. Hence, the predictable fraction of returns – and predictability – increases. “Disagreement” (dispersion in analyst forecasts) also intensifies in bad times if (i) analysts report (close to) risk-neutral expectations weighted by state prices, which become more volatile, or (ii) dividend volatility changes with the price of risk – for example, because consumption volatility changes. In both cases, individual analysts produce unbiased forecasts based on partial information.
    Keywords: Predictability; bad times; efficient market hypothesis; disagreement; rational expectations
    JEL: G11 G12 G14
    Date: 2019–06–26

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