nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2019‒07‒29
thirteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Boolean Representations of Preferences under Ambiguity By Mira Frick; Ryota Iijima; Yves Le Yaouanq
  2. Experimental Asset Markets with An Indefinite Horizon By John Duffy; Janet Hua Jiang; Huan Xie
  3. Your money and your life: risk attitudes over gains and losses By Oliver, Adam
  4. Information processing constraints in travel behaviour modelling: A generative learning approach By Melvin Wong; Bilal Farooq
  5. Behavior of the Lithuanian investors at the period of economic growth By Egidijus Bikas; Vitalija Saponaitė
  6. From small markets to big markets By Laurence Carassus; Miklos Rasonyi
  7. Existence and Uniqueness of Solutions to the Stochastic Bellman Equation with Unbounded Shock By Juan Pablo Rinc\'on-Zapatero
  8. Discrete Choice and Welfare Analysis with Unobserved Choice Sets By Victor H. Aguiar; Nail Kashaev
  9. The likelihood of divorce and the riskiness of financial decisions By Stark, Oded; Szczygielski, Krzysztof
  10. Bounded Rationality, Monetary Policy, and Macroeconomic Stability By Francisco Ilabaca; Greta Meggiorini; Fabio Milani
  11. Multivariate LQG Control under Rational Inattention in Continuous Time By Jianjun Miao
  12. Monopolistic competition and optimum product selection: why and how heterogeneity matters By Nocco, Antonella; Ottaviano, Gianmarco I. P.; Salto, Matteo
  13. Longevity, Retirement and Intra-Generational Equity By Svend E. Hougaard Jensen; Thorsteinn Sigurdur Sveinsson; Gylfi Zoega

  1. By: Mira Frick (Cowles Foundation, Yale University); Ryota Iijima (Cowles Foundation, Yale University); Yves Le Yaouanq (Ludwig-Maximilians-Universität, Munich)
    Abstract: We propose a class of multiple-prior representations of preferences under ambiguity where the belief the decision-maker (DM) uses to evaluate an uncertain prospect is the outcome of a game played by two conflicting forces, Pessimism and Optimism. The model does not restrict the sign of the DM’s ambiguity attitude, and we show that it provides a uni?ed framework through which to characterize di?erent degrees of ambiguity aversion, as well as to represent context-dependent negative and positive ambiguity attitudes documented in experiments. We prove that our baseline representation, Boolean expected utility (BEU), yields a novel representation of the class of invariant biseparable preferences (Ghirardato, Maccheroni, and Marinacci, 2004), which drops uncertainty aversion from maxmin expected utility (Gilboa and Schmeidler, 1989), while extensions of BEU allow for more general departures from independence.
    Keywords: Ambiguity, Multiple priors, Dual-self models
    JEL: D81
    Date: 2019–06
  2. By: John Duffy (University of California, Irvine); Janet Hua Jiang (Bank of Canada); Huan Xie (Concordia University)
    Abstract: We study the trade of indefinitely-lived assets in experimental markets. The traded prices of these assets are on average more than 40% below the risk-neutral fundamental value under the expected utility assumption. We examine the effects of three interrelated factors for the traded price, payoff uncertainty about the asset’s dividend payments, horizon uncertainty about the duration of trade, and the expected utility assumption. Our results suggest that horizon uncertainty does not significantly affect the traded price. Incorporating risk aversion into non-expected utility models with recursive preferences and probability weighting can rationalize the low prices observed in our indefinite-horizon asset markets.
    Keywords: asset pricing, behavioral finance, experiments, indefinite horizon, random termination, risk and uncertainty, expected utility, Epstein-Zin recursive preferences, probability weighting
    JEL: C91 C92 D81 G12
  3. By: Oliver, Adam
    Abstract: Prospect theory is the most influential descriptive alternative to the orthodox model of rational choice under risk and uncertainty, in terms of empirical analyses of some of its principal parameters and as a consideration in behavioural public policy. Yet the most distinctive implication of the theory – a fourfold predicted pattern of risk attitudes called the reflection effect – has been infrequently studied and with mixed results over money outcomes, and has never been completely tested over health outcomes. This article reports tests of reflection over money and health outcomes defined by life years gained from treatment. With open valuation exercises, the results suggest qualified support for the reflection effect over money outcomes and strong support over health outcomes. However, in pairwise choice questions, reflection was substantially ameliorated over life years, remaining significant only for treatments that offered short additional durations of life.
    Keywords: Expected utility theory; Markowitz; Prospect theory; Reflection effect; Risk
    JEL: B21 C12 C91
    Date: 2019–08
  4. By: Melvin Wong; Bilal Farooq
    Abstract: Travel decisions tend to exhibit sensitivity to uncertainty and information processing constraints. These behavioural conditions can be characterized by a generative learning process. We propose a data-driven generative model version of rational inattention theory to emulate these behavioural representations. We outline the methodology of the generative model and the associated learning process as well as provide an intuitive explanation of how this process captures the value of prior information in the choice utility specification. We demonstrate the effects of information heterogeneity on a travel choice, analyze the econometric interpretation, and explore the properties of our generative model. Our findings indicate a strong correlation with rational inattention behaviour theory, which suggest that individuals may ignore certain exogenous variables and rely on prior information for evaluating decisions under uncertainty. Finally, the principles demonstrated in this study can be formulated as a generalized entropy and utility based multinomial logit model.
    Date: 2019–07
  5. By: Egidijus Bikas (Vilnius University [Vilnius]); Vitalija Saponaitė (Vilnius University [Vilnius])
    Abstract: Modern scientists speak and write about investor's psychological factors, decision-making processes, and the importance of financial behavior in the investment process. One of the modern theories-an efficient market-focused on rational investors. According to it, investors rationally manage their investment portfolio; rationally respond to constantly changing information and make rational changes to newly acquired information. However, the prospect theory has proven that irrational investor decisions play an important role in the investment process. An assessment of irrationality of investors is important for governments, fund managers and investors, eventually for all participants of financial market. For some, this is an opportunity to additional funds, to receive higher income, for others, would provide the added value, as they could identify themselves as investors. Understanding how decisions are influenced by behavior it is important both for self-education and investment decision-making. The article aims to identify the typology of the Lithuanian investors by distinguishing behavioral deviations that influence the behavior of investors' decisions in the stage of the country's economic growth. The research will identify types of physical entities, behavioral deviations, motives of investment decisions made. The qualitative and quantitative methods are used to perform the research: investor inquiry, correlation and regression analysis.
    Date: 2018–09–30
  6. By: Laurence Carassus; Miklos Rasonyi
    Abstract: We study the most famous example of a large financial market: the Arbitrage Pricing Model, where investors can trade in a one-period setting with countably many assets admitting a factor structure. We consider the problem of maximising expected utility in this setting. Besides establishing the existence of optimizers under weaker assumptions than previous papers, we go on studying the relationship between optimal investments in finite market segments and those in the whole market. We show that certain natural (but nontrivial) continuity rules hold: maximal satisfaction, reservation prices and (convex combinations of) optimizers computed in small markets converge to their respective counterparts in the big market.
    Date: 2019–07
  7. By: Juan Pablo Rinc\'on-Zapatero
    Abstract: In this paper we develop a general framework to analyze stochastic dynamic problems with unbounded utility functions and correlated and unbounded shocks. We obtain new results of the existence and uniqueness of solutions to the Bellman equation through a general fixed point theorem that generalizes known results for Banach contractions and local contractions. We study an endogenous growth model as well as the Lucas asset pricing model in an exchange economy, significantly expanding their range of applicability.
    Date: 2019–07
  8. By: Victor H. Aguiar; Nail Kashaev
    Abstract: We propose a framework for doing sharp nonparametric welfare analysis in discrete choice models with unobserved variation in choice sets. We recover jointly the distribution of choice sets and the distribution of preferences. To achieve this we use panel data on choices and assume nestedness of the latent choice sets. Nestedness means that choice sets of different decision makers are ordered by inclusion. It may be satisfied, for instance, when it is the result of either a search process or unobserved feasibility. Using variation of the uncovered choice sets we show how to do ordinal (nonparametric) welfare comparisons. When one is willing to make additional assumptions about preferences, we show how to nonparametrically identify the ranking over average utilities in the standard multinomial choice setting.
    Date: 2019–07
  9. By: Stark, Oded; Szczygielski, Krzysztof
    Abstract: We link causally the riskiness of men's management of their finances with the probability of their experiencing a divorce. Our point of departure is that when comparing single men to married men, the former manage their finances in a more aggressive (that is, riskier) manner. Assuming that single men believe that low relative wealth has a negative effect on their standing in the marriage market and that they care about their standing in that market more than married men do, we find that a stronger distaste for low relative wealth translates into reduced relative risk aversion and, consequently, into riskier financial behavior. With this relationship in place we show how this difference varies depending on the "background" likelihood of divorce and, hence, on the likelihood of re-entry into the marriage market: married men in environments that are more prone to divorce exhibit risk-taking behavior that is more similar to that of single men than married men in environments that are little prone to divorce. We offer a theoretical contribution that helps inform and interpret empirical observations and regularities and can serve as a guide for follow-up empirical work, having established and identified the direction of causality.
    Keywords: Men's preferences towards risk,Risk-taking behavior,Concern at having low relative wealth,Relative and absolute risk aversion,Marital-based difference in attitudes towards risk,Likelihood of divorce
    JEL: D21 D81 G32
    Date: 2019
  10. By: Francisco Ilabaca; Greta Meggiorini; Fabio Milani
    Abstract: This paper estimates a Behavioral New Keynesian model to revisit the evidence that passive US monetary policy in the pre-1979 sample led to indeterminate equilibria and sunspot-driven fluctuations, while active policy after 1982, by satisfying the Taylor principle, was instrumental in restoring macroeconomic stability. The model assumes “cognitive discounting”, i.e., consumers and firms pay less attention to variables further into the future. We estimate the model allowing for both determinacy and indeterminacy. The empirical results show that determinacy is preferred both before and after 1979. Even if monetary policy is found to react only mildly to inflation pre-Volcker, the substantial degrees of bounded rationality that we estimate prevent the economy from falling into indeterminacy.
    Keywords: Behavioral New Keynesian model, cognitive discounting, estimation under determinacy and indeterminacy, Taylor principle, active vs passive monetary policy
    JEL: E31 E32 E52 E58
    Date: 2019
  11. By: Jianjun Miao (Boston University)
    Abstract: I propose a multivariate linear-quadratic-Gaussian control framework with rational inattention in continuous time. I propose a three-step solution procedure and numerical methods. The critical step is to transform the problem into a rate distortion problem and derive a semidefinite programming representation. I provide generalized reverse water-filling solutions for some special cases and characterize the optimal signal dimension. I apply my approach to study a consumption/saving problem and illustrate two pitfalls in the literature.
    Keywords: Rational Inattention, Optimal Control, Semidefinite Programming, Consumption, Information Theory
    JEL: C6 D8 E2
    Date: 2019–02
  12. By: Nocco, Antonella; Ottaviano, Gianmarco I. P.; Salto, Matteo
    Abstract: After some decades of relative oblivion, the interest in the optimality properties of monopolistic competition has recently re-emerged due to the availability of an appropriate and parsimonious framework to deal with firm heterogeneity. Within this framework we show that non-separable utility, variable demand elasticity and endogenous firm heterogeneity cause the market equilibrium to err in many ways, concerning the number of products, the size and the choice of producers, the overall size of the monopolistically competitive sector. More crucially with respect to the existing literature, we also show that the extent of the errors depends on the degree of firm heterogeneity. In particular, the ine¢ ciency of the market equilibrium is largest when selection among heterogenous firms is needed most, that is, when there are relatively many firms with low productivity and relatively few firms with high productivity.
    Keywords: monopolistic competition; product diversity; firm heterogene-ity; selection; welfare
    JEL: J1 L81
    Date: 2017–07–20
  13. By: Svend E. Hougaard Jensen; Thorsteinn Sigurdur Sveinsson; Gylfi Zoega
    Abstract: We find that segments of society who have shorter life expectancy can expect a lower retirement income and lifetime utility due to the longevity of other groups participating in the same pension scheme. Linking retirement age to average life expectancy magnifies the negative effect on the lifetime utility of those who suffer low longevity. Furthermore, when the income of those with greater longevity increases, those with shorter life expectancy become even worse off. Conversely, when the income of those with shorter life expectancy increases, they end up paying more into the pension scheme, which benefits those who live longer. The relative sizes of the low and high longevity groups in the population determine the magnitude of these effects. We calibrate the model based on data on differences in life expectancy of men and women and find that males suffer from a 10 percent drop in the amount of pension benefits from being forced to pay into the same scheme as females.
    Keywords: longevity, pension age, retirement, inequality
    JEL: E21 E24
    Date: 2019

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