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on Utility Models and Prospect Theory |
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Issue of 2019‒09‒09
fifteen papers chosen by |
| By: | Andreas Lichtenstern; Pavel V. Shevchenko; Rudi Zagst |
| Abstract: | In this article we solve the problem of maximizing the expected utility of future consumption and terminal wealth to determine the optimal pension or life-cycle fund strategy for a cohort of pension fund investors. The setup is strongly related to a DC pension plan where additionally (individual) consumption is taken into account. The consumption rate is subject to a time-varying minimum level and terminal wealth is subject to a terminal floor. Moreover, the preference between consumption and terminal wealth as well as the intertemporal coefficient of risk aversion are time-varying and therefore depend on the age of the considered pension cohort. The optimal consumption and investment policies are calculated in the case of a Black-Scholes financial market framework and hyperbolic absolute risk aversion (HARA) utility functions. We generalize Ye (2008) (2008 American Control Conference, 356-362) by adding an age-dependent coefficient of risk aversion and extend Steffensen (2011) (Journal of Economic Dynamics and Control, 35(5), 659-667), Hentschel (2016) (Doctoral dissertation, Ulm University) and Aase (2017) (Stochastics, 89(1), 115-141) by considering consumption in combination with terminal wealth and allowing for consumption and terminal wealth floors via an application of HARA utility functions. A case study on fitting several models to realistic, time-dependent life-cycle consumption and relative investment profiles shows that only our extended model with time-varying preference parameters provides sufficient flexibility for an adequate fit. This is of particular interest to life-cycle products for (private) pension investments or pension insurance in general. |
| Date: | 2019–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1908.09976&r=all |
| By: | Federico Echenique |
| Abstract: | The chapter reviews recent developments in revealed preference theory. It discusses the testable implications of theories of choice that are germane to specific economic environments. The focus is on expected utility in risky environments; subjected expected utility and maxmin expected utility in the presence of uncertainty; and exponentially discounted utility for intertemporal choice. The testable implications of these theories for data on choice from classical linear budget sets are described, and shown to follow a common thread. The theories all imply an inverse relation between prices and quantities, with different qualifications depending on the functional forms in the theory under consideration. |
| Date: | 2019–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1908.07561&r=all |
| By: | Cheung, Stephen L. (University of Sydney) |
| Abstract: | This paper examines the effects of alternative assumptions regarding the curvature of utility upon estimated discount rates in experimental data. To do so, it introduces a novel design to elicit time preference building upon a translation of the Holt and Laury method for risk. The results demonstrate that utility elicited directly from choice over time is significantly concave, but far closer to linear than utility elicited under risk. As a result, the effect of adjusting discount rates for this curvature is modest compared to assuming linear utility, and considerably less than when utility from a risk preference task is imposed. |
| Keywords: | time preference, measurement of utility, discounted utility, choice list |
| JEL: | C91 D01 D90 |
| Date: | 2019–08 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp12535&r=all |
| By: | Andreas H Hamel; Birgit Rudloff; Zhou Zhou |
| Abstract: | A market model with $d$ assets in discrete time is considered where trades are subject to proportional transaction costs given via bid-ask spreads, while the existence of a num\`eraire is not assumed. It is shown that robust no arbitrage holds if, and only if, there exists a Pareto solution for some vector-valued utility maximization problem with component-wise utility functions. Moreover, it is demonstrated that a consistent price process can be constructed from the Pareto maximizer. |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1909.00354&r=all |
| By: | Gutierrez, Federico H. |
| Abstract: | This paper proposes a simple solution to the independence of irrelevant alternatives (IIA) problem in Choo and Siow (2006) model, overcoming what is probably the main limitation of this approach. The solution consists of assuming match-specific rather than choice-specific random preferences. The original marriage matching function gets modified by an adjustment factor that improves its empirical properties. Using the American Community Survey, I show that the new approach yields significantly different results affecting the qualitative conclusions of the analysis. The proposed solution to the IIA problem applies to other settings in which the relative "supply" of choices is observable. |
| Keywords: | Independence of irrelevant alternatives,marriage market,transferable utility |
| JEL: | J12 J16 J10 |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:glodps:387&r=all |
| By: | Ulrich Horst; Xiaonyu Xia; Chao Zhou |
| Abstract: | We study an optimal liquidation problem under the ambiguity with respect to price impact parameters. Our main results show that the value function and the optimal trading strategy can be characterized by the solution to a semi-linear PDE with superlinear gradient, monotone generator and singular terminal value. We also establish an asymptotic analysis of the robust model for small amount of uncertainty and analyse the effect of robustness on optimal trading strategies and liquidation costs. In particular, in our model ambiguity aversion is observationally equivalent to increased risk aversion. This suggests that ambiguity aversion increases liquidation rates. |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1909.00748&r=all |
| By: | Maxim Bichuch; Jean-Pierre Fouque |
| Abstract: | The problem of portfolio allocation in the context of stocks evolving in random environments, that is with volatility and returns depending on random factors, has attracted a lot of attention. The problem of maximizing a power utility at a terminal time with only one random factor can be linearized thanks to a classical distortion transformation. In the present paper, we address the problem with several factors using a perturbation technique around the case where these factors are perfectly correlated reducing the problem to the case with a single factor. We illustrate our result with a particular model for which we have explicit formulas. A rigorous accuracy result is also derived using sub- and super-solutions of the HJB equation involved. In order to keep the notations as explicit as possible, we treat the case with one stock and two factors and we describe an extension to the case with two stocks and two factors. |
| Date: | 2019–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1908.07626&r=all |
| By: | Bram De Rock; Laurens Cherchye; Bart Smeulders |
| Abstract: | Kitamura and Stoye (2018) recently proposed a nonparametric statistical test for random utility models of consumer behavior. The test is formulated in terms of linear inequality constraints and a quadratic objective function. While the nonparametric test is conceptually appealing, its practical implementation is computationally challenging. In this note, we develop a column generation approach to operationalize the test. We show that these novel computational tools generate considerable computational gains in practice, which substantially increases the empirical usefulness of Kitamura and Stoye’s statistical test. |
| Keywords: | computational tools; statistical testing |
| Date: | 2019–08 |
| URL: | http://d.repec.org/n?u=RePEc:eca:wpaper:2013/292215&r=all |
| By: | Julia M. Puaschunder (The New School, NY) |
| Abstract: | Economics is concerned about utility. Utility theory captures people’s preferences or values. As one of the foundations of economic theory, the wealth of information and theories on utility lacks information about decision-making conflicts between preferences and values. The preference for communication is inherent in human beings as a distinct feature of humanity. Leaving a written legacy that can inform many generations to come is a humane-unique advancement of society. At the same time, however, privacy is a core human value. People choose what information to share with whom and like to protect some parts of their selves by secrecy. Protecting people’s privacy is a codified virtue around the globe grounded in the wish to uphold individual’s dignity. Yet to this day, no utility theory exists to describe the internal conflict arising from the individual preference to communicate and the value of privacy. In the age of instant communication and social media big data storage and computational power; the need for understanding people’s trade off between communication and privacy has leveraged to unprecedented momentum. For one, enormous data storage capacities and computational power in the e-big data era have created unforeseen opportunities for big data hoarding corporations to reap hidden benefits from individual’s information sharing, which occurs bit by bit in small tranches over time. |
| Keywords: | Behavioral Economics, Behavioral Political Economy, Democratisation of information, Education, Exchange value, Governance, Preferences, Right to delete, Right to be forgotten, Social media, Utility, Value |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:smo:rpaper:01&r=all |
| By: | Thomas Bassetti (Department of Economics and Management, University of Padova); Stefano Bonini (Stevens Institute of Technology); Fausto Pacicco (LIUC Università Carlo Cattaneo); Filippo Pavesi (LIUC Università Carlo Cattaneo and Stevens Institute of Technology) |
| Abstract: | Behavioral biases affect a large number of human decisions, many of which have relevant welfare effects. We identify a bias that we denote as "reversibility bias" and explore how the introduction of explicit exposure mechanisms can contribute to attenuate it. To do this, we exploit a unique natural experiment - the introduction of a decision review system represented by player challenges and the associated Hawk-Eye technology in professional tennis. This experiment allows us to identify the bias, by illustrating that if such a bias exists, the challenge rule should reduce the number of calls that postpone the assignment of a point. Our findings may have significant policy implications providing a conceptual framework for the design of institutions to alleviate the welfare costs associated with reversibility bias in different contexts, such as court rulings, human resource management and debt roll-over decisions. |
| Keywords: | prospect theory, natural experiment, uncertainty |
| JEL: | D81 D91 C93 |
| Date: | 2019–08 |
| URL: | http://d.repec.org/n?u=RePEc:pad:wpaper:0238&r=all |
| By: | Philipp Külpmann (University of Vienna, Austria); Christoph Kuzmics (University of Graz, Austria) |
| Abstract: | We propose a novel challenge for assessing the predictive power of a theory of one shotplay in games (subjects playing a game exactly once): we test the predictive power of theories in situations for which we do not (yet) have any data. To do so, we consider a variety of such theories and fix their parameter estimates from the recent large scale meta-analysis of Wright and Leyton-Brown (2017). We then compare the predictive power of these theories, measured in terms of log-likelihood, for a series of symmetric hawk-dove games played in the lab. We find that even for such a narrow class of games, no theory is uniformly better than all others across all treatments. Furthermore, the theory that provides the highest overall log-likelihood for our data is Nash equilibrium with risk aversion, with an estimated risk aversion parameter taken from Hey and Orme (1994) and its replication in Harrison and Rutström (2009). In particular, it significantly beats the two theories (based on quantal level k and cognitive hierarchy models) which performed best in Wright and Leyton-Brown’s (2017) standard out-of-sample prediction task. |
| Keywords: | Hawk-dove games; Testing theories; One-shot play; Risk aversion; Nash equilibrium, Quantal response equilibria; Level-k theory; Cognitive hierarchy theory |
| JEL: | C72 C91 |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:grz:wpaper:2019-09&r=all |
| By: | Yvo Desmedt; Arkadii Slinko |
| Abstract: | The study of Rational Secret Sharing initiated by Halpern and Teague regards the reconstruction of the secret in secret sharing as a game. It was shown that participants (parties) may refuse to reveal their shares and so the reconstruction may fail. Moreover, a refusal to reveal the share may be a dominant strategy of a party. In this paper we consider secret sharing as a sub-action or subgame of a larger action/game where the secret opens a possibility of consumption of a certain common good. We claim that utilities of participants will be dependent on the nature of this common good. In particular, Halpern and Teague scenario corresponds to a rivalrous and excludable common good. We consider the case when this common good is non-rivalrous and non-excludable and find many natural Nash equilibria. We list several applications of secret sharing to demonstrate our claim and give corresponding scenarios. In such circumstances the secret sharing scheme facilitates a power sharing agreement in the society. We also state that non-reconstruction may be beneficial for this society and give several examples. |
| Date: | 2019–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1908.07581&r=all |
| By: | David Walker-Jones |
| Abstract: | This paper uses an axiomatic foundation to create a new measure for the cost of learning that allows for multiple perceptual distances in a single choice environment so that some events can be harder to differentiate between than others. The new measure maintains the tractability of Shannon's classic measure but produces richer choice predictions and identifies a new form of informational bias significant for welfare and counterfactual analysis. The model also provides a new foundation for non-compensatory behavior, connecting the literatures on rational inattention and heuristic style choice rules. |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1909.00888&r=all |
| By: | Erwin Bulte; John List; Daan van Soest |
| Abstract: | Social scientists have recently explored how framing of gains and losses affects productivity. We conducted a field experiment in peri-urban Uganda, and compared output levels across 1000 workers over isomorphic tasks and incentives, framed as either losses or gains. We find that loss aversion can be leveraged to increase the productivity of labor. The estimated welfare costs of using the loss contract are quite modest -- perhaps because the loss contract is viewed as a (soft) commitment device. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:feb:natura:00674&r=all |
| By: | Steven Jacob Bosworth (University of Reading); Dennis J. Snower (Christian-Albrechts-University of Kiel) |
| Abstract: | We develop a model of the social fragmentation along communitarian vs. individualistic values. The endogenous adoption of social values hinges on whether people choose to derive more utility from comparisons with others (materialistic but universalist values) or derive relatively more utility from membership of a group with its distinguishing characteristics (communitarian but exclusive values). Those more well-off, socioeconomically, gravitate towards individualism while those of lower status gravitate towards communitarianism. Crucially, those at the lower end of the middle classes are predicted to align more and more with communitarian values when the status advantage of those at the top increases, holding their own income constant (i.e. rising socioeconomic inequality). Conversely, those at the higher end of the middle classes are predicted to align more and more with individualist values, polarising society. These shifts also increase size of the political constituency for enacting protectionist policies, which act as a stabilising force against socioeconomic polarisation. The model therefore predicts political realignments from the incidence of income growth and the importance of status-oriented (conspicuous) consumption. |
| Keywords: | inequality, values, political fragmentation, nationalism |
| JEL: | A13 D63 F50 O00 Q43 |
| Date: | 2019–08–27 |
| URL: | http://d.repec.org/n?u=RePEc:rdg:emxxdp:em-dp2019-17&r=all |