nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2019‒11‒04
eleven papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Almost Quasi-linear Utilities in Disguise: Positive-representation An Extension of Roberts' Theorem By Ilan Nehama
  2. Hedging and the regret theory of the competitive firm By Broll, Udo; Welzel, Peter; Wong, Kit Pong
  3. Dual decision processes: retrieving preferences when some choices are automatic By Francesco Cerigioni
  4. Dynamic Consistency in English Auctions and Expected Utility Theory By Karni, Edi; Safra, Zvi
  5. The Value of Precise Communication in Persuasion By Eray Turkel; Yunus C. Aybas
  6. The Politics of News Personalization By Lin Hu; Anqi Li; Ilya Segal
  7. Costly Verification in Collective Decisions By Albin Erlanson; Andreas Kleiner
  8. Option-based Equity Risk Premiums By Alan L. Lewis
  9. Loss aversion in the trade-off between wages and commuting distances By Dauth, Wolfgang; Haller, Peter
  10. Attention and Framing By Mihir Bhattacharya; Saptarshi Mukherjee; Ruhi Sonal
  11. Dynamic Contracting for Innovation Under Ambiguity By Swagata Bhattacharjee

  1. By: Ilan Nehama
    Abstract: This work deals with the implementation of social choice rules using dominant strategies for unrestricted preferences. The seminal Gibbard-Satterthwaite theorem shows that only few unappealing social choice rules can be implemented unless we assume some restrictions on the preferences or allow monetary transfers. When monetary transfers are allowed and quasi-linear utilities w.r.t. money are assumed, Vickrey-Clarke-Groves (VCG) mechanisms were shown to implement any affine-maximizer, and by the work of Roberts, only affine-maximizers can be implemented whenever the type sets of the agents are rich enough. In this work, we generalize these results and define a new class of preferences: Preferences which are positive-represented by a quasi-linear utility. That is, agents whose preference on a subspace of the outcomes can be modeled using a quasi-linear utility. We show that the characterization of VCG mechanisms as the incentive-compatible mechanisms extends naturally to this domain. Our result follows from a simple reduction to the characterization of VCG mechanisms. Hence, we see our result more as a fuller more correct version of the VCG characterization. This work also highlights a common misconception in the community attributing the VCG result to the usage of transferable utility. Our result shows that the incentive-compatibility of the VCG mechanisms does not rely on money being a common denominator, but rather on the ability of the designer to fine the agents on a continuous (maybe agent-specific) scale. We think these two insights, considering the utility as a representation and not as the preference itself (which is common in the economic community) and considering utilities which represent the preference only for the relevant domain, would turn out to fruitful in other domains as well.
    Date: 2019–10
  2. By: Broll, Udo; Welzel, Peter; Wong, Kit Pong
    Abstract: This paper examines the production and hedging decisions of the competitive firm under price uncertainty when the firm is not only risk averse but also regret averse. Regret-averse preferences are characterized by a modified utility function that includes disutility from having chosen ex-post suboptimal alternatives. The extent of regret depends on the difference between the actual profit and the maximum profit attained by making the optimal production and hedging decisions had the firm observed the true realization of the random output price. While the separation theorem holds under regret aversion, the prevalence of hedging opportunities may have perverse effect on the firm's optimal output level, particularly when the firm is sufficiently regret averse. The full-hedging theorem, however, does not hold. We derive sufficient conditions under which the regret-averse firm's optimal futures position is an under-hedge (over-hedge). We further show that the firm optimally increases (decreases) its futures position when the price risk possesses more positive (negative) skewness.
    Keywords: Futures,Production,Regret theory
    JEL: D21 D24 D81
    Date: 2019
  3. By: Francesco Cerigioni
    Abstract: Evidence from the cognitive sciences suggests that some choices are conscious and reflect individual volition while others tend to be automatic, being driven by analogies with past experiences. Under these circumstances, standard economic modeling might not always be applicable because not all choices are the result of individual tastes. We propose a behavioral model that can be used in standard economic analysis that formalizes the way in which conscious and automatic choices arise by presenting a decision maker comprised of two selves. One self compares past decision problems with the one the decision maker faces and, when the problems are similar enough, it replicates past behavior (Automatic choices). Otherwise, a second self is activated and preferences are maximized (Conscious choices). We then present a novel method capable of identifying a set of conscious choices from observed behavior and discuss its usefulness as a framework for studying asymmetric pricing and empirical puzzles in different settings.
    Keywords: Dual processes, similarity, revealed preferences, fluency, automatic choice
    JEL: D01 D03 D60
    Date: 2019–10
  4. By: Karni, Edi; Safra, Zvi
    Keywords: Teaching/Communication/Extension/Profession
  5. By: Eray Turkel; Yunus C. Aybas
    Abstract: Persuasion is an exceedingly difficult task. A leading cause of this difficulty is the misalignment of preferences, which is studied extensively by the literature on persuasion games. However, the difficulty of communication also has a first order effect on outcomes and welfare of agents. Motivated by this observation, we study a model of Bayesian persuasion in which the communication between the sender and the receiver is constrained. We limit the cardinality of the signal space to be less than the cardinality of the action space and the state space. This limits the sender's ability of making arbitrarily many action recommendations. We prove the existence of a solution to the sender's utility maximization problem and characterize its properties. In solving this problem, we develop a novel approach for solving Bayesian persuasion problems, which can be applied to a wide range of settings. We characterize the sender's willingness to pay for an additional signal as a function of the prior belief, which we interpret as the value of precise communication. We show that increased precision might not be always welfare improving by showing that the receiver might prefer coarse communication.
    Date: 2019–10
  6. By: Lin Hu; Anqi Li; Ilya Segal
    Abstract: We study how news personalization affects policy polarization. In a two-candidate electoral competition model, an attention-maximizing infomediary aggregates information about candidate valence into news, whereas voters decide whether to consume news, trading off the expected utility gain from improved expressive voting against the attention cost. Broadcast news attracts a broad audience by offering a symmetric signal. Personalized news serves extreme voters with skewed signals featuring own-party bias and occasional big surprise. Rational news aggregation yields policy polarization even if candidates are office-motivated. Personalization makes extreme voters the disciplining entity for equilibrium polarization and increases polarization through occasional big surprise.
    Date: 2019–10
  7. By: Albin Erlanson; Andreas Kleiner
    Abstract: We study how a principal should optimally choose between implementing a new policy and maintaining the status quo when information relevant for the decision is privately held by agents. Agents are strategic in revealing their information and we exclude monetary transfers, but the principal can verify an agent's information at a cost. We characterize the mechanism that maximizes the expected utility of the principal. This mechanism can be implemented as a cardinal voting rule, in which agents can either cast a baseline vote, indicating only whether they are in favor of the new policy, or they make specific claims about their type. The principal gives more weight to specific claims and verifies a claim whenever it is decisive.
    Date: 2019–10
  8. By: Alan L. Lewis
    Abstract: We construct the term structure of the (forward-looking, US market) equity risk premium from SPX option chains. The method is "model-light". Risk-neutral probability densities are estimated by fitting $N$-component Gaussian mixture models to option quotes, where $N$ is a small integer (here 4 or 5). These densities are transformed to their real-world equivalents by exponential tilting with a single parameter: the Coefficient of Relative Risk Aversion $\kappa$. From history, I estimate $\kappa = 3 \pm 0.5$. From the inferred real-world densities, the equity risk premium is readily calculated. Three term structures serve as examples.
    Date: 2019–10
  9. By: Dauth, Wolfgang; Haller, Peter
    JEL: D90 J31 J64 R12 R40
    Date: 2019
  10. By: Mihir Bhattacharya (Department of Economics, Ashoka University); Saptarshi Mukherjee (Department of Humanities and Social Sciences, IIT Delhi); Ruhi Sonal (Department of Humanities and Social Sciences, IIT Delhi)
    Abstract: We consider individual decision-making where every alternative appears with a frame (a la Salant and Rubinstein (2008)). The decision maker is subject to inattention due to framing effects that leads to random choice. We characterize a frame-based stochastic choice rule according to which the choice probability of an alternative (say, x) is the probability with which attention is drawn by its frame and not by the frames which are associated with the alternatives that beat x according to a complete binary relation.
    Keywords: attention, framing, stochastic choice
    Date: 2019–09
  11. By: Swagata Bhattacharjee (Ashoka University)
    Abstract: Outsourcing of research is commonly observed in knowledge-intensive industries e.g. biotech. We model innovation as an ambiguous stochastic process, and assume that the commercial firms are more ambiguity averse than the research labs. We characterize the optimal sequence of short-term contracts governing innovation, and show how it facilitates ambiguity sharing. The firm's ambiguity aversion mitigates the dynamic moral hazard problem, resulting in monotonically decreasing investment and prevents equilibrium delay. However, compared to an ambiguity-neutral policymaker's benchmark, the research alliance stops experimenting earlier, and may liquidate the project even after being patented; even redesigning patent laws cannot solve both of the problems.
    Keywords: Ambiguity, Dynamic Contract, Patent law, Innovation, R&D
    Date: 2019–07

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