
on Utility Models and Prospect Theory 
Issue of 2019‒12‒16
thirteen papers chosen by 
By:  Ruggeri, Kai (Columbia University); Alí, Sonia; Berge, Mari Louise; Bertoldo, Giulia; CortijosBernabeu, Anna; Bjørndal, Ludvig Daae; Davison, Clair; Demić, Emir; Esteban Serna, Celia; Friedemann, Maja 
Abstract:  Kahneman and Tversky’s 1979 article on Prospect Theory is one of the most influential papers across all of the behavioural sciences. The study tested a series of binary financial (risky) choices, ultimately concluding that judgments formed under uncertainty deviate significantly from those presumed by expected utility theory, which was the prevailing theoretical construct at the time. In the forty years since publication, this study has had a remarkable impact on science, policy, and other realworld applications. At the same time, a number of critiques have been raised about its conclusions and subsequent constructs that were founded on it, such as loss aversion. In an era where such presumed canonical theories have increasingly drawn scrutiny for inability to replicate, we attempted a multinational study of N = 4,099 participants from 19 countries and 13 languages. The same methods and procedures were used as in the original paper, adjusting only currencies to make them relative to current values, and requiring all participants to respond to all items. Overall, we found that results replicated for 94% of the 17 choice items tested. At most, results from the 1979 study were attenuated in our findings, which is most likely due to a more robust sample. Twelve of the 13 theoretical contrasts presented by Kahneman and Tversky also replicated, with a further 89% replication rate of the total contrasts possible when separating by location, up to 100% replication in some countries. We conclude that the principles of Prospect Theory replicate beyond any reasonable thresholds, and provide a number of important insights about replications, attenuation, and implications for the study of human decisionmaking at populationlevel. 
Date:  2019–08–21 
URL:  http://d.repec.org/n?u=RePEc:osf:osfxxx:2nyd6&r=all 
By:  Guilherme Dean Pelegrina (DSPCom  Laboratory of Signal Processing for Communications  UNICAMP  University of Campinas [Campinas]); Leonardo Tomazeli Duarte; Michel Grabisch (CES  Centre d'économie de la Sorbonne  UP1  Université PanthéonSorbonne  CNRS  Centre National de la Recherche Scientifique); João Marcos Travassos Romano (UnB  University of Brasilia [Brazil]) 
Abstract:  In several multicriteria decision making problems, it is important to consider interactions among criteria in order to satisfy the preference relations provided by the decision maker. This can be achieved by using aggregation functions based on fuzzy measures, such as the Choquet integral and the multilinear model. Although the Choquet integral has been studied in a large number of works, one does not find the same literature with respect to the multilinear model. In this context, the contribution of this work is twofold. We first provide a formulation of the multilinear model by means of a 2additive capacity. A second contribution lies in the problem of capacity identification. We consider a supervised approach and apply optimization models with and without regularization terms. Results obtained in numerical experiments with both synthetic and real data attest the performance of the considered approaches. 
Keywords:  multiple criteria analysis,multiattribute utility theory,multilinear model,2additive capacity,capacity identification 
Date:  2019–10 
URL:  http://d.repec.org/n?u=RePEc:hal:cesptp:halshs02379646&r=all 
By:  Junjie Hu; Wolfgang Karl H\"ardle; Weiyu Kuo 
Abstract:  Among all the emerging markets, the cryptocurrency market is considered the most controversial and simultaneously the most interesting one. The visibly significant market capitalization of cryptos motivates modern financial instruments such as futures and options. Those will depend on the dynamics, volatility, or even the jumps of cryptos. In this paper, the risk characteristics for Bitcoin are analyzed from a realized volatility dynamics view. The realized variance is estimated with the corrected threshold jump components, realized semivariance, and signed jumps. Our empirical results show that the BTC is far riskier than any of the other developed financial markets. Up to 68% of the days are identified to be entangled with jumps. However, the discontinuities do not contribute to the variance significantly. The fullsample fitting suggests that future realized variance has a positive relationship with downside risk and a negative relationship with the positive jump. The rollingwindow outofsample forecasting results reveal that the forecasting horizon plays an important role in choosing forecasting models. For the long horizon risk forecast, explicitly modeling jumps and signed estimators improve forecasting accuracy and give extra utility up to 19 bps annually, while the HAR model without accounting jumps or signed estimators suits the short horizon case best. Lastly, a simple equalweighted portfolio of BTC not only significantly reduces the size and quantity of jumps but also gives investors higher utility in short horizon case. 
Date:  2019–12 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1912.05228&r=all 
By:  Jaelle Scheuerman; Jason L. Harman; Nicholas Mattei; K. Brent Venable 
Abstract:  In many collective decision making situations, agents vote to choose an alternative that best represents the preferences of the group. Agents may manipulate the vote to achieve a better outcome by voting in a way that does not reflect their true preferences. In real world voting scenarios, people often do not have complete information about other voter preferences and it can be computationally complex to identify a strategy that will maximize their expected utility. In such situations, it is often assumed that voters will vote truthfully rather than expending the effort to strategize. However, being truthful is just one possible heuristic that may be used. In this paper, we examine the effectiveness of heuristics in single winner and multiwinner approval voting scenarios with missing votes. In particular, we look at heuristics where a voter ignores information about other voting profiles and makes their decisions based solely on how much they like each candidate. In a behavioral experiment, we show that people vote truthfully in some situations and prioritize high utility candidates in others. We examine when these behaviors maximize expected utility and show how the structure of the voting environment affects both how well each heuristic performs and how humans employ these heuristics. 
Date:  2019–11 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1912.00011&r=all 
By:  Lee H. Endress (University of Hawaiâ€˜i at Manoa, UHERO); James A. Roumasset (Graduate School for International Development and Cooperation, Hiroshima University; University of Hawaiâ€˜i at Manoa, Department of Economics; UHERO); Christopher A. Wada (UHERO,) 
Abstract:  We consider the prospects for sustainable growth using expected utility models of optimal investment under threat from natural disasters. Adoption of a continuous time, stochastic Ramsey growth model over an infinite time horizon permits the analysis of sustainability under uncertainty regarding adverse events, including both onetime and recurrent disasters. As appropriate to small economies, we consider adaptation to the risk of disaster. Natural disasters reduce capital stocks and disrupt the optimal consumption and felicity paths. While the time path of intertemporal welfare might consequently shift downward, the path may still be nondecreasing over time, even without adding strong or weak sustainability constraints. Prudent disaster preparedness includes precautionary investment in productive capital, programs of adaptation to disaster risk, and avoiding distortionary policies undermining the prospects of optimality and sustainability. 
Keywords:  sustainable growth, natural disaster, expected utility, golden rule, Ramsey 
JEL:  O11 O44 Q20 Q28 
Date:  2019–12 
URL:  http://d.repec.org/n?u=RePEc:hae:wpaper:20199&r=all 
By:  Riccardo Camboni (DSEA, University of Padova); Luca Corazzini (Department of Economics, University of Venice "Ca' Foscari"); Stefano Galavotti (DEMDI, University of Bari); Paola Valbonesi (DSEA, University of Padova and HSENRU, Moscow) 
Abstract:  We run an experiment on procurement auctions in a setting where both quality and price matter. We compare two unidimensional treatments in which the buyer fixes one dimension (quality or price) and sellers compete on the other, with three bidimensional treatments (with different strategy spaces) in which sellers submit a pricequality bid and the winner is determined by a score that linearly combines the two offers. We find that, with respect to the theoretical predictions, the bidimensional treatments significantly underperform, both in terms of efficiency and buyer's utility. We attribute this result to the higher strategic complexity of these treatments and test this intuition by fitting a structural Quantal Response Equilibrium model with risk aversion to our experimental data. We find very similar estimates for the risk aversion parameter across all treatments; instead, the error parameter, which captures deviations between the observed bids and the payoffmaximizing ones, is larger in the bidimensional treatments than in the unidimensional ones. Our evidence suggests that increasing the dimensionality and the size of the suppliers' strategy space increases their tendency to make suboptimal offers, thus undermining the theoretical superiority of more complex mechanisms. 
Keywords:  scoring auctions, multidimensional auctions, complexity, bidding behaviour, Quantal Response Equilibrium 
JEL:  D44 H11 H57 
Date:  2019–12 
URL:  http://d.repec.org/n?u=RePEc:pad:wpaper:0243&r=all 
By:  Garnadi, Agah D.; SYAHRIL, 
Abstract:  This work considers a consumption and investment decision problem for an~individual who has available a~riskless asset paying fixed interest rate and a~risky asset driven by Brownian motion price fluctuations. The individual is supposed to observe his or her current wealth only, when making transactions, that transactions incur costs, and that decisions to transact can be made at any time based on all current information. The transactions costs under consideration could be a fixed, linear or a nonlinear function of the amount transacted. In addition, the investor is charged a fixed fraction of total wealth as management fee. The investor's objective is to maximize the expected utility of consumption over a given horizon. On the basis of this model, the existence of an optimal solution is given. Optimal consumption and investment strategies are obtained in closed form for each type of transaction costs function. In addition, the optimal interval of time between transactions is also derived. Results show that, for each transaction cost, transaction interval satisfies a nonlinear equation, which depends on total wealth at the beginning of that intervals. If, at each transaction, there is no costs involved other than that of management fee which is a fixed fraction of current portfolio value, then the optimal interval of time between transactions is fixed, independent of time and current wealth. 
Date:  2018–06–01 
URL:  http://d.repec.org/n?u=RePEc:osf:inarxi:k6s4q&r=all 
By:  Christoph Czichowsky (LSE  London School of Economics and Political Science); Rémi Peyre (IECL  Institut Élie Cartan de Lorraine  UL  Université de Lorraine  CNRS  Centre National de la Recherche Scientifique, Fakultät für Mathematik [Wien]  Universität Wien); Walter Schachermayer (ETH Zürich  Eidgenössische Technische Hochschule  Swiss Federal Institute of Technology in Zürich [Zürich], Fakultät für Mathematik [Wien]  Universität Wien); Junjian Yang (Fakultät für Mathematik [Wien]  Universität Wien, CMAP  Centre de Mathématiques Appliquées  Ecole Polytechnique  X  École polytechnique  CNRS  Centre National de la Recherche Scientifique) 
Abstract:  The present paper accomplishes a major step towards a reconciliation of two conflicting approaches in mathematical finance: on the one hand, the mainstream approach based on the notion of no arbitrage (Black, Merton & Scholes); and on the other hand, the consideration of nonsemimartingale price processes, the archetype of which being fractional Brownian motion (Mandelbrot). Imposing (arbitrarily small) proportional transaction costs and considering logarithmic utility optimisers, we are able to show the existence of a semimartingale, frictionless shadow price process for an exponential fractional Brownian financial market. 
Keywords:  logarithmic utility,proportional transaction costs,fractional Brownian motion,shadow prices,twoway crossing 
Date:  2018 
URL:  http://d.repec.org/n?u=RePEc:hal:journl:hal02373296&r=all 
By:  Höfer, Tim (E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN)); von Nitzsch, Rüdiger (Chair of Decision Theory and Financial Services); Madlener, Reinhard (E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN)) 
Abstract:  The future transformation of the energy system is a contentious topic, involving a variety of conflicting opinions and interests. In order to structure and evaluate these opinions, we develop a group decisionmaking process with professional stakeholders and energy experts. The aim of this process is to develop a common objective system for the energy transition and to evaluate four possible energy transition alternatives for Germany until 2030. The stakeholders are involved in every step of the decisionmaking process – the development of the alternatives, the definition of the objective system, and the final evaluation of the alternatives. We apply ValueFocused Thinking (VFT) to define and structure the objectives of the stakeholders and use MultiAttribute Utility Theory (MAUT) to evaluate the preferences of the stakeholders towards these objectives. The results show that a majority of the stakeholders prefers the energy transition alternative, which has the highest ambitions to limit climate change. A minority prefers the panEuropean alternative where Germany’s power system is further integrated into the European energy system. 
Keywords:  Group DecisionMaking; MAUT; ValueFocused Thinking; Energy Scenarios 
JEL:  D70 D81 D90 Q40 
Date:  2019–04–01 
URL:  http://d.repec.org/n?u=RePEc:ris:fcnwpa:2019_004&r=all 
By:  Hippolyte d'Albis (PJSE  Paris Jourdan Sciences Economiques  UP1  Université PanthéonSorbonne  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:  Selfinsurance,annuity,uncertain survival probabilities,smooth ambiguity aversion,charity,experiment 
Date:  2019–05 
URL:  http://d.repec.org/n?u=RePEc:hal:wpaper:halshs02132858&r=all 
By:  Moro, Alessio (University of Cagliari); Valdes, Carlo (Cassa Depositi e Prestiti) 
Abstract:  Models of structural change in general equilibrium are commonly used to address a number of questions regarding the behaviour of the macroeconomy. In this paper, we first revise the main mechanisms at work in generating structural change in a multisector environment. These effects emerge due to both an interaction between consumers' preferences and technological change and to different income elasticities of the various goods and services entering the utility function. Next, we address the issue of measurement of these models when comparing them to the data. The typical assumption in multisector models is to define GDP as aggregate output in units of a numeraire good, often chosen to be the investment good. However, this procedure is equivalent to deriving nominal GDP in the data (i.e. total output of the economy in units of one particular good), and not to deriving a measure of real GDP. We then discuss how GDP in the model should be measured to provide a statistic that is comparable with the data in national accounts. The last part of the paper is devoted to show how structural transformation from manufacturing to services, when appropriately compared to the data, generates a decline in GDP growth and volatility along the growth path of an economy. 
Keywords:  Technological Change, Structural Change, Growth, Volatility 
JEL:  O33 C67 C68 E25 E32 
Date:  2019–12–04 
URL:  http://d.repec.org/n?u=RePEc:unm:unumer:2019049&r=all 
By:  Tao Chen; Michael Ludkovski 
Abstract:  We investigate the adaptive robust control framework for portfolio optimization and lossbased hedging under drift and volatility uncertainty. Adaptive robust problems offer many advantages but require handling a double optimization problem (infimum over market measures, supremum over the control) at each instance. Moreover, the underlying Bellman equations are intrinsically multidimensional. We propose a novel machine learning approach that solves for the local saddlepoint at a chosen set of inputs and then uses a nonparametric (Gaussian process) regression to obtain a functional representation of the value function. Our algorithm resembles control randomization and regression Monte Carlo techniques but also brings multiple innovations, including adaptive experimental design, separate surrogates for optimal control and the local worstcase measure, and computational speedups for the supinf optimization. Thanks to the new scheme we are able to consider settings that have been previously computationally intractable and provide several new financial insights about learning and optimal trading under unknown market parameters. In particular, we demonstrate the financial advantages of adaptive robust framework compared to adaptive and static robust alternatives. 
Date:  2019–11 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1912.00244&r=all 
By:  Ripamonti, Alexandre; Silva, Diego; Moreira Neto, Eurico 
Abstract:  This study applies JohansenFisher panel cointegration to a sample of the most liquid shares on the Brazilian stock market for 20 years. It finds that stock prices are determined by the asymmetric information of a lagged period, and the dilution of information corrects stock prices in the current period. This shows that rational expectations theory can offer a new price measure in the rational valuation formula, and its main assumptions are met. Uninformed traders can benefit from this paper´s findings by monitoring asymmetric information. 
Keywords:  Asset pricing; rational valuation formula; asymmetric Information; CorwinSchultz BidAsk spread estimator; JohansenFisher Panel Cointegration 
JEL:  C33 D82 G11 G12 
Date:  2018–06–14 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:87403&r=all 