nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2020‒01‒13
ten papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Entropic Decision Making By Adnan Rebei
  2. Behavioral sciences and auto-transformations. Introduction By Harin, Alexander
  3. Monetary Payoff and Utility Function in Adaptive Learning Models By Erhao Xie
  4. Heterogeneous Choice Sets and Preferences By Levon Barseghyan; Maura Coughlin; Francesca Molinari; Joshua C. Teitelbaum
  5. Utility and income transfer principles: Interplay and incompatibility By Marc Dubois; Stéphane Mussard
  6. Long Term Care Insurance with State-Dependent Preferences By De Donder, Philippe; Leroux, Marie-Louise
  7. Embezzlement and guilt aversion By Giuseppe Attanasi; Claire Rimbaud; Marie Claire Villeval
  8. Portfolio Optimization under Correlation Constraint By Aditya Maheshwari; Traian Pirvu
  9. A general framework for studying contests By Bastani, Spencer; Giebe, Thomas; Gürtler, Oliver
  10. Cognitive Uncertainty By Benjamin Enke; Thomas Graeber

  1. By: Adnan Rebei
    Abstract: Using results from neurobiology on perceptual decision making and value-based decision making, the problem of decision making between lotteries is reformulated in an abstract space where uncertain prospects are mapped to corresponding active neuronal representations. This mapping allows us to maximize non-extensive entropy in the new space with some constraints instead of a utility function. To achieve good agreements with behavioral data, the constraints must include at least constraints on the weighted average of the stimulus and on its variance. Both constraints are supported by the adaptability of neuronal responses to an external stimulus. By analogy with thermodynamic and information engines, we discuss the dynamics of choice between two lotteries as they are being processed simultaneously in the brain by rate equations that describe the transfer of attention between lotteries and within the various prospects of each lottery. This model is able to give new insights on risk aversion and on behavioral anomalies not accounted for by Prospect Theory.
    Date: 2019–12
  2. By: Harin, Alexander
    Abstract: The goal of the present article is to define transformations (named here as auto-transformations) of probability density functions of random variables into similar functions having smaller sizes of their domains. In particular, auto-transformations from infinite to finite sizes of domains will be analyzed. The goal is aroused from the well-known problems of behavioral sciences.
    Keywords: probability; variance; noise; bias; measurement; utility theory; prospect theory; behavioral economics; psychology; decision sciences; social sciences;
    JEL: C0 C02 C1 C18 D8 D81 D84
    Date: 2019–12–01
  3. By: Erhao Xie
    Abstract: When players repeatedly face an identical or similar game (e.g., coordination game, technology adoption game, or product choice game), they may learn through experience to perform better in the future. This learning behaviour has important economic implications. It determines which economic outcome a game will reach and how fast it will get there. Given the importance of players’ learning behaviours, economists have proposed various adaptive models to study them. These models are usually estimated and tested using experimental data. Moreover, economists usually assume that individuals’ preference—their utility—is equal to the monetary reward they obtain. However, such an assumption can be wrong since players are not necessarily risk neutral. They could be risk averse or risk loving. I study the consequences of this false assumption and propose a method to deal with it. I then apply the method to an existing experimental dataset. The estimation results show that utility does not necessarily equal monetary reward. Imposing such a false assumption leads researchers to draw incorrect conclusions about players’ learning behaviours. For instance, we may incorrectly estimate the speed of learning and wrongly predict the final outcome of a game. In contrast, the method I propose in this paper allows researchers to achieve more accurate estimates.
    Keywords: Econometric and statistical methods; Economic models
    JEL: C57 C72 C92
    Date: 2019–12
  4. By: Levon Barseghyan (Institute for Fiscal Studies); Maura Coughlin (Institute for Fiscal Studies); Francesca Molinari (Institute for Fiscal Studies and Cornell University); Joshua C. Teitelbaum (Institute for Fiscal Studies)
    Abstract: We propose a robust method of discrete choice analysis when agents’ choice sets are unobserved. Our core model assumes nothing about agents’ choice sets apart from their minimum size. Importantly, it leaves unrestricted the dependence, conditional on observables, between agents’ choice sets and their preferences. We ?rst establish that the model is partially identi?ed and characterize its sharp identi?cation region. We also show how the model can be used to assess the welfare cost of limited choice sets. We then apply our theoretical ?ndings to learn about households’ risk preferences and choice sets from data on their deductible choices in auto collision insurance. We ?nd that the data can be explained by expected utility theory with relatively low levels of risk aversion and heterogeneous choice sets. We also ?nd that a mixed logit model, as well as some familiar models of choice set formation, are rejected in our data.
    Date: 2019–07–05
  5. By: Marc Dubois (Institut Langevin ondes et images - UPMC - Université Pierre et Marie Curie - Paris 6 - UPD7 - Université Paris Diderot - Paris 7 - ESPCI ParisTech - CNRS - Centre National de la Recherche Scientifique); Stéphane Mussard (CHROME - Détection, évaluation, gestion des risques CHROniques et éMErgents (CHROME) / Université de Nîmes - UNIMES - Université de Nîmes)
    Abstract: In this paper, it is assumed that income does not have a linear correspondence with utility. Consequently, transfers of income and transfers of utility that could improve social welfare are studied. The conditions for the fulfillment of generalized income transfer principles, relevant to any given order of stochastic dominance, are determined. The result relies on Bell polynomials and states that an income transfer principle of any order does not necessarily satisfy the utility transfer principle of the corresponding order.
    Keywords: Bell polynomial,Inequality aversion,Transfer principle JEL Classification: D63
    Date: 2019–05
  6. By: De Donder, Philippe; Leroux, Marie-Louise
    Abstract: We study the demand for actuarially fair Long Term Care (LTC hereafter) insurance in a setting where autonomous agents only care for daily life consumption while dependent agents also care for LTC expenditures. We assume that dependency decreases the marginal utility of daily life consumption. We rst obtain that some agents optimally choose not to insure themselves, while no agent wishes to buy complete insurance. We then show that the comparison of marginal utility of income (as opposed to consumption) across health states depends on (i) whether agents do buy LTC insurance at equilibrium or not, (ii) the comparison of the degree of risk aversion for consumption and for LTC expenditures, and (iii) the income level of agents. Our results then oer testable implications that can explain (i) why few people buy Long Term Care insurance and (ii) the discrepancies between various empirical works when measuring the extent of state-dependent preferences for LTC.
    Keywords: Long Term Care Insurance Puzzle; Actuarially Fair Insurance; Risk Aversion
    JEL: D11 I13
    Date: 2019–12
  7. By: Giuseppe Attanasi; Claire Rimbaud (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - ENS Lyon - École normale supérieure - Lyon - UL2 - Université Lumière - Lyon 2 - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon - UJM - Université Jean Monnet [Saint-Étienne] - Université de Lyon - CNRS - Centre National de la Recherche Scientifique); Marie Claire Villeval (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - ENS Lyon - École normale supérieure - Lyon - UL2 - Université Lumière - Lyon 2 - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon - UJM - Université Jean Monnet [Saint-Étienne] - Université de Lyon - CNRS - Centre National de la Recherche Scientifique)
    Abstract: Psychological game theory can contribute to renew the analysis of unethical behavior by providing insights on the nature of the moral costs of dishonesty. We investigate the moral costs of embezzlement in situations where donors need intermediaries to transfer their donations to recipients and where donations can be embezzled before they reach the recipients. We design a novel three-player Embezzlement Mini-Game to study whether intermediaries in the laboratory suffer from guilt aversion and whether guilt aversion affects the decision to embezzle. We show that the proportion of guilt-averse intermediaries is the same irrespective of the direction of guilt and guilt aversion reduces embezzlement. Structural estimates indicate no difference in the effect of guilt aversion toward the donor and toward the recipient on intermediaries' behavior. This is striking as embezzlement affects the earnings of the recipient but not those of the donor. It shows that guilt aversion matters even when decisions have no direct monetary consequences. JEL code: C91
    Keywords: Embezzlement,dishonesty,guilt aversion,psychological game theory,experiment
    Date: 2019
  8. By: Aditya Maheshwari; Traian Pirvu
    Abstract: We consider the problem of portfolio optimization with a correlation constraint. The framework is the multiperiod stochastic financial market setting with one tradable stock, stochastic income and a non-tradable index. The correlation constraint is imposed on the portfolio and the non-tradable index at some benchmark time horizon. The goal is to maximize portofolio's expected exponential utility subject to the correlation constraint. Two types of optimal portfolio strategies are considered: the subgame perfect and the precommitment ones. We find analytical expressions for the constrained subgame perfect (CSGP) and the constrained precommitment (CPC) portfolio strategies. Both these portfolio strategies yield significantly lower risk when compared to the unconstrained setting, at the cost of a small utility loss. The performance of the CSGP and CPC portfolio strategies is similar.
    Date: 2019–12
  9. By: Bastani, Spencer; Giebe, Thomas; Gürtler, Oliver
    Abstract: We develop a general framework to study contests, containing the well-known models of Tullock (1980) and Lazear and Rosen (1981) as special cases. The contest outcome depends on players' effort and skill, the latter being subject to symmetric uncertainty. The model is tractable, because a symmetric equilibrium exists under general assumptions regarding production technologies and skill distributions. We construct a link between our contest model and expected utility theory and exploit this link to revisit important comparative statics results of contest theory and show how these can be overturned. Finally, we apply our results to study optimal workforce composition.
    Keywords: contest theory, symmetric equilibrium, heterogeneity, risk, decision theory
    JEL: C72 D74 D81 J23 M51
    Date: 2019–12–03
  10. By: Benjamin Enke; Thomas Graeber
    Abstract: This paper introduces a formal definition and an experimental measurement of the concept of cognitive uncertainty: people’s subjective uncertainty about what the optimal action is. This concept allows us to bring together and partially explain a set of behavioral anomalies identified across four distinct domains of decision-making: choice under risk, choice under ambiguity, belief updating, and survey expectations about economic variables. In each of these domains, behavior in experiments and surveys tends to be insensitive to variation in probabilities, as in the classical probability weighting function. Building on existing models of noisy Bayesian cognition, we formally propose that cognitive uncertainty generates these patterns by inducing people to compress probabilities towards a mental default of 50:50. We document experimentally that the responses of individuals with higher cognitive uncertainty indeed exhibit stronger compression of probabilities in choice under risk and ambiguity, belief updating, and survey expectations. Our framework makes predictions that we test using exogenous manipulations of both cognitive uncertainty and the location of the mental default. The results provide causal evidence for the role of cognitive uncertainty in belief formation and choice, which we quantify through structural estimations.
    Keywords: cognitive uncertainty, beliefs, bounded rationality
    Date: 2019

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