nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2020‒02‒24
ten papers chosen by

  1. Relaxed Optimization: e-Rationalizability and the FOC-Departure Index in Consumer Theory By Geoffroy de Clippel; Kareen Rozen
  2. Sequential equilibrium without rational expectations of prices: A theorem of full existence By Lionel de Boisdeffre
  3. Efficient Incentives in Social Networks: Gamification and the Coase Theorem By Daske, Thomas
  4. Bounded Rationality and Limited Datasets By Geoffroy de Clippel; Kareen Rozen
  5. Pollution, Mortality and Time Consistent Abatement Taxes By Aditya Goenka; Lin Liu; William Pouliot
  6. Treasury Term Premia: 1961-Present By Richard K. Crump; Emanuel Moench; Benjamin Mills; Tobias Adrian
  7. Herd Behavior in Financial Markets By Antonio Guarino; Marco Cipriani
  8. How does the EU ETS reform impact allowance prices? The role of myopia, hedging requirements and the Hotelling rule By Bocklet, Johanna; Hintermayer, Martin
  9. Statistical Consequences of Fat Tails: Real World Preasymptotics, Epistemology, and Applications By Nassim Nicholas Taleb
  10. How Puzzling Is the Forward Premium Puzzle? A Meta-Analysis By Diana Zigraiova; Tomas Havranek; Jiri Novak

  1. By: Geoffroy de Clippel; Kareen Rozen
    Abstract: We propose relaxing the first-order conditions in optimization to approximate rational consumer choice. Departures from the FOCs are assessed using an axiomatically founded measure that is also interpretable in terms of a money-pump multiplier. The framework encompasses measurement errors, information unobservable to the modeler, and consumer misperception. We develop testable implications for demand data, including for subclasses of regular utility functions, and develop the FOC-Departure Index (FDI), which is applicable in all contexts where the _rst-order approach is meaningful. We extend these ideas to convex budget sets. Our analysis extends to non-convex preferences under a narrower interpretation of price misperception.
    Date: 2020
  2. By: Lionel de Boisdeffre (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)
    Abstract: We consider a pure exchange economy, where agents, typically asymmetrically informed, exchange securities, on financial markets and commodities, on spot markets. Consumers have private characteristics, anticipations and beliefs and no model to forecast prices. They are dispensed with rational expectation and bounded rationality assumptions, such as Radner's (1972, 1979), Kurz' (1994) or Koutsougeras-Yannelis' (1999). We show that they face an incompressible uncertainty represented by a so-called "minimum uncertainty set". This uncertainty typically adds to the exogenous one, on the state of nature, an ‘endogenous uncertainty' over future spot prices. At equilibrium, all agents expect the ‘true' price on every spot market as a possible outcome and elect optimal strategies, ex ante, which clear on all markets ex post. We show this sequential equilibrium exists whenever agents' prior anticipations embed the minimum uncertainty set. This outcome differs from the standard generic existence results of Hart (1975), Radner (1979) and Duffie-Shaffer (1985), among others, based on the rational expectations of prices.
    Keywords: sequential equilibrium,temporary equilibrium,perfect foresight,existence,rational exceptations,financial markets,asymmetric information,arbitrage
    Date: 2018–06
  3. By: Daske, Thomas
    Abstract: This study explores mechanism design for networks of interpersonal relationships. Agents' social (more or less altruistic or spiteful) preferences and private payoffs are all subject to asymmetric information; utility is quasi-linear. Remarkably, the asymmetry of information about agents' social preferences can be operationalized to satisfy agents' participation constraints. The main result is a constructive proof of the Coase theorem, in its typical mechanism-design interpretation, for networks of at least three agents: If endowments are sufficiently large, any such network can resolve any given allocation problem with a budget-balanced mechanism that is Bayesian incentive-compatible, interim individually rational, and ex-post Pareto-efficient. The endogenously derived solution concept is interpreted as gamification: Resolve the agents' allocation problem with an efficient social-preference robust mechanism; attract agents' participation by complementing this mechanism with a budget-balanced game that operates on their social preferences and provides them with a platform to live out their propensities to cooperate or compete.
    Keywords: mechanism design,social preferences,gamification,Coase theorem
    JEL: C72 C78 D62 D82
    Date: 2020
  4. By: Geoffroy de Clippel; Kareen Rozen
    Abstract: Bounded rationality theories are typically characterized over exhaustive data sets. We develop a methodology to understand the empirical content of such theories with limited data, adapting the classic, revealed-preference approach to new forms of revealed information. We apply our approach to an array of theories, illustrating its versatility. We identify theories and datasets testable in the same elegant way as Rationality, and theories and datasets where testing is more challenging. We show that previous attempts to test consistency of limited data with bounded rationality theories are subject to a conceptual pitfall that can yield false positives and empty out-of-sample predictions.
    Date: 2020
  5. By: Aditya Goenka (University of Birmingham); Lin Liu (University of Liverpool); William Pouliot (University of Birmingham)
    Abstract: We study dynamically consistent policy in a neoclassical overlapping generations growth model where pollution externalities undermine health but are mitigated via tax-financed abatement. With arbitrarily constant taxation, two steady states arise: an unstable 'poverty trap' and a 'neoclassical' steady state near which the dynamics might either be monotonically convergent or oscillating. When the planner chooses a time consistent abatement path that maximises a weighted intergenerational sum of expected utility, the optimal tax is zero at low levels of capital and then a weakly increasing function of the capital stock. The non-homogeneity of the tax function along with its feedback effect on savings induces additional steady states, stability reversals and oscillations.
    Keywords: Time consistency, pollution, mortality, overlapping generations model, poverty traps, endogenous fluctuations, optimal environmental policy.
    JEL: O11 O13 O23 O44 E32 H21 H23
    Date: 2019–10
  6. By: Richard K. Crump; Emanuel Moench (Deutsche Bundesbank; Halle (Saale); Bank für Internationalen Zahlungsausgleich); Benjamin Mills (Research and Statistics Group); Tobias Adrian
    Abstract: Treasury yields can be decomposed into two components: expectations of the future path of short-term Treasury yields and the Treasury term premium. The term premium is the compensation that investors require for bearing the risk that short-term Treasury yields do not evolve as they expected. Studying the term premium over a long time period allows us to investigate what has historically driven changes in Treasury yields. In this blog post, we estimate and analyze the Treasury term premium from 1961 to the present, and make these estimates available for download here.
    Keywords: Term structure of interest rates; Treasury term premia
    JEL: G1
  7. By: Antonio Guarino (Dublin City University; Boston University); Marco Cipriani (New York University; Federal Reserve Bank; Federal Reserve Bank of New York; George Washington University; National Bureau of Economic Research)
    Abstract: Over the last twenty-five years, there has been a lot of interest in herd behavior in financial markets?that is, a trader?s decision to disregard her private information to follow the behavior of the crowd. A large theoretical literature has identified abstract mechanisms through which herding can arise, even in a world where people are fully rational. Until now, however, the empirical work on herding has been completely disconnected from this theoretical analysis; it simply looked for statistical evidence of trade clustering and, when that evidence was present, interpreted the clustering as herd behavior. However, since decision clustering may be the result of something other than herding?such as the common reaction to public announcements?the existing empirical literature cannot distinguish ?spurious? herding from ?true? herd behavior.
    Keywords: Herd behavior; financial markets
    JEL: G1
  8. By: Bocklet, Johanna (Energiewirtschaftliches Institut an der Universitaet zu Koeln (EWI)); Hintermayer, Martin (Energiewirtschaftliches Institut an der Universitaet zu Koeln (EWI))
    Abstract: This paper uses a discrete-time partial equilibrium model of the European Emissions Trading System (EU ETS) to analyze the impact of the recent reform on allowance prices. By including bounded rationality such as myopia or hedging requirements, we find that the Hotelling price path is no longer visible ex-post even though the Hotelling price rule holds ex-ante in the decision making of the firms. Myopia and hedging requirements have little impact in the pre-reform market but strongly drive market outcomes after the reform. In the post-reform market, hedging requirements in combination with restrictive allowance supply may even cause a physical shortage of allowances. Yet, neither form of bounded rationality can fully explain the market outcomes in the third trading period of the EU ETS. If myopia and edging requirements are considered simultaneously, the price increase in the EU ETS can be attributed to the reform fundamentals.
    Keywords: Dynamic Optimization; EU ETS; Bounded Rationality; Hotelling; Hedging; Myopia
    JEL: D91 H32 Q58
    Date: 2020–02–19
  9. By: Nassim Nicholas Taleb
    Abstract: The book investigates the misapplication of conventional statistical techniques to fat tailed distributions and looks for remedies, when possible. Switching from thin tailed to fat tailed distributions requires more than "changing the color of the dress". Traditional asymptotics deal mainly with either n=1 or $n=\infty$, and the real world is in between, under of the "laws of the medium numbers" --which vary widely across specific distributions. Both the law of large numbers and the generalized central limit mechanisms operate in highly idiosyncratic ways outside the standard Gaussian or Levy-Stable basins of convergence. A few examples: + The sample mean is rarely in line with the population mean, with effect on "naive empiricism", but can be sometimes be estimated via parametric methods. + The "empirical distribution" is rarely empirical. + Parameter uncertainty has compounding effects on statistical metrics. + Dimension reduction (principal components) fails. + Inequality estimators (GINI or quantile contributions) are not additive and produce wrong results. + Many "biases" found in psychology become entirely rational under more sophisticated probability distributions + Most of the failures of financial economics, econometrics, and behavioral economics can be attributed to using the wrong distributions. This book, the first volume of the Technical Incerto, weaves a narrative around published journal articles.
    Date: 2020–01
  10. By: Diana Zigraiova (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Opletalova 26, 110 00, Prague, Czech Republic; European Stability Mechanism, Luxembourg); Tomas Havranek (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Opletalova 26, 110 00, Prague, Czech Republic); Jiri Novak (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Opletalova 26, 110 00, Prague, Czech Republic)
    Abstract: A key theoretical prediction in financial economics is that under risk neutrality and rational expectations a currency’s forward rates should form unbiased predictors of future spot rates. Yet scores of empirical studies report negative slope coefficients from regressions of spot rates on forward rates, which is inconsistent with the forward rate unbiasedness hypothesis. We collect 3,643 estimates from 91 research articles and using recently developed techniques investigate the effect of publication and misspecification biases on the reported results. Correcting for these biases we estimate the slope coefficients of 0.31 and 0.98 for developed and emerging currencies respectively, which implies that empirical evidence is in line with the theoretical prediction for emerging economies and less puzzling than commonly thought for developed economies. Our results also suggest that the coefficients are systematically influenced by the choice of data, numeraire currencies, and estimation methods.
    Keywords: Forward rate bias, uncovered interest parity, meta-analysis, publication bias, model uncertainty
    JEL: C83 F31 G14
    Date: 2020–02

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