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on Utility Models and Prospect Theory |
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Issue of 2020‒04‒06
twenty papers chosen by |
| By: | Antoine Billot (LEM - Laboratoire d'Économie Moderne - UP2 - Université Panthéon-Assas); Sujoy Mukerji (QMUL - Queen Mary University of London); Jean-Marc Tallon (PSE - Paris School of Economics, PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement) |
| Abstract: | We review some of the (theoretical) economic implications of David Schmeidler's models of decision under uncertainty (Choquet expected utility and maxmin expected utility) in competitive market settings. We start with the portfolio inertia result of Dow and Werlang (1992), show how it does or does not generalize in an equilibrium setting. We further explore the equilibrium implications (indeterminacies, non revelation of information) of these decision models. A section is then devoted to the studies of Pareto optimal arrangements under these models. We conclude with a discussion of experimental evidence for these models that relate, in particular, to the implications for market behaviour discussed in the preceding sections. |
| Abstract: | Nous passons en revue les implications en termes d'allocation du risque des modèles de décision développés par David Schmeidler. Nous revenons sur le résultat d'inertie des portfeuilles de Dow et Werlang (1992) et discutons de l'extension du résultat dans un cadre d'équilibre. Nous procédons ensuite à une revue des propriétés d'équilibre (indétermination, non révélation d'information) liées à ces modèles. Nous exposons ensuite les propriétés d'optimalité et concluons avec une discussion de la littérature expérimentale sur le sujet.. |
| Keywords: | Maxmin Expected Utility,No-trade,Risk Sharing,Indeterminacy,Experimental evidence,Choquet Expected Utility,Espérance d'utilité à la Choquet,Minimum d'espérances d'utilité,absence d'échanges,partage du risque,indétermination,expériences |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-02495663&r=all |
| By: | Ali Al-Aradi; Sebastian Jaimungal |
| Abstract: | We address the Merton problem of maximizing the expected utility of terminal wealth using techniques from variational analysis. Under a general continuous semimartingale market model with stochastic parameters, we obtain a characterization of the optimal portfolio for general utility functions in terms of a forward-backward stochastic differential equation (FBSDE) and derive solutions for a number of well-known utility functions. Our results complement a previous studies conducted on optimal strategies in markets driven by Brownian noise with random drift and volatility parameters. |
| Date: | 2020–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2003.08450&r=all |
| By: | Philippe De Donder; Marie-Louise Leroux |
| 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 first 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 offer 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: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:rsi:creeic:2001&r=all |
| By: | Eichberger, Jürgen; Pasichnichenko, Illia |
| Abstract: | In this paper, we study choice under uncertainty with belief functions on a set of outcomes as objects of choice. Belief functions describe what is objectively known about the probabilities of outcomes. We assume that decision makers have preferences over belief functions that reflect both their valuation of outcomes and the information available about the likelihood of outcomes. We provide axioms which characterize a preference representation for belief functions that captures what is (objectively) known about the likelihood of outcomes and combines it with subjective beliefs about unknown probabilities according to the “principle of insufficient reason”. The approach is novel in its treatment of partial information and in its axiomatization of the uniform distribution in the case of ignorance. Moreover, our treatment of partial information yields a natural distinction between ambiguity and ambiguity attitude. |
| Date: | 2020–03–30 |
| URL: | http://d.repec.org/n?u=RePEc:awi:wpaper:0680&r=all |
| By: | Alain Venditti (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique) |
| Abstract: | We study the existence of endogenous competitive equilibrium cycles under small discounting in a two-sector discrete-time optimal growth model. We provide precise concavity conditions on the indirect utility function leading to the existence of period-two cycles with a critical value for the discount factor that can be arbitrarily close to one. Contrary to the continuous-time case where the existence of periodic-cycles is obtained if the degree of concavity is close to zero, we show that in a discrete-time setting the driving condition does not require a close to zero degree of concavity but a symmetry of the indirect utility function's concavity properties with respect to its two arguments. |
| Keywords: | period-two cycles,small discounting,strong and weak concavity,two-sector optimal growth model |
| Date: | 2019–09–25 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-02352979&r=all |
| By: | Nesje, Frikk |
| Abstract: | Decisions with long-term consequences require comparing utility derived from present consumption to future welfare. But can we infer socially relevant intertemporal preferences from saving behavior? I allow for a decomposition of the present generation’s preference for the next generation into its dynastic and crossdynastic counterparts, in the form of welfare weights on the next generation in the own dynasty and other dynasties. Welfare weights on other dynasties can be motivated by a concern for sustainability, or if descendants may move or marry outside the dynasty. With such cross-dynastic intergenerational altruism, savings for one’s own descendants benefit present members of other dynasties, giving rise to preference externalities. I find that socially relevant intertemporal preferences may not be inferred from saving behavior if there is cross-dynastic intergenerational altruism. I also show that the external effect of present saving decreases over time. This means that intertemporal preferences inferred from saving behavior are time-inconsistent, unless cross-dynastic intergenerational altruism is accounted for. |
| Keywords: | intergenerational altruism; social discounting; time-inconsistency; declining discount rates; generalized consumption Euler equations; interdependent utility; isolation paradox |
| Date: | 2020–03–03 |
| URL: | http://d.repec.org/n?u=RePEc:awi:wpaper:0678&r=all |
| By: | Peter John Robinson; W.J.W. Botzen; F. Zhou |
| Abstract: | This paper examines the problem of “charity hazard†, which is the crowding out of private insurance demand by government compensation. In the context of flood insurance and disaster financing, charity hazard is particularly worrisome given current trends of increasing flood risks as a result of climate change and more people choosing to locate in high-risk areas. We conduct an experimental analysis of the influence on flood insurance demand of risk and ambiguity preferences and the availability of different forms of government compensation for disaster damage. Certain and risky government compensation crowd out demand, confirming charity hazard, but this is not observed for ambiguous compensation. Ambiguity averse subjects have higher insurance demand when government compensation is ambiguous relative to risky. Policy recommendations are discussed to overcome charity hazard |
| Keywords: | Ambiguity preferences, charity hazard;, economic experiment;, flood insurance demand, risk preferences |
| Date: | 2019–10 |
| URL: | http://d.repec.org/n?u=RePEc:use:tkiwps:1919&r=all |
| By: | Thomas Demuynck; Tom Potoms |
| Date: | 2020–04–01 |
| URL: | http://d.repec.org/n?u=RePEc:ulb:ulbeco:2013/303534&r=all |
| By: | Haylock, Michael |
| Abstract: | Executives are often paid for short-term changes in shareholder wealth, but rational shareholders want executives to maximize long-term shareholder wealth. Incentives for short-term and long-term oriented behavior may depend on an executive's level of pay in the distribution, holding other factors constant. This paper tests for distributional heterogeneity of short-term and long-term incentives in a 12 year cross-country panel of executives. I use the band-pass filter to separate short-term and long-term shareholder wealth changes (Christiano and Fitzgerald, 2003), and estimate of the shareholder wealth-pay relation using method of moments-quantile regression, developed by Machado and Santos Silva (2019), which accounts for time-constant unobserved heterogeneity of executive-firm pairs across the distribution. When using yearly total compensation to measure pay, executives in the upper tail of the conditional compensation distribution have longer-term oriented incentives. In contrast, when accumulated executive wealth is used to measure pay, executives in the upper tail of the wealth distribution have shorter-term oriented incentives. Since executive wealth encompasses changes to executive utility after pay is granted through accumulated equity-linked pay, it is the preferred measure for evaluating equity-linked pay. Results thus suggest that equity-linked pay should have a longer vesting period for executives in the upper tail than in the lower tail. I find evidence that executives in the upper-tail are evaluated relatively to the industry's short-run and long-run performance. |
| Keywords: | Executive Compensation,Method of Moments-Quantile Regression,Short-Term Performance,Long-Term Performance,Distribution,Benchmarking |
| JEL: | J31 M12 M52 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:tuewef:131&r=all |
| By: | Argenton, Cedric (Tilburg University, TILEC); Wang, Xiaoyu (Tilburg University, TILEC) |
| Abstract: | In this paper, we investigate how loss aversion affects people's behavior in civil litigation. We find that a loss-averse plaintiff demands a higher offer for small claims to maintain her threat to proceed to trial compared to a loss- neutral plaintiff. For larger claims, a loss-averse plaintiff demands a lower offer to increase the settlement probability as loss pains her extra in trial. We also investigate how various policies affect loss-averse litigants' settlement decisions. Only a reduction in the asymmetry of information about trial odds uniformly leads to higher settlement rates. |
| Keywords: | settlement; loss aversion; Asymmetric Information |
| JEL: | D82 K41 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:tiu:tiutil:3a267c4a-2f7d-41c9-966b-efc7d23d0894&r=all |
| By: | Jason Abaluck; Giovanni Compiani |
| Abstract: | We state a sufficient condition under which choice data alone suffices to identify consumer preferences when choices are not fully informed. Suppose that: (i) the data generating process is a search model in which the attribute hidden to consumers is observed by the econometrician; (ii) if a consumer searches good j, she also searches goods which are better than j in terms of the non-hidden component of utility; and (iii) consumers choose the good that maximizes overall utility among searched goods. Canonical models will be biased: the value of the hidden attribute will be understated because consumers will be unresponsive to variation in the attribute for goods that they do not search. Under the conditions above and additional mild restrictions, an alternative method of recovering preferences using cross derivatives of choice probabilities succeeds regardless of the search protocol and is thus robust to whether consumers are informed. The approach nests several standard models, including full information. Our methods suggest natural tests for full information and can be used to forecast how consumers will respond to additional information. We verify in a lab experiment that our approach succeeds in recovering preferences when consumers engage in costly search. |
| JEL: | C5 C8 C9 D0 D6 D8 |
| Date: | 2020–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:26849&r=all |
| By: | Miroslav Gabrovski (University of Hawaii at Manoa); Jang-Ting Guo (Department of Economics, University of California Riverside) |
| Abstract: | Previous research has shown that in the context of a prototypical New Keynesian model, more progressive income taxation may lead to higher volatilities of hours worked and total output in response to a monetary disturbance. We analytically show that this business-cycle destabilization result is overturned within an otherwise identical macroeconomy subject to impulses to the household's utility formulation. Under a continuously or linearly progressive fiscal policy rule, an increase in the tax progressivity will always raise the degree of equilibrium nominal-wage rigidity, and thus serve as an automatic stabilizer that mitigates cyclical fluctuations driven by preference shocks. Our analysis illustrates that whether a more progressive tax schedule (de)stabilizes the business cycle depends crucially on the underlying driving source. |
| Keywords: | Progressive Income Taxation, Automatic Stabilizer, Nominal Wage Rigidity, Preference Shocks. |
| JEL: | E12 E32 E62 |
| Date: | 2020–03 |
| URL: | http://d.repec.org/n?u=RePEc:ucr:wpaper:202004&r=all |
| By: | Zhang, Quing ⓡ; Greiner, Ben |
| Abstract: | We experimentally study the relationship between time inconsistency, sophistication about time inconsistency, and self-commitment. Previous research has interpreted demand for commitment devices as evidence for the sophistication of a time-inconsistent decision-maker. In our laboratory experiment, we attempt to measure sophistication directly by way of a cognitive test. We then test the hypothesis that people who are both time-inconsistent and show high cognitive capacity take up commitment devices when offered in the strategic game between their current and their future self. For experimental laboratory commitment choices, we cannot detect a moderating effect of cognition on commitment demand of time-inconsistent subjects. However, we find that the existence of time-inconsistent preferences and sophistication (proxied by cognitive performance) can predict the demand for savings commitment in our hypothetical survey vignette question. |
| Keywords: | time-inconsistency, sophistication, present bias, future bias |
| Date: | 2020–03–25 |
| URL: | http://d.repec.org/n?u=RePEc:wiw:wus055:7530&r=all |
| By: | Jürgen Eichberger (Universität Heidelberg [Heidelberg]); Ani Guerdjikova (GAEL - Laboratoire d'Economie Appliquée de Grenoble - Grenoble INP - Institut polytechnique de Grenoble - Grenoble Institute of Technology - CNRS - Centre National de la Recherche Scientifique - UGA - Université Grenoble Alpes - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement) |
| Abstract: | In the 1990's David Schmeidler and Itzhak Gilboa initiated the study of decision making under uncertainty in a completely new framework, without states but with data sets as the information on which to build choice behavior. While the first formulations of Case-Based Decision Theory (CBDT) aimed at applications in economic decision making, this theory which takes data as a primitive concept provides an alternative foundation for deriving beliefs and driving the choice of predictions. This opened a new perspective on old questions in statistics and artificial intelligence. In this review, we summarize these developments in Case-Based Decision Theory and highlight the immensely innovative nature of David Schmeidler's academic work. Dans les années 1990's David Schmeidler et Itzhak Gilboa ont intro-duit un nouvel cadre d'analyse des décisions sous incertitude: les bases des données se substituent auxétats du monde comme primitive du modèle et informent le choix du décideur. Au début la théorie de décision au cas-par-casétait orientée principalement vers des applicationséconomiques, mais ses méthodes se sont avérées aussi pertinentes pour l'analyse des croyances et des prédictions statistiques. Ceci a ouvert des nouvelles perspectives sur des questions classiques en statistique et en intelligence artificielle. Dans cet article, nous passons en revue ces développements et mettons en avance le caractère extrêmement novateur des travaux académiques de David Schmei-dler. |
| Keywords: | Modes of reasoning,Predictions,Beliefs,Case-based decisions,Similarity |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-02505265&r=all |
| By: | Alexandros Botsis; Christoph Görtz; Plutarchos Sakellaris |
| Abstract: | Using a novel dataset that contains qualitative firm survey data on sales forecasts as well as balance-sheet data on realized sales, we document that only major forecast errors are predictable and display autocorrelation. This result is a particular violation of the Full Information Rational Expectations hypothesis that requires explanation. In contrast, minor forecast errors are neither predictable nor autocorrelated. To arrive at this result, we develop a novel methodology to quantify qualitative survey data on firm forecasts. It is generally applicable when quantitative information, e.g. from balance sheets, is available on the realization of the forecasted variable. Finally, we provide a model of rational inattention that explains our empirical results. Firms optimally limit their degree of attention to information when operating in market environments where information processing is more costly. This results in major forecast errors that are predictable and autocorrelated. |
| Keywords: | survey data, firm data, expectations, forecast errors, rational inattention |
| JEL: | C53 C83 D22 D84 E32 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_8148&r=all |
| By: | Guilhem Lecouteux (Université Côte d'Azur; GREDEG CNRS) |
| Abstract: | The aim of this paper is first to review the different conceptions of welfare advanced in the literature on behavioural welfare economics. I then argue that Savage’s distinction between small and large worlds offers the adequate framework to conceptualise the problem of inferring a notion of welfare from possibly incoherent individual choices. I distinguish between welfarist, behaviourist, constitutional, and procedural approaches to the reconciliation problem, and show that they offer complementary solutions depending on the nature of the uncertainty of the choice problem, and on the epistemic position of the theoretician with respect to the agent we intend to model. |
| Keywords: | reconciliation problem, nudge, boost, large worlds, welfare |
| JEL: | A11 B40 D01 D63 D91 |
| Date: | 2020–03 |
| URL: | http://d.repec.org/n?u=RePEc:gre:wpaper:2020-08&r=all |
| By: | Laudenbach, Christine; Loos, Benjamin; Pirschel, Jenny; Wohlfart, Johannes |
| Abstract: | We use data from a German online brokerage and a survey to show that retail investors sharply reduce risk-taking in response to nearby firm bankruptcies, which are not predictive of returns. The e.ects on trading are spatially highly concentrated, immediate and not persistent. They seem to operate through more pessimistic expected returns and increased risk aversion and do not reflect wealth e.ects or changes in background risks. Investors learn about bankruptcies through immediate coverage in local newspapers. Our findings suggest that non-informative local experiences that make downside risks of stock investment more salient contribute to idiosyncratic short-term fluctuations in trading. |
| Keywords: | Individual investors,risk-taking,trading,experiences |
| JEL: | D14 G11 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:safewp:272&r=all |
| By: | Fischer, Sabine; Grosch, Kerstin |
| Abstract: | Contract compliance is key for economic growth. However, determinants affecting contract breach are not yet well understood. In this paper, we focus on contract situations with a potential hold-up problem, such as contract farming agreements which are prevalent in many developing countries. We examine if agents' payoff expectations serve as a reference point affecting (non-)compliant behavior by inducing a subjective loss when the agent compares the realized payoff and the expected payoff from the contract. Results from our lab experiment in Ghana indicate that overconfident agents, i.e., agents with relatively high payoff expectations, breach more often than underconfident agents, i.e., agents with relatively low payoff expectations. Moreover, more pronounced individual loss aversion amplies the effect of subjective losses on contract breach. In a treatment, we manipulate agent's overestimation exogenously and use it as an instrument to demonstrate that the reported effectects are causal. |
| Keywords: | Agricultural and Food Policy, Institutional and Behavioral Economics |
| Date: | 2020–03 |
| URL: | http://d.repec.org/n?u=RePEc:ags:gagfdp:302641&r=all |
| By: | Sara Cecchetti (Bank of Italy) |
| Abstract: | We study the determinants of sovereign credit risk in the euro area in a time period that includes the financial and sovereign debt crisis, as well as the unconventional monetary policy adopted by the European Central Bank. First, we detect the presence of commonality in sovereign credit spreads of different countries, justifying the search for the common factors that drive CDS prices. Building on the work of Longstaff et al. (2011), we employ the econometric model used in Cecchetti (2017) to decompose sovereign credit default swap spreads into expected default losses and risk premia, finding evidence of a significant contribution of the latter component. We use the model to understand to what extent the variations in CDS spreads and in the two embedded components of selected euro-area countries are more linked to local or euro area economic variables. The results point to the importance of both global and local factors, which have a greater impact on the risk premium component. Finally, we estimate the contribution of the objective probability and risk premium components of redenomination risk (as measured by the ISDA basis) to the related CDS spread components, detecting some differences between countries. |
| Keywords: | bond excess return, credit default swap, distress risk premium, credit losses |
| JEL: | B26 C02 F30 G12 G15 |
| Date: | 2020–03 |
| URL: | http://d.repec.org/n?u=RePEc:bdi:wptemi:td_1271_20&r=all |
| By: | Cui, Xiangyu; Li, Duan; Shi, Yun |
| Abstract: | When a stochastic decision problem is time inconsistent, the decision maker would be puzzled by his conflicting decisions optimally derived from his time-varying preferences at different time instants (with different time horizons). While the long-run self (LR) of the decision maker pursues the long-term optimality, the short-run selves (SRs) of the decision maker at different time instants bow to short-term temptations. While the literature began to recognize the importance to strike a balance between LR's and SRs' interests, the existing results are not applicable to situations where the decision maker's preferences involve non-expectation operators. We propose an operable unified two-tier dual-self game model with commitment by punishment, which can cope with general time inconsistent stochastic decision problems with both expectation and non-expectation operators in the objective function. By attaching punishment terms to both the preferences of LR and SRs which quantitatively evaluate the internal conflict among different selves, our game model aligns the interests of the LR and SRs to a certain degree. The equilibrium strategy, termed strategy of self-coordination, achieves some degree of internal harmony among various selves. We successfully apply the model to the investment and consumption problem with quasi-hyperbolic discounting and the dynamic mean-variance portfolio selection problem. |
| Date: | 2020–03–27 |
| URL: | http://d.repec.org/n?u=RePEc:osf:socarx:8m5w2&r=all |