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on Utility Models and Prospect Theory |
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Issue of 2020‒04‒13
nineteen papers chosen by |
| By: | Nicolas Gravel (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); Thierry Marchant (UGENT - Ghent University [Belgium]); Arunava Sen (Indian Statistical Institute [New Delhi]) |
| Abstract: | We provide an axiomatic characterization of a family of criteria for ranking completely uncertain and/or ambiguous decisions. A completely uncertain decision is described by the set of all its consequences (assumed to be finite). An ambiguous decision is described as a set of possible probability distributions over a set of prizes. Every criterion in the family compares sets on the basis of their conditional expected utility , for some "likelihood" function taking strictly positive values and some utility function both having the universe of alternatives as their domain. |
| Keywords: | Ignorance,Ambiguity,Conditional Probabilities,Expected Utility,Ranking Sets,axioms JEL classification numbers: D80,D81 |
| Date: | 2018–10 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-01988972&r=all |
| By: | Jos\'e Moran; Antoine Fosset; Davide Luzzati; Jean-Philippe Bouchaud; Michael Benzaquen |
| Abstract: | Historically, rational choice theory has focused on the utility maximization principle to describe how individuals make choices. In reality, there is a computational cost related to exploring the universe of available choices and it is often not clear whether we are truly maximizing an underlying utility function. In particular, memory effects and habit formation may dominate over utility maximisation. We propose a stylized model with a history-dependent utility function where the utility associated to each choice is increased when that choice has been made in the past, with a certain decaying memory kernel. We show that self-reinforcing effects can cause the agent to get stuck with a choice by sheer force of habit. We discuss the special nature of the transition between free exploration of the space of choice and self-trapping. We find in particular that the trapping time distribution is precisely a Zipf law at the transition, and that the self-trapped phase exhibits super-aging behaviour. |
| Date: | 2020–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2003.13660&r=all |
| By: | Emmanuelle GABILLON |
| Abstract: | This paper is a contribution to regret theory, which we generalize in two ways. Since the intensity of regret depends on the information the decision-maker has about the results of the foregone strategies (feedback), we build a model of choice which accommodates any feedback structure. We also show that the reference point, which characterizes the regret utility function introduced by Quiggin (1994), does not always represent an anticipated feeling of regret. It can also correspond to another negative feeling related to the act of choosing, which we call psychological opportunity cost (POC), borne at the very moment of choosing. We find behavioral deviations from the predictions of the classical Expected Utility Theory. We obtain correlation loving, greater reluctance to take on risk, and information avoidance at decision time. Our model also offers a theoretical framework for experimental studies about inaction inertia. |
| Keywords: | Choice; Correlation loving; Inaction inertia; Information; Regret; Risk aversion |
| JEL: | D80 D81 D91 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:grt:bdxewp:2020-04&r=all |
| By: | Douadia Bougherara (CEE-M, Univ. Montpellier, CNRS, INRAE, Institut Agro, Montpellier, France); Lana Friesen (School of Economics, University of Queensland); Céline Nauges (Toulouse School of Economics, INRAE, University of Toulouse Capitole, Toulouse, France) |
| Abstract: | While much literature has focused on preferences regarding risk, preferences over skewness also have significant economic implications. An important and understudied aspect of skewness preferences is how they affect risk taking. In this paper, we design a novel laboratory experiment that elicits certainty equivalents over lotteries where the variance and skewness of the outcomes are orthogonal to each other. This design enables us to cleanly measure both skewness seeking/avoiding and risk taking behavior, and their interaction, without needing to make parametric assumptions. Our experiment includes both left- and right-skewed lotteries. The results reveal that the majority of subjects are skewness avoiding risk takers who correspondingly also take more risk when facing less skewed lotteries. Our second contribution is to link these choices to individual rank-dependent utility preference parameters estimated using a separate lottery choice protocol. Using a latent-class model, we are able to identify two classes of subjects: skewness avoiders with the classic inverse s-shaped probability weighting function and skewness neutral subjects that do not distort probabilities. Our results thus demonstrate the link between probability distortion and skewness seeking/avoidance choices. They also highlight the importance of accounting for individual heterogeneity. |
| Keywords: | Risk; Skewness; Laboratory Experiment; Probability Weighting |
| JEL: | C91 D81 |
| Date: | 2020–04–02 |
| URL: | http://d.repec.org/n?u=RePEc:qld:uq2004:619&r=all |
| By: | Duffy, Sean; Smith, John |
| Abstract: | Standard choice experiments are hampered by the fact that utility is either unknown or imperfectly measured by experimenters. As a consequence, the inferences available to researchers are limited. By contrast, we design a choice experiment where the objects are valued according to only a single attribute with a continuous measure and we can observe the true preferences of subjects. Subjects have an imperfect perception of the choice objects but can improve the precision of their perception with cognitive effort. Subjects are given a choice set involving several lines of various lengths and are told to select one of them. They strive to select the longest line because they are paid an amount that increases with the length of their choice. Our design allows us to observe the search history, the response times, and make unambiguous conclusions about the optimality of choices. We find a negative relationship between the demanding nature of the choice problems and the likelihood that subjects select the optimal lines. We also find a positive relationship between the demanding nature of the choice problems and the response times. However, we find evidence that suboptimal choices are associated with longer response times than are optimal choices. This result appears to be consistent with Fudenberg, Strack, and Strzalecki (2018). Additionally, our experimental design permits a multinomial discrete choice analysis. Our results suggest that the errors in our data are better described as having a Gumbel distribution rather than a normal distribution. We also observe effects consistent with memory decay and attention. Finally, we find evidence that choices in our experiment exhibit the independence from irrelevant alternatives (IIA) property. |
| Keywords: | judgment, memory, response times, independence from irrelevant alternatives |
| JEL: | C91 D03 |
| Date: | 2020–04–02 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:99417&r=all |
| By: | Becker, Anke (University of Bonn); Enke, Benjamin (University of Bonn); Falk, Armin (briq, University of Bonn) |
| Abstract: | Variation in economic preferences is systematically related to both individual and aggregate economic outcomes, yet little is known about the origins of the worldwide preference variation. This paper uses globally representative data on risk aversion, time preference, altruism, positive reciprocity, negative reciprocity, and trust to uncover that contemporary preference heterogeneity has its roots in the structure of the temporally distant migration patterns of our very early ancestors: In dyadic regressions, differences in preferences between populations are significantly increasing in the length of time elapsed since the ancestors of the respective groups broke apart from each other. To document this pattern, we link genetic and linguistic distance measures to population-level preference differences (i) in a wide range of cross-country regressions, (ii) in within-country analyses across groups of migrants, and (iii) in analyses that leverage variation across linguistic groups. While temporal distance drives differences in all preferences, the patterns are strongest for risk aversion and prosocial traits. |
| Keywords: | risk preferences, time preferences, social preferences, origins of preferences |
| JEL: | D01 D03 |
| Date: | 2020–03 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp13052&r=all |
| By: | Samuel Shye; Ido Haber |
| Abstract: | Challenge Theory (Shye & Haber 2015; 2020) has demonstrated that a newly devised challenge index (CI) attributable to every binary choice problem predicts the popularity of the bold option, the one of lower probability to gain a higher monetary outcome (in a gain problem); and the one of higher probability to lose a lower monetary outcome (in a loss problem). In this paper we show how Facet Theory structures the choice-behavior concept-space and yields rationalized measurements of gambling behavior. The data of this study consist of responses obtained from 126 student, specifying their preferences in 44 risky decision problems. A Faceted Smallest Space Analysis (SSA) of the 44 problems confirmed the hypothesis that the space of binary risky choice problems is partitionable by two binary axial facets: (a) Type of Problem (gain vs. loss); and (b) CI (Low vs. High). Four composite variables, representing the validated constructs: Gain, Loss, High-CI and Low-CI, were processed using Multiple Scaling by Partial Order Scalogram Analysis with base Coordinates (POSAC), leading to a meaningful and intuitively appealing interpretation of two necessary and sufficient gambling-behavior measurement scales. |
| Date: | 2020–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2003.12474&r=all |
| By: | A. B. Leoneti; G. A. Prataviera |
| Abstract: | Motivated by empirical evidence that individuals within group decision making simultaneously aspire to maximize utility and avoid inequality we propose a criterion based on the entropy-norm pair for geometric selection of strict Nash equilibria in n-person games. For this, we introduce a mapping of an n-person set of Nash equilibrium utilities in an Entropy-Norm space. We suggest that the most suitable group choice is the equilibrium closest to the largest entropy-norm pair of a rescaled Entropy-Norm space. Successive application of this criterion permits an ordering of the possible Nash equilibria in an n-person game accounting simultaneously equality and utility of players payoffs. Limitations of this approach for certain exceptional cases are discussed. In addition, the criterion proposed is applied and compared with the results of a group decision making experiment. |
| Date: | 2020–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2003.09225&r=all |
| By: | Oz Shy |
| Abstract: | Low-income consumers are not only constrained with spending, but also with the type and variety of payment methods available to them. Using a representative sample of the U.S. adult population, this paper analyzes the low possession (adoption) of credit and debit cards among low-income consumers who are also unbanked. Using a random utility model, I estimate the potential welfare gains associated with policy options suggested in the literature to provide subsidized and unsubsidized debit cards to this consumer population. |
| Keywords: | consumer payment choice; household income; diversity; unbanked consumers; random utility analysis; unbanked; financial inclusion; consumer surveys; consumer behavior |
| JEL: | D90 E42 |
| Date: | 2020–02–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedawp:87693&r=all |
| By: | Monica Anna Giovanniello; Simone Tonin |
| Abstract: | We study how the quality dimension affects the social optimum in a model of spatial differentiation where two facilities provide a public service. If quality enters linearly in the individuals' utility function, a symmetric configuration, in which both facilities have the same quality and serve groups of individuals of the same size, does not maximize the social welfare. This is a surprising result as all individuals are symmetrically identical having the same quality valuation. We also show that a symmetric configuration of facilities may maximize the social welfare if the individuals' marginal utility of quality is decreasing. |
| Date: | 2020–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2004.00669&r=all |
| By: | Ketter, W.; Collins, J.; de Weerdt, M.M. |
| Abstract: | This is the specification for the Power Trading Agent Competition for 2020 (Power TAC 2020). Power TAC is a competitive simulation that models a “liberalized” retail electrical energy market, where competing business entities or “brokers” offer energy services to customers through tariff contracts, and must then serve those customers by trading in a wholesale market. Brokers are challenged to maximize their profits by buying and selling energy in the wholesale and retail markets, subject to fixed costs and constraints; the winner of an individual “game” is the broker with the highest bank balance at the end of a simulation run. Costs include fees for publication and withdrawal of tariffs, for rectifying supply-demand imbalances, for contributions to peak demand, and for customer connections. The simulation environment models a wholesale market, a regulated distribution utility, and a population of energy customers, situated in a real location on Earth during a specific period for which weather data is available. The wholesale market is a relatively simple call market, similar to many existing wholesale electric power markets, such as Nord Pool in Scandinavia or FERC markets in North America, but unlike the FERC markets we are modeling a single region, and therefore we approximate the effects of locational-marginal pricing through manipulation of the wholesale supply curve. Customer models include households, electric vehicles, and a variety of commercial and industrial entities, many of whom have production capacity such as solar panels or wind turbines. All have “real-time” metering to support allocation of their hourly supply and demand to their subscribed brokers, and all are approximate utility maximizers with respect to tariff selection, although the factors making up their utility functions may include aversion to change and complexity that can retard uptake of marginally better tariff offers. A distribution utility models the regulated natural monopoly that owns the regional distribution network, and is responsible for maintenance of its infrastructure. Real-time balancing of supply and demand is managed by a market-based mechanism that uses economic incentives to encourage brokers to achieve balance within their portfolios of tariff subscribers and wholesale market posi- tions, in the face of stochastic customer behaviors and weather-dependent renewable energy sources. Changes for 2020 are focused on stability and on making customer evaluation of regulation rates more realistic, and are highlighted by change bars in the margins. See Section 4.1.1 for details. |
| Keywords: | Autonomous Agents, Electronic Commerce, Energy, Preferences, Portfolio Management, Power, Policy Guidance, Sustainability, Trading Agent Competition |
| Date: | 2020–03–30 |
| URL: | http://d.repec.org/n?u=RePEc:ems:eureri:125794&r=all |
| By: | Beine, Michel (University of Luxembourg); Charness, Gary (University of California, Santa Barbara); Dupuy, Arnaud (University of Luxembourg); Joxhe, Majlinda (University of Luxembourg) |
| Abstract: | We conduct a survey and incentivized lab-in-the-field experimental tasks in Tirana, Albania. While the original purpose of our study was to examine whether and how deep parameters such as time and risk preferences affect the intention to migrate, our study was transformed into a natural experiment owing to two large earthquakes that shook the Tirana area during our data-collection period. These events provide us with a rare opportunity to gather evidence (including a preearthquake control) on the effect of natural disasters on time and risk preferences. We find unambiguous effects towards more risk aversion and impatience for affected individuals. Moreover, as it turns out, the second earthquake amplified the effect of the first one, suggesting that experiences cumulate in their influence on these preferences. |
| Keywords: | time preferences, risk preferences, natural disaster, Albania, migration |
| JEL: | B49 C90 D91 F22 |
| Date: | 2020–03 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp13084&r=all |
| By: | Dariusz Zawisza |
| Abstract: | We consider a semilinear equation linked to the finite horizon consumption - investment problem under the stochastic factor framework and we prove it admits a classical solution and provide all obligatory estimates to successfully apply a verification reasoning. The paper covers the standard time additive utility, as well as the recursive utility framework. We extend existing results by considering more general factor dynamics including a non-trivial diffusion part and a stochastic correlation between assets and factors. In addition, this is the first paper which compromises many other optimization problems in finance, for example those related to the indifference pricing or the quadratic hedging problem. The extension of the result to the stochastic differential utility and robust portfolio optimization is provided as well. The essence of our paper lays in using improved stochastic methods to prove gradient estimates for suitable HJB equations with restricted control space. |
| Date: | 2020–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2003.13317&r=all |
| By: | Bertoli, Simone (CERDI, University of Auvergne); Fernández-Huertas Moraga, Jesús (Universidad Carlos III de Madrid); Guichard, Lucas (Institute for Employment Research (IAB), Nuremberg) |
| Abstract: | Acquiring information about destinations can be costly for migrants. We model information frictions in the rational inattention framework and obtain a closed-form expression for a migration gravity equation that we bring to the data. The model predicts that ows from countries with a higher cost of information or stronger priors are less responsive to variations in economic conditions at destination, as migrants rationally get less information before deciding where to move. The econometric analysis reveals systematic heterogeneity in the pro-cyclical behavior of migration flows across origins that is consistent with the existence of information frictions. |
| Keywords: | rational inattention, information, international migration, gravity equation |
| JEL: | F22 D81 D83 |
| Date: | 2020–03 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp13083&r=all |
| By: | Sato, Hideyasu |
| Abstract: | The necessary conditions for data to be rationalized by weakly separable utility functions are verified by aggregation using representative price indexes. For processed food and beverages, the generalized axiom of revealed preference (GARP) is tested using large-scale product-level point-of-sale data. If GARP is not satisfied, the Afriat efficiency index (AEI) is introduced to assess the degree of optimization error. We find that the larger the number of observations in the time series direction, the less likely GARP is to be satisfied. However, the maximum level of AEI is, at most, more than 99.6%, indicating that the degree of the optimization error is small. |
| Keywords: | Aggregation, Revealed preference, Weak separability, POS data |
| JEL: | C43 D12 Q11 |
| Date: | 2020–03–30 |
| URL: | http://d.repec.org/n?u=RePEc:hit:rcesrs:dp19-2&r=all |
| By: | Malakhov, Sergey |
| Abstract: | The transformation of the classical labor-leisure choice into the labor-search-leisure choice enables the analysis of the individual behavior under price dispersion. The consumer maximizes his consumption-leisure utility with respect to the equality of marginal loss on the search with its marginal benefit. The satisficing approach challenges this equality but the analysis of the moment of the intention to buy, when real balances and supplies as well as the knowledge about the price distribution are close to zero, discovers the unit elasticity of total consumer’s efforts on purchase with respect to any level of consumption for the given time horizon. If at the beginning the consumer evaluates correctly his purchasing power with respect to the market trade-off of leisure for consumption and if he is realistic about what he can buy with his efforts, he avoids the computational complexity of marginal values because the unit elasticity rule mechanically reproduces his optimal psychic consumption-leisure trade-off. The reproduction of the optimal choice by the unit elasticity rule looks like the law of nature but the optimal allocation of time between the labor and the search at any level of consumption, which. maximizes the consumption-leisure utility, appears like the work of the invisible hand. The satisficing decision with the inequality of the marginal values of search comes to the corner solution, when the consumer doesn’t make efforts on labor and search because the quantity demanded is not worth these efforts. If the consumer challenges the corner solution and start to work and to search, the unit elasticity rule reproduces high prior expectations and the outcome results in the disappointment on purchase. The unit elasticity rule provides the exit for the satisficing decision-making from the corner. If the consumer gradually changes his aspiration level and his optimistic prior expectations during the search, once he finds the satisficing price for the quantity demanded and the disappointment is gone. But the first satisficing offer, which doesn’t generate the disappointment, is the optimal one. The satisficing suboptimal purchase of the item of the immediate consumption occurs, when real balances, supplies, and knowledge are positive. These positive values produce the noise, which weakens the unit elasticity rule and make it useless. Under the unworkable unit elasticity rule the optimal choice really needs cumbersome calculations, and the consumer prefers to choose the first satisficing offer. The satisficing purchase of the durable item becomes necessary because the consumer substitutes the uncertainty of the search by the certainty of the use of the item and optimizes his consumption-leisure choice during its lifecycle with the help of his willingness to take care of the big-ticket purchase. The consumer stops to care for the durable item, when the efforts on its following use are expected greater than on average. This simple commonsense rule produces the equality of the marginal costs with the average after-purchase costs and becomes the sufficient condition to optimize the prior purchase. While the following negative willingness to take care exponentially raises the maintenance costs, the equality of the marginal and average after-purchase costs results in the optimal consumption-leisure choice of the purchase and exhibits the right moment to replace or to sell the item. |
| Keywords: | satisficing, optimal consumption-leisure choice, search, equilibrium price dispersion, invisible hand, willingness to take care |
| JEL: | D11 D83 |
| Date: | 2020–03–19 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:99158&r=all |
| By: | Giancarlo Corsetti (University of Cambridge and CEPR (E-mail: gc422@cam.ac.uk)); Luca Dedola (European Central Bank and CEPR); Sylvain Leduc (Federal Reserve Bank of San Francisco) |
| Abstract: | How should monetary policy respond to capital inflows that appreciate the currency, widen the current account deficit and cause domestic overheating? Using the workhorse open-macro monetary model, we derive a quadratic approximation of the utility-based global loss function in incomplete market economies, solve for the optimal targeting rules under cooperation and characterize the constrained-optimal allocation. The answer is sharp: the optimal monetary stance is contractionary if the exchange rate pass-through (ERPT) on import prices is incomplete, expansionary if ERPT is complete-implying that misalignment and exchange rate volatility are higher in economies where incomplete pass through contains the effects of exchange rates on price competitiveness. |
| Keywords: | Currency misalignments, trade imbalances, asset markets and risk sharing, optimal targeting rules, international policy cooperation, exchange rate pass-through |
| JEL: | E44 E52 E61 F41 F42 |
| Date: | 2020–03 |
| URL: | http://d.repec.org/n?u=RePEc:ime:imedps:20-e-04&r=all |
| By: | Frijters, Paul (London School of Economics); Krekel, Christian (London School of Economics); Ulker, Aydogan (Deakin University) |
| Abstract: | Is wellbeing higher if the same number of negative events is spread out rather than bunched in time? Should positive events be spread out or bunched? We answer these questions exploiting quarterly data on six positive and twelve negative life events in the Household, Income and Labour Dynamics in Australia panel. Accounting for selection, anticipation, and adaptation, we find a tipping point when it comes to negative events: once people experience about two negative events, their wellbeing depreciates disproportionally as more and more events occur in a given period. For positive events, effects are weakly decreasing in size. So both the good and the bad should be spread out rather than bunched in time, corresponding to the classic economic presumption of concave utility rather than Machiavelli's prescript of inflicting all injuries at once. Yet, differences are small, with complete smoothing of all negative events over all people and periods calculated to yield no more than a 12% reduction in the total negative welbeing impact of negative events. |
| Keywords: | wellbeing, mental health, life events, non-linearities, hedonic adaptation, welfare analysis |
| JEL: | D1 I31 K0 |
| Date: | 2020–02 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp13021&r=all |
| By: | Nathan Dahlin; Rahul Jain |
| Abstract: | A market consisting of a generator with thermal and renewable generation capability, a set of non-preemptive loads (i.e., loads which cannot be interrupted once started), and an independent system operator (ISO) is considered. Loads are characterized by durations, power demand rates and utility for receiving service, as well as disutility functions giving preferences for time slots in which service is preferred. Given this information, along with the generator's thermal generation cost function and forecast renewable generation, the social planner solves a mixed integer program to determine a load activation schedule which maximizes social welfare. Assuming price taking behavior, we develop a competitive equilibrium concept based on a relaxed version of the social planner's problem which includes prices for consumption and incentives for flexibility, and allows for probabilistic allocation of power to loads. Considering each load as representative of a population of identical loads with scaled characteristics, we demonstrate that the relaxed social planner's problem gives an exact solution to the original mixed integer problem in the large population limit, and give a market mechanism for implementing the competitive equilibrium. |
| Date: | 2020–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2003.13220&r=all |