
on Utility Models and Prospect Theory 
By:  Yehuda John Levy; Andre Veiga 
Abstract:  We assume a fixed number of symmetric firms, competition in prices, constant returns to scale and frictionless consumer choices. Consumers differ in their preferences and profitability (e.g., due to heterogeneous risk aversion and loss probabilities), which creates adverse selection. Firms can offer multiple contracts to screen individuals, in equilibrium and in any deviation. We show that equilibrium profits vanish if each consumer has a unique optimizing bundle at equilibrium prices or, more generally, if there exists a linear ordering over of contracts that dictates the preferences of firms whenever consumers are indifferent between multiple optimal contracts. For instance, equilibrium profits vanish if the marginal rate of substitution of quality for price is sharper for profit than for utility. In particular, profit also vanishes if utility equals the sum of (negative) profit, and a surplus (eg, due to risk aversion). We provide examples of economies where there exists an equilibrium with strictly positive profit and show that these examples are robust (hold for an open set of economies). 
Keywords:  Perfect Competition, Equilibrium, Screening 
JEL:  D41 C62 D82 G22 
Date:  2020–01 
URL:  http://d.repec.org/n?u=RePEc:gla:glaewp:2020_02&r=all 
By:  Yuval Heller; Amnon Schreiber 
Abstract:  We study various decision problems regarding shortterm investments in risky assets whose returns evolve continuously in time. We show that in each problem, all riskaverse decision makers have the same (problemdependent) ranking over shortterm risky assets. Moreover, in each problem, the ranking is represented by the same risk index as in the case of CARA utility agents and normally distributed risky assets. 
Date:  2020–05 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:2005.06576&r=all 
By:  BenZhang Yang; XinJiang He; SongPing Zhu 
Abstract:  In this paper, we propose a new class of optimization problems, which maximize the terminal wealth and accumulated consumption utility subject to a mean variance criterion controlling the final risk of the portfolio. The multipleobjective optimization problem is firstly transformed into a singleobjective one by introducing the concept of overall "happiness" of an investor defined as the aggregation of the terminal wealth under the meanvariance criterion and the expected accumulated utility, and then solved under a game theoretic framework. We have managed to maintain analytical tractability; the closedform solutions found for a set of special utility functions enable us to discuss some interesting optimal investment strategies that have not been revealed before in literature. 
Date:  2020–05 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:2005.06782&r=all 
By:  Senda Ounaies (CES  Centre d'économie de la Sorbonne  CNRS  Centre National de la Recherche Scientifique  UP1  Université PanthéonSorbonne); JeanMarc Bonnisseau (CES  Centre d'économie de la Sorbonne  CNRS  Centre National de la Recherche Scientifique  UP1  Université PanthéonSorbonne, PSE  Paris School of Economics); Souhail Chebbi (LEGI  Laboratoire d'Économie et de Gestion Industrielle [Tunis]  Ecole Polytechnique de Tunisie) 
Abstract:  In this paper, we consider a production economy with an unbounded attainable set where the consumers may have noncomplete nontransitive preferences. To get the existence of an equilibrium, we provide an asymptotic property on preferences for the attainable consumptions and we use a combination of the nonlinear optimization and fixed point theorems on truncated economies together with an asymptotic argument. We show that this condition holds true if the set of attainable allocations is compact or, when the preferences are representable by utility functions, if the set of attainable individually rational utility levels is compact. This assumption generalizes the CPP condition of [N. Allouch, An equilibrium existence result with short selling, J. Math. Econom. 37 2002, 2, 81–94] and covers the example of [F. H. Page, Jr., M. H. Wooders and P. K. Monteiro, Inconsequential arbitrage, J. Math. Econom. 34 2000, 4, 439–469] when the attainable utility levels set is not compact. So we extend the previous existence results with noncompact attainable sets in two ways by adding a production sector and considering general preferences. 
Keywords:  nonlinear optimization,quasiequilibrium,noncompact attainable allocations,Production economy 
Date:  2019–03–01 
URL:  http://d.repec.org/n?u=RePEc:hal:pseptp:halshs01859163&r=all 
By:  Flint O'Neil 
Abstract:  Recursive preferences, of the sort developed by Epstein and Zin (1989), play an integral role in modern macroeconomics and asset pricing theory. Unfortunately, it is nontrivial to establish the unique existence of a solution to recursive utility models. We show that the tightest known existence and uniqueness conditions can be extended to (i) Schorfheide, Song and Yaron (2018) recursive utilities and (ii) recursive utilities with `narrow framing'. Further, we sharpen the solution space of Borovicka and Stachurski (2019) from $L_1$ to $L_p$ so that the results apply to a broader class of modern asset pricing models. For example, using $L_2$ Hilbert space theory, we find the class of parameters which generate a unique $L_2$ solution to the Bansal and Yaron (2004) and Schorfheide, Song and Yaron (2018) models. 
Date:  2020–05 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:2005.07067&r=all 
By:  Torben M. Andersen; Joydeep Bhattacharya; Qing Liu 
Abstract:  In the real world, public payasyougo pension (PAYG) schemes are popular and coexist with private, retirementsaving schemes. This is true even in dynamically efficient economies where such pensions offer a lower return. The classic AaronSamuelson result argues that, in theory, this is impossible. Later work has shown that it may be possible if agents, left on their own, undersave due to myopia or timeinconsistency. In that case, if the government is paternalistic, a welfare rationale for PAYG pensions arises but only if voluntary retirement saving is fully crowded out because of a binding borrowing constraint. This paper generalizes the AaronSamuelson discussion to the referencedependent utility setup of Kőszegi and Rabin (2009) where undersaving happens naturally. No borrowing constraint is imposed. In this case, it is possible to offer a nonpaternalistic, welfare rationale for returndominated, PAYG pensions to coexist with private retirement saving. 
Keywords:  referencedependence, crowdingout, pensions, dynamic efficiency 
JEL:  H55 E60 
Date:  2020 
URL:  http://d.repec.org/n?u=RePEc:ces:ceswps:_8260&r=all 
By:  Fanghui Li (Center for Economic Research, Shandong University); Gaowang Wang (Center for Economic Research, Shandong University); Hengfu Zou (China Economics and Management Academy, Central University of Finance and Economics) 
Abstract:  The paper reexamines the famous ChamleyJudd zero capital tax theorem in model economies where the agents are endowed with the spirit of capitalism. It is shown that the limiting capital income tax is not zero in general and depends on the utility speciffications rather than the production technology. The similar formulas of optimal capital taxes are derived in more general settings with multiple physical capitals or heterogeneous agents (capitalists and workers). 
Date:  2020 
URL:  http://d.repec.org/n?u=RePEc:cuf:wpaper:614&r=all 
By:  Sawosri, Arieska Wening; Mußhoff, Oliver 
Abstract:  This crosscountry study compares risk and time preferences of farmers from two lowermiddle income countries, India and Indonesia. Current literature mainly focuses on a single country context; however, this study involves more than one country. Hence, we could investigate whether the individual preferences of farmers from two countries with similar income level are the same. The preferences are key for the policymakers to make informed policy decisions regarding investments and acceptance of development programs. Our study involved 1,528 farmers. The risk and time preferences were elicited using incentivised experiments and simultaneously estimated following the jointestimationmethod by Andersen et al. (2008). Results show that the farmers in India show a higher level of risk aversion and lower discount rates, even though very high discount rates were encountered in both countries. As a result, policymakers should consider implementing policies to deal with high discount rates causing poverty and lack of investment. 
Keywords:  Crosscountry dataset,lowermiddle income countries,risk preferences,smallholder farmers,time preferences 
Date:  2020 
URL:  http://d.repec.org/n?u=RePEc:zbw:crc990:32&r=all 
By:  Geert Bekaert; Eric Engstrom; Andrey Ermolov 
Abstract:  The equity variance risk premium is the expected compensation earned for selling variance risk in equity markets. The variance risk premium is positive and shows moderate persistence. High variance risk premiums coincide with the left tail of the consumption growth distribution shifting down. These facts, together with a positive, yet moderate, difference between the riskneutral entropy and variance of the aggregate market return, refute the bulk of the extant consumptionbased asset pricing models. We introduce a tractable habit model that does fit the data. In the model, the variance risk premium depends positively (negatively) on “bad” (“good”) consumption growth uncertainty. 
JEL:  E44 G12 G13 
Date:  2020–05 
URL:  http://d.repec.org/n?u=RePEc:nbr:nberwo:27108&r=all 
By:  Christopher Heiberger (University of Augsburg, Department of Economics); Daniel Fehrle (University of Augsburg, Department of Economics) 
Abstract:  A The risk premium puzzle is even worse than previously reported if housing is also taken into consideration next to equity. While housing premia are only moderately smaller than equity premia, they are significantly less volatile and the Sharpe ratio of housing is significantly larger. Hence, three question arise: i) are existing approaches to explain the equity premium puzzle also capable of explaining even larger Sharpe ratios than previously required, ii) can return rates and volatilities of various assets be differentiated, and iii) can different Sharpe ratios between the two risky assets be matched. We analyze these questions, next to business cycle statistics, by including housing into seminal approaches to solve the risk premium puzzle in production economies. Nondisaster economies with habit formation, capital adjustment costs and limited factor mobility fail to generate a Sharpe ratio of housing of the empirically observed size and do not explain comoving economic activity. A basic model with timevarying disaster risk can reproduce the large Sharpe ratio of housing. Moreover, the model can explain different means and volatilities of the risky assets, economic activity comoves and the model explains the volatility ratio of business investments, residential investments and house prices. However, the model does not allow to disentangle the Sharpe ratios of the risky assets and premia on equity remain too involatile. 
Keywords:  equity premium puzzle, housing, rare disasters, production CAPM, real business cycle literature 
JEL:  C63 E32 E44 G12 
Date:  2020–05 
URL:  http://d.repec.org/n?u=RePEc:aug:augsbe:0338&r=all 
By:  Patrick Arni; Davide Dragone; Lorenz Goette; Nicolas R. Ziebarth 
Abstract:  This paper investigates the role of biased health perceptions as driving forces of risky health behavior. We define absolute and relative health perception biases, illustrate their measurement in surveys and provide evidence on their relevance. Next, we decompose the theoretical effect into its extensive and intensive margin: when the extensive margin dominates, people (wrongly) believe they are healthy enough to “afford” unhealthy behavior. Finally, using three population surveys, we provide robust empirical evidence that respondents who overestimate their health are less likely to exercise and sleep enough, but more likely to eat unhealthily and drink alcohol daily. 
JEL:  C93 D03 D83 I12 
Date:  2020–04 
URL:  http://d.repec.org/n?u=RePEc:bol:bodewp:wp1146&r=all 
By:  Lustenhouwer, Joep 
Abstract:  I study liquidity traps in a model where agents have heterogeneous expectations and finite planning horizons. Backwardlooking agents base their expectations on past observations, while forwardlooking agents have fully rational expectations. Liquidity traps that are fully or partly driven by expectations can arise due to pessimism of backwardlooking agents. Only when planning horizons are finite, these liquidity traps can be of longer duration without ending up in a deflationary spiral. I further find that fiscal stimulus in the form of an increase in government spending or a cut in consumption taxes can be very effective in mitigating the liquidity trap. A feedback mechanism of heterogeneous expectations causes fiscal multipliers to be the largest when the majority of agents is backwardlooking but there also is a considerable fraction of agents that are forwardlooking. Labor tax cuts are always deflationary and are not an effective tool in a liquidity trap. 
Keywords:  bounded rationality; fiscal policy; liquidity trap; heterogeneous expectations 
Date:  2020–05–14 
URL:  http://d.repec.org/n?u=RePEc:awi:wpaper:0683&r=all 
By:  Alberto Prati (AixMarseille University, CNRS, EHESS, Centrale Marseille, AMSE; France); Claudia Senik (SorbonneUniversity and Paris School of Economics, France) 
Abstract:  Can people remember correctly their past wellbeing? We study three national surveys of the British, German and French population, where more than 50,000 European citizens were asked questions about their current and past life satisfaction. We uncover systematic biases in recalled subjective wellbeing: on average, people tend to overstate the improvement in their wellbeing over time and to understate their past happiness. But this aggregate figure hides a deep asymmetry: while happy people recall the evolution of their life to be better than it was, unhappy ones tend to exaggerate its worsening. It thus seems that feeling happy today implies feeling better than yesterday. These results offer an explanation of why happy people are more optimistic, perceive risks to be lower and are more open to new experiences. 
Keywords:  life satisfaction, remembered utility, memory biases, intrapersonal comparisons 
JEL:  I31 D91 
Date:  2020–04 
URL:  http://d.repec.org/n?u=RePEc:aim:wpaimx:2014&r=all 
By:  Shilpa Aggarwal; Rebecca DizonRoss; Ariel D. Zucker 
Abstract:  How should the design of incentives vary with agent time preferences? We develop two predictions. First, “bundling” the payment function over time – specifically by making the payment for future effort increase in current effort – is more effective if individuals are impatient over effort. Second, increasing the frequency of payment is more effective if individuals are impatient over payment. We test the efficacy of timebundling and payment frequency, and their interactions with impatience, using a randomized evaluation of an incentive program for exercise among diabetics in India. Consistent with our theoretical predictions, bundling payments over time meaningfully increases effort among the impatient relative to the patient. In contrast, increasing payment frequency has limited efficacy, suggesting limited impatience over payments. On average, incentives increase daily steps by 1,266 (13 minutes of brisk walking) and improve health. 
JEL:  D9 I12 I15 
Date:  2020–05 
URL:  http://d.repec.org/n?u=RePEc:nbr:nberwo:27079&r=all 
By:  Yerkin Kitapbayev; Scott Robertson 
Abstract:  We analyze recently proposed mortgage contracts which aim to eliminate selective borrower default when the loan balance exceeds the house price (the "underwater" effect). We show that contracts which automatically reduce the outstanding balance in the event of local house price decline remove the default incentive, but may induce prepayment in low price states. However, low state prepayments vanish if borrower utility from home ownership, or outside options such as rental costs, are too high. We also show that capital gain sharing features, through prepayment penalties in high house price states, are ineffective, as they virtually eliminate prepayment in such states. For typical foreclosure costs, we find that contracts with automatic balance adjustments become preferable to the traditional fixed rate mortgage at contract rate spreads of approximately 50100 basis points, depending on how far prices must fall before adjustments are made. Furthermore, these spreads rapidly decrease with the borrower utility from home ownership. Our results are obtained using American options pricing methods, in a model with diffusive home prices, and either diffusive or constant interest rates. We determine the contract, default and prepayment option values with optimal decision rules. We provide explicit solutions in the perpetual case with constant interest rates; and numerically compute the prepayment and default boundaries in the general case. 
Date:  2020–05 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:2005.03554&r=all 
By:  Hippolyte d'Albis (PSE  Paris School of Economics); JeanPierre Drugeon (PJSE  Paris Jourdan Sciences Economiques  UP1  Université PanthéonSorbonne  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:  The purpose of this contribution is to consider a discrete time formulation that would allow for clarifying some salient features of a vintage based understanding of the capital stock..ree main lines of conclusions are established on an analytical basis. First and for an elementary conguration with linear utility, it is proved that the rate of growth of investment is prone to andoscillating—convergent, sustained or unstable—motions. Second and for an environment with a linear production technology and a AK setup, the dynamics of investment is explicitly solved and it is established that the rate of growth of investment may either converge to the steady growth solution in oscillating way, diverge from that solution in a oscillating way, or even undergo permanent sustained oscillations with a periodicity of two. .ird, it is proved that no perennial .uctuations can emerge within a benchmark environment with strictly concave utilities and production technologies. On a methodological basis, few restrictions are superimposed, the arguments remain fairly general and the proofs are elementary. 
Keywords:  Vintage Capital,Optimal Growth,Discrete Time 
Date:  2020–05 
URL:  http://d.repec.org/n?u=RePEc:hal:psewpa:halshs02570648&r=all 
By:  Arthur Lewbel (Boston College); Lars Nesheim (CeMMAP) 
Abstract:  We propose a demand model where consumers simultaneously choose a few different goods from a large menu of available goods, and choose how much to consume of each good. The model nests multinomial discrete choice and continuous demand systems as special cases. Goods can be substitutes or complements. Random coefficients are employed to capture the wide variation in the composition of consumption baskets. Nonnegativity constraints produce corners that account for different consumers purchasing different numbers of types of goods. We show semiparametric identification of the model. We apply the model to the demand for fruit in the United Kingdom. We estimate the model’s parameters using UK scanner data for 2008 from the Kantar World Panel. Using our parameter estimates, we estimate a matrix of demand elasticities for 27 categories of fruit and analyze a range of tax and policy change scenarios. 
Keywords:  sparse demand, discrete choice, continuous choice, complements, complementarity, substitutes, demand estimation, scanner data, fruit, quadratic utility 
JEL:  C13 C34 D12 L40 L66 
Date:  2019–11–15 
URL:  http://d.repec.org/n?u=RePEc:boc:bocoec:1005&r=all 