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on Utility Models and Prospect Theory |
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Issue of 2020‒06‒22
eleven papers chosen by |
| By: | Laurens Cherchye; Thomas Demuynck; Bram De Rock; Joshua Lanier |
| Abstract: | We present a statistical test for the hypothesis of rational utility maximization on the basis of nonparametric revealed preference conditions. Our test is conservative for the utility maximization hypothesis. We take as null hypothesis that the consumer behaves randomly, and as alternative hypothesis that she is approximately utility maximizing. Our statistical test uses a permutation method to operationalize the principle of random consumer behavior. We show that the test has an asymptotic power of one against the alternative hypothesis of approximately utility maximizing behavior. We also provide simulated power results and two empirical applications (to experimental and observational data, respectively). |
| Keywords: | utility maximization; revealed preferences; random behavior; permutation test |
| JEL: | D10 |
| Date: | 2020–06 |
| URL: | http://d.repec.org/n?u=RePEc:eca:wpaper:2013/307516&r=all |
| By: | Svetlana Pashchenko (University of Georgia); Ponpoje Porapakkarm (National Graduate Institute for Policy Studies) |
| Abstract: | How does the value of life affect annuity demand? To address this question, we construct a portfolio choice problem with three key features: i) agents have access to life-contingent assets, ii) they always prefer living to dying, iii) agents have non-expected utility preferences. We show that as utility from being alive increases, annuity demand decreases (increases) if agents are more (less) averse to risk rather than to intertemporal fluctuations. Put differently, if people prefer early resolution of uncertainty, they are less interested in annuities when the value of life is high. Our findings have two important implications. First, we get a better understanding of the well-known annuity puzzle. Second, we argue that the observed low annuity demand provides evidence that people prefer early rather than late resolution of uncertainty. |
| Keywords: | annuities, value of a statistical life, portfolio choice problem, life-contingent assets, longevity insurance |
| JEL: | D91 G11 G22 |
| Date: | 2020–06 |
| URL: | http://d.repec.org/n?u=RePEc:hka:wpaper:2020-042&r=all |
| By: | Krist\'of B\'erczi; Erika R. B\'erczi-Kov\'acs; Endre Boros; Fekadu Tolessa Gedefa; Naoyuki Kamiyama; Telikepalli Kavitha; Yusuke Kobayashi; Kazuhisa Makino |
| Abstract: | In fair division problems, we are given a set $S$ of $m$ items and a set $N$ of $n$ agents with individual preferences, and the goal is to find an allocation of items among agents so that each agent finds the allocation fair. There are several established fairness concepts and envy-freeness is one of the most extensively studied ones. However envy-free allocations do not always exist when items are indivisible and this has motivated relaxations of envy-freeness: envy-freeness up to one item (EF1) and envy-freeness up to any item (EFX) are two well-studied relaxations. We consider the problem of finding EF1 and EFX allocations for utility functions that are not necessarily monotone, and propose four possible extensions of different strength to this setting. In particular, we present a polynomial-time algorithm for finding an EF1 allocation for two agents with arbitrary utility functions. An example is given showing that EFX allocations need not exist for two agents with non-monotone, non-additive, identical utility functions. However, when all agents have monotone (not necessarily additive) identical utility functions, we prove that an EFX allocation of chores always exists. As a step toward understanding the general case, we discuss two subclasses of utility functions: Boolean utilities that are $\{0,+1\}$-valued functions, and negative Boolean utilities that are $\{0,-1\}$-valued functions. For the latter, we give a polynomial time algorithm that finds an EFX allocation when the utility functions are identical. |
| Date: | 2020–06 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2006.04428&r=all |
| By: | Neofytos Rodosthenous; Hongzhong Zhang |
| Abstract: | We consider risk averse investors with different levels of anxiety about asset price drawdowns. The latter is defined as the distance of the current price away from its best performance since inception. These drawdowns can increase either continuously or by jumps, and will contribute towards the investor's overall impatience when breaching the investor's private tolerance level. We investigate the unusual reactions of investors when aiming to sell an asset under such adverse market conditions. Mathematically, we study the optimal stopping of the utility of an asset sale with a random discounting that captures the investor's overall impatience. The random discounting is given by the cumulative amount of time spent by the drawdowns in an undesirable high region, fine tuned by the investor's personal tolerance and anxiety about drawdowns. We prove that in addition to the traditional take-profit sales, the real-life employed stop-loss orders and trailing stops may become part of the optimal selling strategy, depending on different personal characteristics. This paper thus provides insights on the effect of anxiety and its distinction with traditional risk aversion on decision making. |
| Date: | 2020–05 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2006.00282&r=all |
| By: | Sander Barendse; Andrew J. Patton |
| Abstract: | We develop tests for out-of-sample forecast comparisons based on loss functions that contain shape parameters. Examples include comparisons using average utility across a range of values for the level of risk aversion, comparisons of forecast accuracy using characteristics of a portfolio return across a range of values for the portfolio weight vector, and comparisons using a recently-proposed “Murphy diagrams†for classes of consistent scoring rules. An extensive Monte Carlo study verifies that our tests have good size and power properties in realistic sample sizes, particularly when compared with existing methods which break down when then number of values considered for the shape parameter grows. We present three empirical illustrations of the new test. |
| Keywords: | Forecasting, model selection, out-of-sample testing, nuisance parameters |
| JEL: | C53 C52 C12 |
| Date: | 2020–05–27 |
| URL: | http://d.repec.org/n?u=RePEc:oxf:wpaper:909&r=all |
| By: | Xinyang Wang |
| Abstract: | If agents cooperate only within small groups of some bounded sizes, is there a way to partition the population into small groups such that no collection of agents can do better by forming a new group? This paper revisited f-core in a transferable utility setting. By providing a new formulation to the problem, we built up a link between f-core and the transportation theory. Such a link helps us to establish an exact existence result, and a characterization result of f-core for a general class of agents, as well as some improvements in computing the f-core in the finite type case. |
| Date: | 2020–05 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2005.11244&r=all |
| By: | Dainis Zegners; Uwe Sunde; Anthony Strittmatter |
| Abstract: | This paper presents novel evidence for the prevalence of deviations from rational behavior in human decision making - and for the corresponding causes and consequences. The analysis is based on move-by-move data from chess tournaments and an identification strategy that compares behavior of professional chess players to a rational behavioral benchmark that is constructed using modern chess engines. The evidence documents the existence of several distinct dimensions in which human players deviate from a rational benchmark. In particular, the results show deviations related to loss aversion, time pressure, fatigue, and cognitive limitations. The results also demonstrate that deviations do not necessarily lead to worse performance. Consistent with an important influence of intuition and experience, faster decisions are associated with more frequent deviations from the rational benchmark, yet they are also associated with better performance. |
| Date: | 2020–05 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2005.12638&r=all |
| By: | Nicholas C. Barberis; Lawrence J. Jin; Baolian Wang |
| Abstract: | We present a new model of asset prices in which investors evaluate risk according to prospect theory and examine its ability to explain 22 prominent stock market anomalies. The model incorporates all the elements of prospect theory, takes account of investors' prior gains and losses, and makes quantitative predictions about an asset's average return based on empirical estimates of its volatility, skewness, and past capital gain. We find that the model is helpful for thinking about a majority of the 22 anomalies. |
| JEL: | G11 G12 |
| Date: | 2020–05 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:27155&r=all |
| By: | Grabisch, Michel (Paris School of Economics); Sudhölter, Peter (Department of Business and Economics) |
| Abstract: | A balanced transferable utility game (N, v) has a stable core if its core is externally stable, that is, if each imputation that is not in the core is dominated by some core element. Given two payoff allocations x and y, we say that x outvotes y via some coalition S of a feasible set if x dominates y via S and x allocates at least v(T ) to any feasible T that is not contained in S. It turns out that outvoting is transitive and the set M of maximal elements with respect to outvoting coincides with the core if and only if the game has a stable core. By applying the duality theorem of linear programming twice, it is shown that M coincides with the core if and only if a certain nested balancedness condition holds. Thus, it can be checked in finitely many steps whether a balanced game has a stable core. We say that the game has a super-stable core if each payoff vector that allocates less than v(S) to some coalition S is dominated by some core element and prove that core super-stability is equivalent to vital extendability, requiring that each vital coalition is extendable. |
| Keywords: | Domination; stable set; core; TU game |
| JEL: | C71 |
| Date: | 2020–06–15 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:sdueko:2020_006&r=all |
| By: | Freund, Lukas; Rendahl, Pontus |
| Abstract: | This paper studies the role of uncertainty in a search-and-matching framework with risk-averse households. A mean-preserving spread to future productivity contracts current economic activity even in the absence of nominal rigidities, although the effect is reinforced by the presence of the latter. That is, uncertainty shocks carry both contractionary demand- and supply effects. The reason is that a more uncertain future increases the precautionary behavior of households, which reduces interest rates and contracts demand. At the same time, as future asset prices becomes more volatile and positively covary with aggregate consumption, households demand a larger risk premium, which puts negative pressure on current asset values and thereby contracts supply. Thus, in comparison to a pure negative demand shock, an uncertainty shock puts less deflationary pressure on the economy and, as a result, renders a flatter Phillips curve. |
| Keywords: | inflation; search frictions; uncertainty; unemployment |
| JEL: | E21 E32 J64 |
| Date: | 2020–05 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:14690&r=all |
| By: | Aggarwal, Shilpa; Dizon-Ross, Rebecca; Zucker, Ariel |
| Abstract: | How should the design of incentives vary with agent time preferences? We develop two predictions. First, "bundling" the payment function over time â?? 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 time-bundling and payment frequency, and their interactions with impatience, using a randomized evaluation of an incentives 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. |
| Date: | 2020–05 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:14751&r=all |