nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2020‒07‒27
fifteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Rational Inattention via Ignorance Equivalence By Roc Armenter; Michèle Müller-Itten; Zachary Stangebye
  2. Why Does Consumption Fluctuate in Old Age and How Should the Government Insure It? By Richard Blundell; Margherita Borella; Jeanne Commault; Mariacristina De Nardi
  3. Optimal Consumption with Reference to Past Spending Maximum By Shuoqing Deng; Xun Li; Huyen Pham; Xiang Yu
  4. Temptation in Consumption and Optimal Redistributive Taxation By Maria Arvaniti; Tomas Sjögren
  5. On the Causes and Consequences of Deviations from Rational Behavior By Dainis Zegners; Uwe Sunde; Anthony Strittmatter
  6. Competition on Unobserved Attributes: The Case of the Hospital Industry By Choné, Philippe; Wilner, Lionel
  7. Mean Field Exponential Utility Game: A Probabilistic Approach By Guanxing Fu; Xizhi Su; Chao Zhou
  8. Riding the Yield Curve: Risk Taking Behavior in a Low Interest Rate Environment By Ralph Chami; Thomas F. Cosimano; Celine Rochon; Julieta Yung
  9. Does sophistication of the weighting scheme enhance the performance of long-short commodity portfolios? By Hossein Rad; Rand Low; Joelle Miffre; Robert Faff
  10. Joint Bayesian Inference about Impulse Responses in VAR Models By Atsushi Inoue; Lutz Kilian
  11. The Equilibrium Existence Duality: Equilibrium with Indivisibilities & Income Effects By Elizabeth Baldwin; Omer Edhan; Ravi Jagadeesan; Paul Klemperer; Alexander Teytelboym
  12. Betting on the Lord: Lotteries and Religiosity in Haiti By Auriol, Emmanuelle; Diego, Delissaint; fourati, maleke; Miquel-Florensa, Josepa; Seabright, Paul
  13. The effects of presentation formats in choice experiments By Genius Murwirapachena; Johane Dikgang
  14. I Am Innocent: Hourly Variations in Air Pollution and Crime Behavior By Luis Sarmiento
  15. Bentham and Ricardo's rendez-vous manqués By Christophe Depoortère; André Lapidus; Nathalie Sigot

  1. By: Roc Armenter; Michèle Müller-Itten; Zachary Stangebye
    Abstract: We present a novel approach to finite Rational Inattention (RI) models based on the ignorance equivalent, a fictitious action with state-dependent payoffs that effectively summarizes the optimal learning and conditional choices. The ignorance equivalent allows us to recast the RI problem as a standard expected utility maximization over an augmented choice set called the learning-proof menu, yielding new insights regarding the behavioral implications of RI, in particular as new actions are added to the menu. Our geometric approach is also well suited to numerical methods, outperforming existing techniques both in terms of speed and accuracy, and offering robust predictions on the most frequently implemented actions.
    Keywords: Rational inattention; information acquisition; learning.
    JEL: D81 D83 C63
    Date: 2020–06–22
  2. By: Richard Blundell; Margherita Borella; Jeanne Commault; Mariacristina De Nardi
    Abstract: In old age, consumption can fluctuate because of shocks to available resources and because health shocks affect utility from consumption. We find that even temporary drops in income and health are associated with drops in consumption and most of the effect of temporary drops in health on consumption stems from the reduction in the marginal utility from consumption that they generate. More precisely, after a health shock, richer households adjust their consumption of luxury goods because their utility of consuming them changes. Poorer households, instead, adjust both their necessary and luxury consumption because of changing resources and utility from consumption.
    JEL: D1 D11 D12 D14 E2 E21 H2 H31 H51
    Date: 2020–06
  3. By: Shuoqing Deng; Xun Li; Huyen Pham; Xiang Yu
    Abstract: This paper studies an infinite horizon optimal consumption problem under exponential utility, together with non-negativity constraint on consumption rate and a reference point to the past consumption peak. The performance is measured by the distance between the consumption rate and a fraction $0\leq\lambda\leq 1$ of the historical consumption maximum. To overcome its path-dependent nature, the consumption running maximum process is chosen as an auxiliary state process that renders the value function two dimensional depending on the wealth variable $x$ and the reference variable $h$. The associated Hamilton-Jacobi-Bellman (HJB) equation is expressed in the piecewise manner across different regions to take into account constraints. By employing the dual transform and smooth-fit principle, the classical solution of the HJB equation is obtained in an analytical form, which in turn provides the feedback optimal investment and consumption. For $0
    Date: 2020–06
  4. By: Maria Arvaniti (Center of Economic Research (CER-ETH), ETH Zurich, Switzerland); Tomas Sjögren (Department of Economics, USBE, Umeå University, Sweden)
    Abstract: The purpose of this article is to integrate the class of preferences developed by Gul and Pesendorfer into the theory of optimal redistributive taxation with heterogenous consumers and asymmetric information. The consumers are inclined to over-spend on a commodity for which they experience temptation (TP good). Resisting that temptation gives rise to a utility cost. This cost provides two novel motives for influencing the consumption and labor supply choices; improving the welfare (by reducing the utility cost of exercising self-control) and providing the government with a novel channel via which tax policy can be used to relax a binding self-selection constraint. The welfare motive implies a positive tax on the TP good, as well as a positive (negative) marginal labor income tax rate if the consumer´s marginal valuation of leisure exceeds (falls short of) the marginal valuation of leisure that arises if the consumer would succumb to the temptation. We use iso-elastic and logarithmic utility functional form specifications to exemplify when the self-selection channel may lead to higher/lower commodity and marginal labor income taxes.
    Keywords: Temptation, self-control, optimal taxation, redistribution, commodity taxation, income taxation
    JEL: D03 H21 H24 H31
    Date: 2020–07
  5. 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.
    Keywords: rational strategies, artificial intelligence, behavioural bias
    JEL: D01 D90 C70 C80
    Date: 2020
  6. By: Choné, Philippe; Wilner, Lionel
    Abstract: To assess strategic interactions in industries where endogenous product characteristics are unobserved to the researcher, we propose an empirical method that brings a competition-in-utility-space framework to the data. We apply the method to the French hospital industry. The utilities offered to patients are inferred from local market shares under AKM exclusion restrictions. The hospitals' objective functions are identified thanks to the gradual introduction of stronger financial incentives over the period of study. Offering more utility to each patient entails incurring higher costs per patient, implying that utilities are mostly strategic complements. Counterfactual simulations show that stronger incentives affect market shares but have little impact on the total number of patient admissions. We quantify the resulting gains for patients and losses for hospitals.
    Keywords: Competition in utility space; Financial incentives; hospital choice; payment reform
    JEL: D22 I11 L13
    Date: 2020–01
  7. By: Guanxing Fu; Xizhi Su; Chao Zhou
    Abstract: We study an $N$-player and a mean field exponential utility game. Each player manages two stocks; one is driven by an individual shock and the other is driven by a common shock. Moreover, each player is concerned not only with her own terminal wealth but also with the relative performance of her competitors. We use the probabilistic approach to study these two games. We show the unique equilibrium of the $N$-player game and the mean field game can be characterized by a novel multi-dimensional FBSDE with quadratic growth and a novel mean-field FBSDEs, respectively. The well-posedness result and the convergence result are established.
    Date: 2020–06
  8. By: Ralph Chami; Thomas F. Cosimano; Celine Rochon; Julieta Yung
    Abstract: Investors seek to hedge against interest rate risk by taking long or short positions on bonds of different maturities. We study changes in risk taking behavior in a low interest rate environment by estimating a market stochastic discount factor that is non-linear and therefore consistent with the empirical properties of cashflow valuations identified in the literature. We provide evidence that non-linearities arise from hedging strategies of investors exposed to interest rate risk. Capital losses are amplified when interest rates increase and risk averse investors have taken positions on instruments with longer maturity, expecting instead interest rates to revert back to their historical average.
    Keywords: Interest rate increases;Discount rates;Risk premium;Financial markets;Financial instruments;Interest rate risk,non-linear stochastic discount factor,investment portfolio,term structure model,risk aversion distribution,low interest rate environment,WP,yield curve,interest-rate,risk aversion,conditional mean,treasury security
    Date: 2020–03–13
  9. By: Hossein Rad; Rand Low; Joelle Miffre (Audencia Business School); Robert Faff
    Abstract: The article develops a long-short portfolio construction technique that captures the fundamentals of backwardation and contango present in commodity futures markets and simultaneously deviates from the equal-weighting scheme traditionally employed in the literature. The sophisticated weighting schemes based on risk minimization and risk timing are found to dominate the traditional naive allocation and the schemes based on utility maximization. The conclusion applies to both momentum and term structure portfolios and persists after accounting for transaction costs, lack of liquidity, various model specifications, and different sub-periods.
    Keywords: optimized weights,risk-timing weights,long-short portfolios,equal weights
    Date: 2020–06–12
  10. By: Atsushi Inoue; Lutz Kilian
    Abstract: Structural VAR models are routinely estimated by Bayesian methods. Several recent studies have voiced concerns about the common use of posterior median (or mean) response functions in applied VAR analysis. In this paper, we show that these response functions can be misleading because in empirically relevant settings there need not exist a posterior draw for the impulse response function that matches the posterior median or mean response function, even as the number of posterior draws approaches infinity. As a result, the use of these summary statistics may distort the shape of the impulse response function which is of foremost interest in applied work. The same concern applies to error bands based on the upper and lower quantiles of the marginal posterior distributions of the impulse responses. In addition, these error bands fail to capture the full uncertainty about the estimates of the structural impulse responses. In response to these concerns, we propose new estimators of impulse response functions under quadratic loss, under absolute loss and under Dirac delta loss that are consistent with Bayesian statistical decision theory, that are optimal in the relevant sense, that respect the dynamics of the impulse response functions and that are easy to implement. We also propose joint credible sets for these estimators derived under the same loss function. Our analysis covers a much wider range of structural VAR models than previous proposals in the literature including models that combine short-run and long-run exclusion restrictions and models that combine zero restrictions, sign restrictions and narrative restrictions.
    Keywords: Loss function; joint inference; median response function; mean response function; modal model
    JEL: C22 C32 C52
    Date: 2020–07–17
  11. By: Elizabeth Baldwin; Omer Edhan; Ravi Jagadeesan; Paul Klemperer; Alexander Teytelboym
    Abstract: We show that, with indivisible goods, the existence of competitive equilibrium fundamentally depends on agents' substitution effects, not their income effects. Our Equilibrium Existence Duality allows us to transport results on the existence of competitive equilibrium from settings with transferable utility to settings with income effects. One consequence is that net substitutability---which is a strictly weaker condition than gross substitutability---is sufficient for the existence of competitive equilibrium. We also extend the ``demand types'' classification of valuations to settings with income effects and give necessary and sufficient conditions for a pattern of substitution effects to guarantee the existence of competitive equilibrium.
    Date: 2020–06
  12. By: Auriol, Emmanuelle; Diego, Delissaint; fourati, maleke; Miquel-Florensa, Josepa; Seabright, Paul
    Abstract: We conducted an experimental study in Haiti testing for the relationship between religious belief and individual risk taking behavior. 774 subjects played lotteries in a standard neutral protocol and subsequently with reduced endowments but in the presence of religious images of Catholic, Protestant and Voodoo tradition. Subjects chose between paying to play a lottery with an image of their choice, and saving their money to play with no image. Those who chose the former are defined as image buyers and those who chose the latter as non-buyers. Image buyers, who tend to be less educated, more rural, and to exhibit greater religiosity, bet more than non-buyers in all games. In addition, in the presence of religious images all participants took more risk, and buyers took more risk when playing in the presence of their chosen images than when playing with other images. We develop a theoretical model calibrated with our experimental data to explore the channels through which religious images might affect risk-taking. Our results suggest that the presence of images tends to increase individuals' subjective probability of winning the lottery, and that subjects therefore believe in a god who intervenes actively in the world in response to their requests.
    Keywords: field experiment; religion; risk preferences
    JEL: C93 D81 Z12
    Date: 2019–12
  13. By: Genius Murwirapachena; Johane Dikgang
    Abstract: Although stated-preference surveys take various forms, the use of either text or visuals to represent attributes is uncontroversial, and they remain the commonly used formats. While prior research has investigated the impact of these commonly used formats in other disciplines, little is known about their effects on results in terms of relative importance in environmental economics literature. We conduct surveys on households’ preferences for water efficient technologies in South Africa, where we compare three presentation formats, namely text, visuals, and both text and visuals. Survey data collected from 894 heads of households in the Gauteng province is analysed using the mixed logit model to test whether these three formats generate differences in estimated utilities and willingness to pay. This research sheds light on how to develop a valid presentation method for attribute levels in choice experiments, which is critical considering most environmental economics goods and services are not traded in the market. Our results show that the visuals format generates more statistically significant coefficients than the other formats. This suggests that the presentation format has significant impacts on choice. The choice between the three elicitation formats may imply a trade-off in choice precision. Our findings suggest that more research on presentation formats in environmental economics is warranted.
    Keywords: choice experiments, format, text, presentation, visuals
    JEL: C25 C35 C93 Q25 Q51
    Date: 2019–10
  14. By: Luis Sarmiento
    Abstract: I posit that hourly changes in air pollution affect criminality through two distinct pathways, via physiological effects on the criminal and by changes in the tightness of the market for criminal activities. To disentangle individual from market effects, I develop a behavioral model of the individual decision to transgress and a model of search-and-matching frictions between criminals and crime opportunities. The study examines the impact on the four largest cities in North America. Causality emerges from instrumental variable panel-models. Results show that pollution increases violent and unpremeditated crimes while decreasing burglaries and sexual offenses through a reduction of crime opportunities.
    Keywords: Local air pollution, criminality, external effects, prospect theory, search and matching frictions, panel models
    JEL: K14 Q53 I18 H23
    Date: 2020
  15. By: Christophe Depoortère (LED - Laboratoire d'Economie Dionysien - UP8 - Université Paris 8 Vincennes-Saint-Denis); André Lapidus (PHARE - Philosophie, Histoire et Analyse des Représentations Économiques - UP1 - Université Panthéon-Sorbonne); Nathalie Sigot (PHARE - Philosophie, Histoire et Analyse des Représentations Economiques - CNRS - Centre National de la Recherche Scientifique - UP1 - Université Panthéon-Sorbonne)
    Abstract: This paper discusses the possibility, often alleged and widely accepted, that Bentham had an influence on the development of Ricardo's economics. Three possible points of contact have been mooted, the first mediated by the key figure of James Mill, the other two being unmediated reactions to their respective works, Bentham's Sur les prix and Ricardo's Essay on Profits. Yet, we argue, none of these claims for influence have firm foundations. Regarding the first proposed rendez vous, we show that (i) if Mill had an influence on Ricardo at the beginning of their friendship (say, around 1808), he was at this time Stewartian and not yet Benthamian; and (ii) if this influence is supposed to have been exerted later, it is clear from Ricardo's own comments that he was not convinced by a basic component of utilitarianism to which Mill made a major contribution-associationism. The second rendezvous manqué turns on Ricardo's reading of Bentham's manuscript Sur les prix: we show that (i) this reading could not have exerted an influence on Ricardo's monetary thought at an early stage-that is, before his first monetary writings-and (ii) that Ricardo expressed such disagreement with it that any influence from it on his views about money is inconceivable. The third rendez-vous was also manqué: commenting on Ricardo's Essay, Bentham accused him of confusing "cost" and "value": we examine this criticism by putting to the fore the different aims of both authors, related to their explanations of, respectively, inflation and the evolution of distribution, and their different conceptions of price.
    Keywords: Bentham,Ricardo,James Mill,utilitarianism,foundations of Ricardian economics
    Date: 2020

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