nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2020‒08‒17
eighteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Duality Theory for Robust Utility Maximization By Daniel Bartl; Michael Kupper; Ariel Neufeld
  2. Reference Dependence in the Housing Market By Andersen, Steffen; Badarinza, Cristian; Liu, Lu; Marx, Julie; Ramadorai, Tarun
  3. Do farmers prefer increasing, decreasing, or stable payments in Agri-Environmental Schemes? By Douadia Bougherara; Margaux Lapierre; Raphaële Préget; Alexandre Sauquet
  4. Transaction Costs in Execution Trading By David Marcos
  5. Optimal Investment, Heterogeneous Consumption and Best Time for Retirement By Zuo Quan Xu; Harry Zheng
  6. Prudence and prevention - Empirical evidence* By Thomas Mayrhofer; Hendrik Schmitz
  7. On dynamic consistency in ambiguous games By Ellis, Andrew
  8. Behavioral Strong Implementation By T Hayashi; R Jain; V Korpela; M Lombardi
  9. Identification of Time Preferences in Dynamic Discrete Choice Models: Exploiting Choice Restrictions By Schneider, Ulrich
  10. Asset Prices and Capital Share Risks: Theory and Evidence By Byrne, Joseph P; Ibrahim, Boulis Maher; Zong, Xiaoyu
  11. Identification of preferences, demand and equilibrium with finite data By Kubler, Felix; Malhotra, Raghav; Polemarchakis, Herakles
  12. Estimating the willingness to pay for urban esthetic projects using an inter-temporal equilibrium: a difference-in-differences hedonic approach By Kono, Tatsuhito; Sega, Kousuke; Seya, Hajime
  13. Nonparametric Euler Equation Identi?cation and Estimation By Escanciano, J C.; Hoderlein, S.; Lewbel, A.; Linton, O.; Srisuma, S.
  14. Building Belief Systems and Medical Ethics: The Covid-19 Controversies By Gérard Mondello
  15. Parallel Inverse Aggregate Demand Curves in Discrete Choice Models By Kory Kroft; René Leal Vizcaíno; Matthew J. Notowidigdo; Ting Wang
  16. Serial Vickrey Mechanism By Yu Zhou; Shigehiro Serizawa
  17. Uncertainty and decision-making during a crisis: How to make policy decisions in the COVID-19 context? By Loïc Berger; Nicolas Berger; Valentina Bosetti; Itzhak Gilboa; Lars Hansen; Christopher Jarvis; Massimo Marinacci; Richard Smith
  18. Deep neural network for optimal retirement consumption in defined contribution pension system By Wen Chen; Nicolas Langrené

  1. By: Daniel Bartl; Michael Kupper; Ariel Neufeld
    Abstract: In this paper we present a duality theory for the robust utility maximization problem in continuous time for utility functions defined on the positive real axis. Our results are inspired by -- and can be seen as the robust analogues of -- the seminal work of Kramkov & Schachermayer [21]. Namely, we show that if the set of attainable trading outcomes and the set of pricing measures satisfy a bipolar relation, then the utility maximization problem is in duality with a conjugate problem. We further discuss the existence of optimal trading strategies. In particular, our general results include the case of logarithmic and power utility, and they apply to drift and volatility uncertainty.
    Date: 2020–07
  2. By: Andersen, Steffen; Badarinza, Cristian; Liu, Lu; Marx, Julie; Ramadorai, Tarun
    Abstract: We model listing decisions in the housing market, and structurally estimate household preference and constraint parameters using comprehensive Danish data. Sellers optimize expected utility from property sales, subject to down-payment constraints, and internalize the effect of their choices on final sale prices and time-on-the-market. The data exhibit variation in the listing price-gains relationship with "demand concavity;" bunching in the sales distribution; and a rising listing propensity with gains. A new fact is that gains and down-payment constraints have interactive effects on listing prices. We find reference-dependence around the nominal purchase price and modest loss-aversion, but our canonical model cannot fully explain the new facts.
    Keywords: down-payment constraints; Housing; loss aversion; Mortgages; reference dependence
    JEL: D03 D12 D14 G02 R21
    Date: 2019–11
  3. By: Douadia Bougherara (CEE-M - Centre d'Economie de l'Environnement - Montpellier - FRE2010 - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique - Montpellier SupAgro - Institut national d’études supérieures agronomiques de Montpellier - Institut Agro - Institut national d'enseignement supérieur pour l'agriculture, l'alimentation et l'environnement - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement); Margaux Lapierre (CEE-M - Centre d'Economie de l'Environnement - Montpellier - FRE2010 - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique - Montpellier SupAgro - Institut national d’études supérieures agronomiques de Montpellier - Institut Agro - Institut national d'enseignement supérieur pour l'agriculture, l'alimentation et l'environnement - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement); Raphaële Préget (CEE-M - Centre d'Economie de l'Environnement - Montpellier - FRE2010 - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique - Montpellier SupAgro - Institut national d’études supérieures agronomiques de Montpellier - Institut Agro - Institut national d'enseignement supérieur pour l'agriculture, l'alimentation et l'environnement - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement); Alexandre Sauquet (CEE-M - Centre d'Economie de l'Environnement - Montpellier - FRE2010 - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique - Montpellier SupAgro - Institut national d’études supérieures agronomiques de Montpellier - Institut Agro - Institut national d'enseignement supérieur pour l'agriculture, l'alimentation et l'environnement - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement)
    Abstract: Nearly all Agri-Environmental Schemes (AES) offer stable annual payments over theduration of the contract. Yet AES are often intended to be a transition tool, designed totrigger changes in farming practices rather than to support them indefinitely. A decreasingsequence of payments thus appears particularly attractive as a reward structure for AES.The standard discounted utility model supports this notion by predicting that individualsshould prefer a decreasing sequence of payments if the total sum of outcomes is con-stant. Nevertheless, the literature shows that numerous mechanisms, such as increasingproductivity, anticipatory pleasure, and loss aversion, can, by contrast, incline individualsto favor an increasing sequence of payments. To understand the preferences of farmersfor different payment sequences, we propose a review of the mechanisms highlighted bythe literature in psychology and economics. We then test farmers' preferences for stable,increasing or decreasing payments through a choice experiment (CE) survey. In this sur-vey, farmers are offered hypothetical contracts rewarding the planting of cover crops. Toreduce hypothetical bias, the choice cards were designed following repeated interactionswith local stakeholders. One hundred twenty-three French farmers, about 15% of thosecontacted, responded to the survey. Overall, farmers do not present a clear willingnessto depart from the usual stable payments. Nevertheless, 17% declare a preference for in-creasing sequences of payment. Moreover, we find a significant rejection of decreasingpayments by farmers with a lower discount rate or farmers more willing to take risks thanthe median farmer, contradicting the discounted utility model
    Keywords: Choice experiment,Cover crops,Farming practices,Sequences of outcomes,Agri-Environmental Schemes,Discounted utility
    Date: 2020–07–07
  4. By: David Marcos
    Abstract: In the present work we develop a formalism to tackle the problem of optimal execution when trading market securities. More precisely, we introduce a utility function that balances market impact and timing risk, with this last being modelled as the very negative transaction costs incurred by our order execution. The framework is built upon existing theory on optimal trading strategies, but incorporates characteristics that enable distinctive execution strategies. The formalism is complemented by an analysis of various impact models and different distributional properties of market returns.
    Date: 2020–07
  5. By: Zuo Quan Xu; Harry Zheng
    Abstract: This paper studies an optimal investment and consumption problem with heterogeneous consumption of basic and luxury goods, together with the choice of time for retirement. The utility for luxury goods is not necessarily a concave function. The optimal heterogeneous consumption strategies for a class of non-homothetic utility maximizer are shown to consume only basic goods when the wealth is small, to consume basic goods and make savings when the wealth is intermediate, and to consume small portion in basic goods and large portion in luxury goods when the wealth is large. The optimal retirement policy is shown to be both universal, in the sense that all individuals should retire at the same level of marginal utility that is determined only by income, labor cost, discount factor as well as market parameters, and not universal, in the sense that all individuals can achieve the same marginal utility with different utility and wealth. It is also shown that individuals prefer to retire as time goes by if the marginal labor cost increases faster than that of income. The main tools used in analysing the problem are from PDE and stochastic control theory including viscosity solution, variational inequality and dual transformation.
    Date: 2020–08
  6. By: Thomas Mayrhofer (Stralsund University of Applied Sciences, Harvard Medical School); Hendrik Schmitz (Paderborn University, RWI Essen, Leibniz Science Campus Ruhr)
    Abstract: Theoretical papers show that optimal prevention decisions in the sense of self-protection (i.e., primary prevention) depend not only on the level of (second-order) risk aversion but also on higher-order risk preferences such as prudence (third-order risk aversion). We study empirically whether these theoretical results hold and whether prudent individuals show less preventive (self-protection) effort than non-prudent individuals. We use a unique dataset that combines data on higher-order risk preferences and various measures of observed real-world prevention behavior. We find that prudent individuals indeed invest less in self-protection as measured by influenza vaccination. This result is driven by high risk individuals such as individuals >60 years of age or chronically ill. We do not find a clear empirical relationship between risk-preferences and prevention in the sense of self-insurance (i.e. secondary prevention). Neither risk aversion nor prudence is related to cancer screenings such as mammograms, Pap smears or X-rays of the lung.
    Keywords: prudence, risk preferences, prevention, vaccination, screening
    JEL: D12 D81 I12
    Date: 2020–08
  7. By: Ellis, Andrew
    Abstract: I consider static, incomplete information games where players may not be ambiguity neutral. Every player is one of a finite set of types, and each knows her own type but not that of the other players. Ex ante, players differ only in their taste for outcomes. If every player is dynamically consistent with respect to her own information structure and respects Consequentialism, then players act as if expected utility for uncertainty about types.
    Keywords: Ambiguity; incomplete information; dynamic consistency; strategic interaction
    JEL: J1
    Date: 2018–09–01
  8. By: T Hayashi (Adam Smith Business School, University of Glasgow); R Jain (Institute of Economics, Academia Sinica, Taipei, Taiwan); V Korpela (Turku School of Economics, University of Turku); M Lombardi (Adam Smith Business School, University of Glasgow)
    Abstract: Choice behavior is rational if it is made in accordance with the maximization of some context-independent preference relation. This study re-examines the classical questions of implementation theory under complete information in a setting in which players' choices need not be rational and in which the game theoretic solution concept invoked is an extension of Aumann's (1959) notion of strong equilibrium beyond the rational domain. The proposed equilibrium notion incorporates a notion of Pareto optimality which refines, sometimes strictly, other extended notions of Pareto optimality proposed in the literature. In contrast to what happens when players' choices are rational, de Clippel's (2014) extension of Maskin monotonicity to non-rational domains is not a necessary condition for implementation in behavioral strong equilibria.
    Keywords: : : Strong equilibrium, implementation, state-contingent choice rules, bounded rationality
    JEL: D11 D60 D83
    Date: 2020–08
  9. By: Schneider, Ulrich
    Abstract: I study the identification of time preferences in dynamic discrete choice models. Time preferences play a crucial role in these models, as they affect inference and counterfactual analysis. Previous literature has shown that observed choice probabilities do not identify the exponential discount factor in general. Recent identification results rely on specific forms of exogenous variation that impact transition probabilities but not instantaneous utilities. Although such variation allows for set identification of the respective parameter, point identification is only achieved in limited cases. To circumvent this shortcoming, I focus on models in which economic decision-makers might be restricted in their choice sets. I show that time preferences can be identified provided that there is variation in the probability of being restricted that does not affect utilities or transition probabilities. The derived exclusion restrictions are easy to interpret and potentially fulfilled in many empirical applications.
    Keywords: discount factor; identification; dynamic discrete choice
    JEL: C14 C23 C61
    Date: 2019–03–11
  10. By: Byrne, Joseph P; Ibrahim, Boulis Maher; Zong, Xiaoyu
    Abstract: An asset pricing model using long-run capital share growth risk has recently been found to successfully explain U.S. stock returns. Our paper adopts a recursive preference utility framework to derive an heterogeneous asset pricing model with capital share risks.While modeling capital share risks, we account for the elevated consumption volatility of high income stockholders. Capital risks have strong volatility effects in our recursive asset pricing model. Empirical evidence is presented in which capital share growth is also a source of risk for stock return volatility. We uncover contrasting unconditional and conditional asset pricing evidence for capital share risks.
    Keywords: Asset Pricing, Capital Share, Recursive Preference, Consumption Growth, Bayesian Methods.
    JEL: C21 C30 E25 G11 G12
    Date: 2020–05–12
  11. By: Kubler, Felix (University of Zurich); Malhotra, Raghav (University of Warwick); Polemarchakis, Herakles (University of Warwick)
    Abstract: We give conditions under which an individual's preferences can be identified with finite data. First, we derive conditions that guarantee that a finite number of observations of an individual's binary choices identify preferences over an arbitrarily large subset of the choice space and allow one to predict how the individual shall decide when faced with choices not previously encountered. Second, we extend the argument to observations of individual demand. Finally, we show that nitely many observations of Walrasian equilibrium prices and pro les of individual endowments suffice to identify individual preferences and, as a consequence, equilibrium comparative statics.
    Keywords: identification ; finite data ; preferences ; choices ; demand ; Walrasian equilibrium JEL codes: D80 ; G10
    Date: 2020
  12. By: Kono, Tatsuhito; Sega, Kousuke; Seya, Hajime
    Abstract: Based on an inter-temporal general equilibrium model, we rigorously derive a measurement method using dynamic changes in cross-sectional hedonic prices to estimate the willingness to pay for urban esthetic projects. The method has advantages in common with a difference-in-differences approach. For example, fewer attributes are used as explanatory variables than with a cross-sectional hedonic approach because fixed effects can be ignored. It can therefore mitigate problems related to omitted variables and multicollinearity, which are prevalent in cross-sectional hedonic approaches. Nevertheless, either the measurement or one additional assumption of marginal utility of income is necessary for provision of correct measures. In addition, we consider the existence of condominiums, which has not been supposed in conventional hedonic approaches but must always be considered in practical situations. We apply the method to utility line undergrounding projects.
    Keywords: project evaluation, amenities, willingness to pay, dynamic hedonic approach, difference in differences
    JEL: C1 R11 R13 R14 R52
    Date: 2020–07–25
  13. By: Escanciano, J C.; Hoderlein, S.; Lewbel, A.; Linton, O.; Srisuma, S.
    Abstract: We consider nonparametric identification and estimation of pricing kernels, or equivalently of marginal utility functions up to scale, in consumption based asset pricing Euler equations. Ours is the first paper to prove nonparametric identification of Euler equations under low level conditions (without imposing functional restrictions or just assuming completeness). We also propose a novel nonparametric estimator based on our identification analysis, which combines standard kernel estimation with the computation of a matrix eigenvector problem. Our estimator avoids the ill-posed inverse issues associated with nonparametric instrumental variables estimators. We derive limiting distributions for our estimator and for relevant associated functionals. A Monte Carlo shows a satisfactory finite sample performance for our estimators.
    Keywords: uler equations, marginal utility, pricing kernel, Fredholm equations, integral equations, nonparametric identification, asset pricing
    JEL: C14 D91 E21 G12
    Date: 2020–07–04
  14. By: Gérard Mondello (Université Côte d'Azur, France; GREDEG CNRS)
    Abstract: The Covid-19 pandemic upset both the economies of most countries, but also the field of medical science. As never, public opinion has interfered in the choice of therapeutic trials as evidenced by the controversies surrounding protocols using hydroxychloroquine. The public's choice for these treatments is explained as the application of a kind of individual "Pascal's wager". This article analyses the formation of the belief system of individuals by applying ambiguity theory's insights and information entropy. It shows that the public's choices are the result of efficient communication strategies chosen by these treatments' promoters.
    Keywords: Uncertainty Theory, Ambiguity, Pharmacy, Medicine
    JEL: I1 I18 I19 D81 L65
    Date: 2020–07
  15. By: Kory Kroft; René Leal Vizcaíno; Matthew J. Notowidigdo; Ting Wang
    Abstract: This paper highlights a previously-unnoticed property of commonly-used discrete choice models, which is that they feature parallel demand curves. Specifically, we show that in random utility models, inverse aggregate demand curves shift in parallel with respect to variety if and only if the random utility shocks follow the Gumbel distribution. Using results from Extreme Value Theory, we provide conditions for other distributions to generate parallel demands asymptotically, as the number of varieties increase. We establish these results in the benchmark case of symmetric products, illustrate them using numerical simulations and show that they hold in extended versions of the model with correlated tastes and asymmetric products. Lastly, we provide a “proof of concept” of parallel demands as an economic tool by showing how to use parallel demands to identify the change in consumer surplus from an exogenous change in product variety.
    JEL: D01 D11 L0
    Date: 2020–06
  16. By: Yu Zhou; Shigehiro Serizawa
    Abstract: We study an assignment market where multiple heterogenous objects are sold to unit demand agents who have general preferences accommodating imperfect transferability of utility and income effects. In such a model, there is a minimum price equilibrium. We establish the structural characterizations of minimum price equilibria and employ these results to design the "Serial Vickrey mechanism," that finds a minimum price equilibrium in a finite number of steps. The Serial Vickrey mechanism introduces the objects one by one, and requires agents to report finite-dimensional prices in finitely many times. Besides, the Serial Vickrey mechanism also has nice dynamic incentive properties.
    Date: 2020–07
  17. By: Loïc Berger (LEM - Lille économie management - LEM - UMR 9221 - UCL - Université catholique de Lille - Université de Lille - CNRS - Centre National de la Recherche Scientifique, CNRS - Centre National de la Recherche Scientifique, IÉSEG School Of Management [Puteaux]); Nicolas Berger (LSHTM - London School of Hygiene and Tropical Medicine); Valentina Bosetti (Bocconi University [Milan, Italy]); Itzhak Gilboa (HEC Paris - Ecole des Hautes Etudes Commerciales, Eitan Berglas School of Economics - Tel Aviv University [Tel Aviv]); Lars Hansen (Booth School of Business [Chicago] - University of Chicago, University of Chicago, Department of Statistics - University of Chicago, University of Chicago); Christopher Jarvis (LSHTM - London School of Hygiene and Tropical Medicine); Massimo Marinacci (Bocconi University [Milan, Italy]); Richard Smith (University of Exeter Medical School - University of Exeter, LSHTM - London School of Hygiene and Tropical Medicine)
    Abstract: Policymaking during a pandemic can be extremely challenging. As COVID-19 is a new disease and its global impacts are unprecedented, decisions need to be made in a highly uncertain, complex and rapidly changing environment. In such a context, in which human lives and the economy are at stake, we argue that using ideas and constructs from modern decision theory, even informally, will make policymaking more a responsible and transparent process.
    Keywords: model uncertainty,ambiguity,robustness,decision rules
    Date: 2020–07–27
  18. By: Wen Chen (CSIRO - Commonwealth Scientific and Industrial Research Organisation [Canberra]); Nicolas Langrené (CSIRO - Commonwealth Scientific and Industrial Research Organisation [Canberra])
    Abstract: In this paper, we develop a deep neural network approach to solve a lifetime expected mortality-weighted utility-based model for optimal consumption in the decumulation phase of a defined contribution pension system. We formulate this problem as a multi-period finite-horizon stochastic control problem and train a deep neural network policy representing consumption decisions. The optimal consumption policy is determined by personal information about the retiree such as age, wealth, risk aversion and bequest motive, as well as a series of economic and financial variables including inflation rates and asset returns jointly simulated from a proposed seven-factor economic scenario generator calibrated from market data. We use the Australian pension system as an example, with consideration of the government-funded means-tested Age Pension and other practical aspects such as fund management fees. The key findings from our numerical tests are as follows. First, our deep neural network optimal consumption policy, which adapts to changes in market conditions, outperforms deterministic drawdown rules proposed in the literature. Moreover, the out-of-sample outperformance ratios increase as the number of training iterations increases, eventually reaching outperformance on all testing scenarios after less than 10 minutes of training. Second, a sensitivity analysis is performed to reveal how risk aversion and bequest motives change the consumption over a retiree's lifetime under this utility framework. Our results show that stronger risk aversion generates a flatter consumption pattern; however, there is not much difference in consumption with or without bequest until age 103. Third, we provide the optimal consumption rate with different starting wealth balances. We observe that optimal consumption rates are not proportional to initial wealth due to the Age Pension payment. Forth, with the same initial wealth balance and utility parameter settings, the optimal consumption level is different between males and females due to gender differences in mortality. Specifically, the optimal consumption level is slightly lower for females until age 84.
    Abstract: Dans cet article, nous développons une approche par réseau de neurones profond pour résoudre un problème de consommation optimale au cours de la phase de décumulation dans un système de retraite à cotisations définies. Le problème est basé sur un modèle d'espérance d'utilité cumulée au cours de la retraite, pondéré par les probabilités de survie à chaque âge. Nous le formulons comme un problème de commande stochastique multi-période à horizon de temps fini, et nous entraînons un réseau de neurones profond représentant les décisions de consommation. La conduite à suivre optimale en matière de consommation est déterminée par des données personnelles du retraité, telles que son âge, son épargne retraite, son aversion pour le risque et son désir de legs, ainsi que par un ensemble de variables économiques et financières comprenant le taux d'inflation et des rendements d'actifs financiers simulés conjointement par un générateur de scénarios économiques développé pour l'occasion, comprenant sept facteurs et calibré sur des données de marché. Nous prenons comme exemple le système de retraite australien, avec prise en compte de la pension de retraite versée par l'État sous condition de ressources, ainsi que d'autres aspects pratiques tels que les frais de gestion du plan d'épargne retraite privé obligatoire. Nos résultats principaux sont les suivants. Premièrement, les règles de décision de consommation déterminées par le réseau de neurones profond, qui prend en compte et s'adapte aux changements aléatoires des conditions du marché, fait mieux que les règles de dépense déterministes classiques proposées dans la littérature. De plus, le ratio de surperformance sur la base de test croît en fonction du nombre d'itérations de l'algorithme d'apprentissage, pour atteindre 100% après moins de 10 minutes d'apprentissage. Deuxièmement, nous avons réalisé une analyse de sensibilité pour révéler comment l'aversion pour le risque et le désir de legs affectent les décisions de consommation au cours de la retraite dans le cadre de ce modèle d'espérance d'utilité cumulée. Troisièmement, nous avons déterminé le taux de consommation optimal en fonction de l'épargne retraite disponible au moment du départ à la retraite. Nous observons que les taux de consommation optimaux ne sont pas proportionnels à l'épargne retraite initiale du fait de la pension de retraite versée par l'État. Quatrièmement, un homme retraité et une femme retraitée avec la même épargne retraite initiale, la même aversion pour le risque et le même désir de legs n'auront néanmoins pas le même taux de consommation optimal, du fait de l'écart de longévité existant entre hommes et femmes.
    Keywords: decumulation,retirement income,deep learning,stochastic control,economic scenario generator,defined-contribution pension,optimal consumption
    Date: 2020–07–31

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