nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2020‒10‒19
twelve papers chosen by

  1. Robust Utility Maximization in a Multivariate Financial Market with Stochastic Drift By J\"orn Sass; Dorothee Westphal
  2. Information order in monotone decision problems under uncertainty By Li, Jian; Zhou, Junjie
  3. Necessity of Hyperbolic Absolute Risk Aversion for the Concavity of Consumption Functions By Alexis Akira Toda
  4. On the Continuity of the Feasible Set Mapping in Optimal Transport By Mario Ghossoub; David Saunders
  5. Reference-dependent preferences, time inconsistency, and unfunded pensions By Andersen, Torben M.; Bhattacharya, Joydeep; Liu, Qing
  6. Framing and loss aversion in tax reporting behavior: Evidence from German income tax return data By Diller, Markus; Kühne, Daniela
  7. On the Revealed Preference Analysis of Stable Aggregate Matchings By Thomas Demuynck; Umutcan Salman
  8. Welfare as Equity Equivalents * By Loïc Berger; Johannes Emmerling
  9. Ethical Voting in Heterogenous Groups By Alberto Grillo
  10. Anticipation of Deteriorating Health and Information Avoidance By Johannes Schünemann; Holger Strulik; Timo Trimborn
  11. The Gender Gap in Aversion to COVID-19 Exposure: Evidence from Professional Tennis By Kowalik, Zuzanna; Lewandowski, Piotr
  12. Why Does the Fed Move Markets so Much? A Model of Monetary Policy and Time-Varying Risk Aversion By Carolin Pflueger; Gianluca Rinaldi

  1. By: J\"orn Sass; Dorothee Westphal
    Abstract: We study a utility maximization problem in a financial market with a stochastic drift process, combining a worst-case approach with filtering techniques. Drift processes are difficult to estimate from asset prices, and at the same time optimal strategies in portfolio optimization problems depend crucially on the drift. We approach this problem by setting up a worst-case optimization problem with a time-dependent uncertainty set for the drift. Investors assume that the worst possible drift process with values in the uncertainty set will occur. This leads to local optimization problems, and the resulting optimal strategy needs to be updated continuously in time. We prove a minimax theorem for the local optimization problems and derive the optimal strategy. Further, we show how an ellipsoidal uncertainty set can be defined based on filtering techniques and demonstrate that investors need to choose a robust strategy to be able to profit from additional information.
    Date: 2020–09
  2. By: Li, Jian; Zhou, Junjie
    Abstract: This paper examines the robustness of Lehmann’s ranking of experiments (Lehmann, 1988) for decisionmakers who are uncertainty-averse à la Cerreia- Vioglio et al. (2011). We show that, assuming commitment, for all uncertaintyaverse indices satisfying some mild assumptions, Lehmann’s informativeness ranking is equivalent to the induced uncertainty-averse value ranking of experiments for all agents with single-crossing vNM utility indices (Theorem 1). Moreover, Lehmann ranking can also be detected by varying the uncertainty-averse indices for a fixed finite collection of vNM utility indices (Theorem 2). Our findings suggest that Lehmann’s ranking can be a useful enrichment of Blackwell’s ranking for monotone decision problems even if ambiguity is present. We apply our results to social aggregation of information preferences and investment decision problems.
    Date: 2019–07–02
  3. By: Alexis Akira Toda
    Abstract: Carroll and Kimball (1996) have shown that, in the class of utility functions that are strictly increasing, strictly concave, and have nonnegative third derivatives, hyperbolic absolute risk aversion (HARA) is sufficient for the concavity of consumption functions in general consumption-saving problems. This paper shows that HARA is necessary, implying the concavity of consumption is not a robust prediction outside the HARA class.
    Date: 2020–09
  4. By: Mario Ghossoub; David Saunders
    Abstract: Consider the set of probability measures with given marginal distributions on the product of two complete, separable metric spaces, seen as a correspondence when the marginal distributions vary. In problems of optimal transport, continuity of this correspondence from marginal to joint distributions is often desired, in light of Berge's Maximum Theorem, to establish continuity of the value function in the marginal distributions, as well as stability of the set of optimal transport plans. Bergin (1999) established the continuity of this correspondence, and in this note, we present a novel and considerably shorter proof of this important result. We then examine an application to an assignment game (transferable utility matching problem) with unknown type distributions.
    Date: 2020–09
  5. By: Andersen, Torben M.; Bhattacharya, Joydeep; Liu, Qing
    Abstract: In the real world, public pay-as-you-go pension (PAYG) schemes are popular and co-exist with private, retirement-saving schemes. This is true even in dynamically efficient economies where such pensions offer a lower return. The classic Aaron- Samuelson 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 time-inconsistency. 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 Aaron- Samuelson discussion to the reference-dependent utility setup of KË oszegi and Rabin (2009) where undersaving happens naturally. No borrowing constraint is imposed. In this case, it is possible to offer a non-paternalistic, welfare rationale for return dominated, PAYG pensions to coexist with private retirement saving.
    Date: 2020–04–17
  6. By: Diller, Markus; Kühne, Daniela
    Abstract: This paper investigates the presence of framing effects and loss aversion in tax reporting behavior of wage earners using a balanced panel of German income tax return data. Reference dependence and loss aversion suggest that individuals in a perceived loss situation attribute higher value to a given amount of positive change in outcome than individuals in a perceived gain situation do. Applied to tax reporting behavior, taxpayers who perceive their tax situation as unfavorable compared to a given reference point are expected to make greater effort or accept higher costs to prevent or reduce that perceived loss than taxpayers perceiving themselves to be in a favorable situation. Greater effort can in turn be associated with higher reporting aggressiveness. We identify a potential reference point in taxpayers' previous year's outcome and examine whether taxpayers claim higher additional tax deductions in a loss situation than in a gain situation. We use a difference-in-difference approach with a one-on-one matching strategy to analyze reporting behavior. We find that taxpayers in a loss situation claim higher income-related deductions than taxpayers in a gain situation.
    Keywords: loss aversion,framing,tax avoidance,nonbusiness tax
    JEL: D91 H24 H26
    Date: 2020
  7. By: Thomas Demuynck; Umutcan Salman
    Abstract: We extend the analysis of (Echenique, Lee, Shum, and Yenmez, 2013) by looking at the testable revealed preference restrictions for stable aggregate matchings with non-transferable utility. We rephrase their revealed preference test in terms of a bipartite graph. From this, we obtain an simple condition that verifies whether a given matching is rationalisable. Next, for a matching that is not rationalisable, we show how to find the minimal number of matches that needs to be removed in order to restore rationalisability. This produces a goodness-of-fit measure that indicates how close a matching is to being rationalisable. We also show that the related problem of finding the minimal number of types that we need to remove in order to obtain rationalisability is NP-hard. We provide two illustrations to demonstrate the usefulness of our results.
    Keywords: Revealed preference theory; com- putational complexity; stability; two-sided matching markets
    JEL: C78 D11
    Date: 2020–09
  8. By: Loïc Berger (CNRS - Centre National de la Recherche Scientifique, IÉSEG School Of Management [Puteaux], LEM - Lille économie management - LEM - UMR 9221 - Université de Lille - UCL - Université catholique de Lille - CNRS - Centre National de la Recherche Scientifique); Johannes Emmerling (EIEE - European Institute on Economics and the Environment)
    Abstract: Equity (or, its counterpart, inequity) plays a fundamental role in the evaluation of social welfare in different dimensions. In this paper, we revisit the concept of inequity-in the sense of unequal distributions-across individuals, time, and states of the world using a unified framework that generalizes the standard expected discounted utilitarianism approach. We propose a general measure of welfare as equity equivalents and a corresponding inequity index. We show that allowing for different attitudes toward inequity across different dimensions covers a scope of possible inequity preferences with different interpretations. We then prove that the order of aggregation across the different dimensions matters for welfare evaluations. Finally, we show that many of the welfare-theoretical approaches recently developed in the literature can be interpreted as special cases of this general framework.
    Keywords: Utilitarianism,Inequality,Inequity Aversion,Risk aversion,Intertemporal Welfare
    Date: 2020–09–01
  9. By: Alberto Grillo (Aix Marseille Univ, CNRS, AMSE, Marseille, France)
    Abstract: Voting in large elections appears to be both ethically motivated and influenced by strategic considerations. One way to capture this interplay postulates a rule-utilitarian calculus, which abstracts away from heterogeneity in the intensity of support (Feddersen and Sandroni 2006, Coate and Conlin 2004). I argue that this approach is unsatisfactory when such heterogeneity is considered, since it implies that idiosyncratic preferences are irrelevant for participation, in contrast to the empirical evidence. A model of Kantian optimizationà la Roemer (2019), based on the maximization of individual utility under a universalization principle, predicts instead differential participation and links ethical motivation to the spatial theory of voting.
    Keywords: voting, turnout, ethical voter, rule-utilitarian, kantian optimization
    JEL: D72
    Date: 2020–10
  10. By: Johannes Schünemann (University of Fribourg, Department of Economics); Holger Strulik (University of Goettingen, Department of Economics); Timo Trimborn (Department of Economics and Business Economics, Aarhus University)
    Abstract: We integrate anticipatory utility and endogenous beliefs about future negative health shocks into a life-cycle model of physiological aging. Individuals care about their future utility derived from their health status and form endogenous beliefs about the probability of a negative health shock. We calibrate the model with data from gerontology and use the model to predict medical testing decisions of individuals. We find that anticipation in combination with endogenous beliefs provides a quantitatively strong motive to avoid medical testing for Huntington's disease which explains the low testing rates found empirically. We also study the case of breast and ovarian cancer and provide an explanation for why testing rates depend on the individual's income when treatment is available.
    Keywords: Health, Anticipation, Longevity, Health behavior, Beliefs, Information avoidance
    JEL: D11 D91 I12 J17
    Date: 2020–09–30
  11. By: Kowalik, Zuzanna (Institute for Structural Research (IBS)); Lewandowski, Piotr (Institute for Structural Research (IBS))
    Abstract: We study the gender differences in aversion to COVID-19 exposure. We use a natural experiment of the 2020 US Open, which was organized in the country with the highest number of COVID-19 cases and deaths, and was the first major professional tennis tournament that was held after the season had been paused for six months. We analyze the gender gap in the propensity to voluntarily withdraw because of COVID-19 concerns among players who were eligible and fit to play. We find that female players were significantly more likely than male players to have withdrawn from the 2020 US Open. While players from countries characterized by relatively high levels of trust and patience and relatively low levels of risk-taking were more likely to have withdrawn than their counterparts from other countries, female players exhibited significantly higher levels of aversion to pandemic exposure than male players even after cross-country differences in preferences are accounted for. About 15% of the probability of withdrawing that is explained by our model can be attributed to gender.
    Keywords: COVID-19, exposure to disease, gender, aversion, tennis
    JEL: J16 I12 J44
    Date: 2020–10
  12. By: Carolin Pflueger; Gianluca Rinaldi
    Abstract: We build a new model integrating a work-horse New Keynesian model with investor risk aversion that moves with the business cycle. We show that the same habit preferences that explain the equity volatility puzzle in quarterly data also naturally explain the large high-frequency stock response to Federal Funds rate surprises. In the model, a surprise increase in the short-term interest rate lowers output and consumption relative to habit, thereby raising risk aversion and amplifying the fall in stocks. The model explains the positive correlation between changes in breakeven inflation and stock returns around monetary policy announcements with long-term inflation news.
    JEL: E43 E44 E52 G12
    Date: 2020–09

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