nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2020‒12‒14
fourteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Inference on Consensus Ranking of Distributions By David M. Kaplan
  2. A Note on the Use of Amenities to Attract Creative Class Members to a City By Batabyal, Amitrajeet; Yoo, Seung Jick
  3. Export investment under uncertainty: a mean-variance decision analysis for Indian manufacturing exporters By Subhadip Mukherjee; Soumyatanu Mukherjee; Tapas Mishra; Udo Broll
  4. On the benefits of index insurance in US agriculture: a large-scale analysis using satellite data By Matthieu Stigler; David Lobell
  5. Herd Behavior of Investments: An Assessment of Indian Stock Market By , AISDL
  6. The adaptive value of probability distortion and risk-seeking in macaques' decision-making By Aurélien Nioche; Nicolas P. Rougier; Marc Deffains; Sacha Bourgeois-Gironde; Sébastien Ballesta; Thomas Boraud
  7. Personal norms — and not only social norms — shape economic behavior By Bašic, Zvonimir; Eugenio Verrina
  8. Export under background risk: A mean-variance decision analysis for Indian manufacturing firms By Subhadip Mukherjee; Soumyatanu Mukherjee; Tapas Mishra
  10. Would Ambiguity Averse Investors Hedge Risk in Equity Markets? By Gertsman, Gleb; Frehen, Rik; Werker, Bas
  11. The Optimal Extraction of Non-Renewable Resources under Hyperbolic Discounting By Anna M. Dugan; Timo Trimborn
  12. Optimal Lockdown and Social Welfare By Pierre Pestieau; Grégory Ponthiere
  13. Litigation and Settlement under Loss Aversion By Argenton, Cedric; Wang, Xiaoyu
  14. Simultaneous Borrowing and Saving in Microfinance By Dyotona Dasgupta; Prabal Roy Chowdhury

  1. By: David M. Kaplan (Department of Economics, University of Missouri)
    Abstract: Instead of testing for unanimous agreement, I propose learning how broad of a consensus favors one distribution over another (of income, productivity, asset returns, test scores, etc.). Specifically, I propose statistical inference methods to learn about the set of utility functions for which one distribution has higher expected utility than another. With high probability, an "inner" confidence set is contained within this true set, while an "outer" confidence set contains the true set. Such confidence sets can be formed by inverting a proposed multiple testing procedure that controls the familywise error rate. Theoretical justification comes from empirical process results, given that very large classes of utility functions are generally Donsker (subject to finite moments). The theory additionally justifies a uniform (over utility functions) confidence band of expected utility differences, as well as tests with a utility-based "restricted stochastic dominance" as either the null or alternative hypothesis. Simulated and empirical examples illustrate the methodology.
    Keywords: confidence set, Donsker, expected utility, familywise error rate, multiple testing, stochastic dominance
    JEL: C29
    Date: 2020–02–20
  2. By: Batabyal, Amitrajeet; Yoo, Seung Jick
    Abstract: We study the decision problem faced by a city authority (CA) who seeks to attract members of the creative class to his city by providing amenities. Creative class members care about their own incomes and about the amenities that the city provides. We construct a stylized model of this interaction and shed light on three questions. First, we determine how much additional income must be paid to a representative creative class member to maintain her utility if amenities are withdrawn. Second, we compute the cost of generating amenity benefits that equal a specific fraction of the representative creative class member’s income. Finally, we discuss whether the provision of amenity benefits is a cost-effective way of raising the representative creative class member’s utility.
    Keywords: Amenity Benefits, City Authority, Cost-Effectiveness, Creative Class, Income
    JEL: R11 R50
    Date: 2020–08–12
  3. By: Subhadip Mukherjee; Soumyatanu Mukherjee; Tapas Mishra; Udo Broll
    Abstract: This paper explores how much a domestic firm should optimally invest for facilitating export to the international market under uncertainty in nominal/spot exchange rate. We consider the presence of exogenous uncontrollable factors, influencing the fixed costs of exports and enhancing the uncertainty surrounding the exporting prospects. We categorise such additional randomness as a “background risk”, affecting the choice variable (i.e. investment) independent of the endogenous exchange rate risk. In this context, we apply a mean-variance decision-theoretic modelling approach to analyse a risk-averse firm’s optimal investment response to the changes in the distributions of the random spot exchange rate and of the background uncertainty, in terms of the relative trade-off between risk and return. Next, using an unbalanced panel data of 840 exporting Indian manufacturing firms over 17 years, we perform a structural estimation of the theoretical model, derived using a flexible utility function that incorporates all possible risk preferences, in order to demonstrate the key results in our model empirically. For this purpose, using fixed effects model and Heckman’s two-step estimation procedure, we empirically estimate firm-level mark-up(s), as proxy for firms’ risk-premium. This helps us to come up with the estimation of risk aversion elasticities in our context.
    Keywords: Exchange rate risk; Background risk; Mark-up estimation; Risk aversion elasticities.
    Date: 2019
  4. By: Matthieu Stigler; David Lobell
    Abstract: Index insurance has been promoted as a promising solution for reducing agricultural risk compared to traditional farm-based insurance. By linking payouts to a regional factor instead of individual loss, index insurance reduces monitoring costs, and alleviates the problems of moral hazard and adverse selection. Despite its theoretical appeal, demand for index insurance has remained low in many developing countries, triggering a debate on the causes of the low uptake. Surprisingly, there has been little discussion in this debate about the experience in the United States. The US is an unique case as both farm-based and index-based products have been available for more than two decades. Furthermore, the number of insurance zones is very large, allowing interesting comparisons over space. As in developing countries, the adoption of index insurance is rather low -- less than than 5\% of insured acreage. Does this mean that we should give up on index insurance? In this paper, we investigate the low take-up of index insurance in the US leveraging a field-level dataset for corn and soybean obtained from satellite predictions. While previous studies were based either on county aggregates or on relatively small farm-level dataset, our satellite-derived data gives us a very large number of fields (close to 1.8 million) comprised within a large number of index zones (600) observed over 20 years. To evaluate the suitability of index insurance, we run a large-scale simulation comparing the benefits of both insurance schemes using a new measure of farm-equivalent risk coverage of index insurance. We make two main contributions. First, we show that in our simulations, demand for index insurance is unexpectedly high, at about 30\% to 40\% of total demand. This result is robust to relaxing several assumptions of the model and to using prospect theory instead of expected utility.
    Date: 2020–11
  5. By: , AISDL
    Abstract: Behavioral finance theorists contradict market efficiency and propose that investment decision making is not always rational. Investors base their decisions on factors in addition to stock fundamentals and such factors include cognitive biases such as loss aversion, herd behavior, regret aversion, price anchoring and the like. This paper makes an attempt to analyze the influence of two major factors – herd behavior and market factors on investment decision making and in turn it's mediating effect on perception of investment performance. Structured questionnaire was used for collecting the sample for study and structural equation modeling was performed. The study presents evidence to ascertain significant influence of both the factors – herd behavior and market – on investment decision making. The mediating effect of investment decision making on perception of investment performance was also observed to be strong and significant.
    Date: 2019–07–09
  6. By: Aurélien Nioche (Department of Communications and Networking [Aalto] - Aalto University); Nicolas P. Rougier (Mnemosyne - Mnemonic Synergy - LaBRI - Laboratoire Bordelais de Recherche en Informatique - CNRS - Centre National de la Recherche Scientifique - École Nationale Supérieure d'Électronique, Informatique et Radiocommunications de Bordeaux (ENSEIRB) - Université Sciences et Technologies - Bordeaux 1 - Université Bordeaux Segalen - Bordeaux 2 - Inria Bordeaux - Sud-Ouest - Inria - Institut National de Recherche en Informatique et en Automatique - IMN - Institut des Maladies Neurodégénératives [Bordeaux] - UB - Université de Bordeaux - CNRS - Centre National de la Recherche Scientifique); Marc Deffains (IMN - Institut des Maladies Neurodégénératives [Bordeaux] - UB - Université de Bordeaux - CNRS - Centre National de la Recherche Scientifique); Sacha Bourgeois-Gironde (LEMMA - Laboratoire d'économie mathématique et de microéconomie appliquée - UP2 - Université Panthéon-Assas - Sorbonne Université, IJN - Institut Jean-Nicod - DEC - Département d'Etudes Cognitives - ENS Paris - ENS Paris - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - Département de Philosophie - ENS Paris - ENS Paris - École normale supérieure - Paris - PSL - Université Paris sciences et lettres); Sébastien Ballesta (UNISTRA - Université de Strasbourg); Thomas Boraud (IMN - Institut des Maladies Neurodégénératives [Bordeaux] - UB - Université de Bordeaux - CNRS - Centre National de la Recherche Scientifique)
    Abstract: In humans, the attitude toward risk is not neutral and is dissimilar between bets involving gains and bets involving losses. The existence and prevalence of these decision features in non-human primates are unclear. In addition, only a few studies have tried to simulate the evolution of agents based on their attitude toward risk. Therefore, we still ignore to which extent Prospect theory's claims are evolutionary rooted. To shed light on this issue, we collected data in 9 macaques that performed bets involving gains or losses. We confirmed that their overall behaviour is coherent with Prospect theory's claims. In parallel, we used a genetic algorithm to simulate the evolution of a population of agents across several generations. We showed that the algorithm selects progressively agents that exhibit risk-seeking and an inverted S-shape distorted perception of probability. We compared these two results and found that monkeys' attitude toward risk when facing losses only is congruent with the simulation. This result is consistent with the idea that gambling in the loss domain is analogous to deciding in a context of life-threatening challenges where a certain level of risk-seeking behaviours and probability distortions may be adaptive.
    Keywords: Genetic algorithm,Cognitive biases,Monkey,Autonomous Cognitive Testing,Experimental economics
    Date: 2021–01–21
  7. By: Bašic, Zvonimir (Max Planck Institute for Research on Collective Goods, Bonn); Eugenio Verrina (Max Planck Institute for Research on Collective Goods, Bonn)
    Abstract: While social norms have received great attention within economics, little is known about the role of personal norms. We propose a simple utility framework — which assumes that people care about monetary payoff, social norms and personal norms — and design a novel two-part experiment to investigate the predictive value of personal norms across four economic games. We show that personal norms — together with social norms and monetary payoff — are highly predictive of individuals’ behavior. Moreover, they are: i) inherently distinct from social norms across a series of economic contexts, ii) robust to an exogenous increase in social image concerns, which increases the predictive value of social norms but does not weaken that of personal norms, and iii) complementary to social norms in predicting behavior, as a model with both personal and social norms outperforms a model with only one of the two norms. Taken together, our results support personal norms as a key driver of economic behavior, relevant in a wide array of economic settings.
    Keywords: Personal norms, social norms, social image, reputation, elicitation method, normative conflict
    JEL: C91 D01 D63 D64 D91
    Date: 2020–10
  8. By: Subhadip Mukherjee; Soumyatanu Mukherjee; Tapas Mishra
    Abstract: How would accessing foreign markets affect risk exposure of manufacturing firms? Producing for and selling specific goods to foreign markets (exports) require specialized attention. For example, manufacturing firms are exposed to idiosyncratic shocks in their global supply chains, such as exchange rate volatility, asset market frictions, transaction risks, credit tightening, and so on. Given this background, we probed production and exporting decision for a manufacturing firm (that serves both domestic and foreign markets) in the context of firm-specific and industry-specific shocks on trade, with a view of searching for optimality. These shocks are aggregated to form a type of risk that literature labels as ‘non-hedgeable’ background risk. We also propose that background risk is dependent on direct (endogenous) risk pertaining to fluctuations in the spot/nominal exchange rates. To test for potential optimal conditions, we employ a mean-variance decision-theoretic modelling approach. This approach was selected in order to trace out the comparative static responses of optimal export sales following the changes in the distribution of background risk or due to the dependence structure between the two sources of risks (i.e., background risk and exchange rate risk). Our contribution includes isolating all comparative static effects of these changes in the context of optimal production and exporting decisions. In particular, we consider the relative trade-offs between risks and returns, and offer intuitive economic theory-based interpretations of our results. In order to demonstrate robustness of the key results in our model empirically, we utilised an unbalanced panel data of 1,273 exporting Indian manufacturing firms over the time period of 1996-2017 to perform a structural estimation of our theoretical model. This model is derived using a flexible utility function that incorporates all possible options of risk preferences. Through this approach, we are able to estimate risk aversion elasticities specific to our context.
    Keywords: ICT; firm growth; cloud computing
    Date: 2020
  9. By: Jean-Charles Pillet (HEC Lausanne - Faculté des Hautes Etudes Commerciales (HEC Lausanne)); Kevin Carillo (TBS - Toulouse Business School); Claudio Vitari (AMU - Aix Marseille Université); Federico Pigni (GEM - Grenoble Ecole de Management)
    Abstract: The digital era is characterized by the widespread diffusion of information technologies (IT) offering great degrees of malleability in how their features may be interpreted and used. While there are immediate advantages to leveraging the malleability of IT, this could also prove a source of confusion for lay users who are faced with multiple interpretations of what IT can do. Despite growing evidence of this phenomenon, current research lacks the concepts and tools to adequately capture its impact on IT acceptance, adoption, and use. In this paper, we first deploy the "perceived functional ambiguity" (PFA) construct, describing its dimensionality and relationships with measures. Then, we develop and validate the corresponding multidimensional measurement instrument. Finally, we test the effect of the construct across three studies assessing how users perceive social media (N=419), smartphones (N=411) and smart speakers (N=346). Our results suggest that ambiguity has a double-edged sword effect on users' perception of IT: greater levels of ambiguity are associated with greater utilitarian and hedonic value, but they also entail substantial learning costs. This research contributes to advancing our theoretical understanding of IT use by introducing ambiguity as a factor underpinning contemporary IT use.
    Keywords: ambiguity,user perception,technology acceptance,multidimensional constructs,scale development
    Date: 2020–06–15
  10. By: Gertsman, Gleb (Tilburg University, School of Economics and Management); Frehen, Rik (Tilburg University, School of Economics and Management); Werker, Bas (Tilburg University, School of Economics and Management)
    Date: 2019
  11. By: Anna M. Dugan (University of Graz, Wegener Center for Climate and Global Change and FWF Doctoral Program Climate Change); Timo Trimborn (Department of Economics and Business Economics, Aarhus University)
    Abstract: In this paper, we investigate the effects of a declining social discount rate (SDR) on the optimal extraction of non-renewable resources and economic growth. For this purpose, we introduce time-consistent hyperbolic utility discounting into models of resource extraction. First, we investigate a small model of pure resource extraction holding constant the magnitude of discounting for hyperbolic and exponential discounting. We show that resource use is more conservative under hyperbolic discounting resulting in a permanently higher resource stock. Second, we introduce hyperbolic discounting into the seminal Dasgupta-Heal-Solow-Stiglitz (DHSS) model and derive analytically that positive long-run consumption growth requires a lower rate of technological progress under hyperbolic discounting. We show numerically that resource use is more conservative under hyperbolic discounting in the medium- and long-run.
    Keywords: Hyperbolic discounting, social discount rate, non-renewable resource extraction, Dasgupta-Heal-Solow-Stiglitz model
    JEL: Q30 C60 H30
    Date: 2020–12–01
  12. By: Pierre Pestieau; Grégory Ponthiere
    Abstract: This paper reexamines the design of the optimal lockdown strategy by paying attention to its robustness to the postulated social welfare criterion. We first characterize optimal lockdown under utilitarianism, and we show that this social criterion can, under some conditions, imply a COVID-19 variant of Parfit’s (1984) Repugnant Conclusion: for any non-maximal lockdown saving lives at the cost of reducing average utility at a given period, there exists always a stricter lockdown, which further reduces average utility, but leads to a larger aggregate welfare. The optimal lock-down under utilitarianism is also shown to deteriorate the situation of the worst-off, against Hammond Equity. In order to do justice to Hammond Equity, we characterize optimal lockdown under the ex post egalitarian criterion, which gives absolute priority to the worst-o¤ ex post. Under general conditions, the ex post egalitarian optimum involves a zero lockdown. Varying between zero and its maximal level, the optimal lockdown policy is not robust to the postulated ethical criterion.
    Keywords: Covid-19, lockdown, optimal policy, social welfare
    JEL: I18 I31 J18
    Date: 2020
  13. By: Argenton, Cedric (Tilburg University, School of Economics and Management); Wang, Xiaoyu (Tilburg University, School of Economics and Management)
    Date: 2020
  14. By: Dyotona Dasgupta (Center for Development Economics, Delhi School of Economics); Prabal Roy Chowdhury (Indian Statistical Institute, Delhi)
    Abstract: This paper studies dynamic incentives provided by the microfinance institutions (MFIs) to ensure repayment. MFIs provide collateral-free loans, and yet observe near perfect repayment rate. In this paper, we provide an explanation of two widely practised mechanisms by MFIs – progressive lending i.e. increasing loan size over time and deposit collection. In our model, the MFI provides both credit and savings services. These help a strategic, poor borrower to accumulate a lumpsum amount and “graduate†to an improved lifetime utility which is not achievable when only credit is provided. These savings also act as an incentive device for repayment. We find that the optimal loan scheme is weakly progressive. It is “progressive with a cap†when the increase in utility from graduation is “modestly positive†. Further, we show that, since the MFI is benevolent, an improvement in the borrower’s outside option lengthens the time required to graduate which in turn reduces her welfare.
    Keywords: dynamic incentives, progressive lending, deposit collection, collateral substitute, graduation
    JEL: O12 O16 D86 G21
    Date: 2020–11

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