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on Utility Models and Prospect Theory |
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Issue of 2021‒01‒04
fifteen papers chosen by |
| By: | Mateane, Lebogang |
| Abstract: | I use a transition probability matrix associated with different global market conditions and I assume that it captures switches in central bank preferences between approximated constant relative risk aversion (CRRA) expected utility and approximated increasing relative risk aversion (IRRA) expected utility. I approximate CRRA and IRRA expected utility, to construct and propose constrained portfolio selection frameworks with skewness, for the currency composition of FX reserves over different global market conditions that influence central bank preferences. These portfolio selection frameworks account for portfolio rebalancing, they satisfy Pratt-Arrow measures of risk aversion and are constrained by the country's currency composition of foreign debt. Thus, for these portfolios, the currency composition of FX reserves is motivated by its country's currency composition of foreign debt. I propose these frameworks for 6 emerging market economies (EMEs) and this is only for a small portion of the total portfolio of FX reserves. These EMEs are Brazil, India, Indonesia, Mexico, South Africa and Turkey and five of these EMEs have been denoted as the "Fragile Five". Using different methods of computing expected FX reserves returns and different maturity structures on FX reserves, I validate my proposal using data over the 2010-2018 period on these EMEs by simulating optimal FX reserve weights for each EME; where each country's actual currency composition of foreign debt is a constraint. |
| Keywords: | IRRA and CRRA Expected Utility,Global Market Conditions,Currency Composition of FX Reserves,Foreign Debt,Portfolio Selection,Skewness,Emerging Market Economies |
| JEL: | E58 F31 G11 G15 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:esprep:227484&r=all |
| By: | Holden, Stein T. (Centre for Land Tenure Studies, Norwegian University of Life Sciences); Tilahun, Mesfin (Centre for Land Tenure Studies, Norwegian University of Life Sciences); Sommervoll, Dag Einar (Centre for Land Tenure Studies, Norwegian University of Life Sciences) |
| Abstract: | The appropriate way to empirically estimate time-dated utility and time preferences based on experimental data has been subject to controversy. Our study assesses whether within-subject magnitude treatments are more appropriately modeled through utility curvature, variable asset integration or as magnitude effects in the discounting function. We find that modeling magnitude effects through utility curvature at the same time as allowing for variable asset integration gives theoretically more consistent parameter ranges than including magnitude effects directly in the discounting function. Models with constant discount rates and limited and constant asset integration are rejected. More restricted but variable asset integration gives close to linear utility functions but such models are less robust than a matching fund model which gives a better fit and is robust and stable across multiple samples. |
| Keywords: | Discounting; Time-dated utility; Utility curvature; Asset integration; field experiment; Ethiopia |
| JEL: | C93 D91 |
| Date: | 2020–12–21 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:nlsclt:2020_008&r=all |
| By: | Kellner, Christian; Thordal-Le Quement, Mark; Riener, Gerhard |
| Abstract: | Ambiguous language is ubiquitous and often deliberate. Recent theoretical work (Beauchêne et al., 2019; Bose and Renou, 2014; Kellner and Le Quement, 2018) has shown how language ambiguation can improve outcomes by mitigating conflict of interest. Our experiment finds a significant effect of language ambiguation on subjects who are competent Bayesian updaters. For both ambiguity averse and neutral subjects within this population, one significant channel is behavioral in nature (anchoring). For ambiguity averse subjects, another channel of similar magnitude is hedging motivated by the desire to reduce ambiguity. This channel is absent in the case of ambiguity neutral subjects. |
| Keywords: | Ambiguity aversion,Communication,Persuasion,Laboratory experiment |
| JEL: | C91 D01 D81 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:dicedp:357&r=all |
| By: | Persichina, Marco (CERE - the Center for Environmental and Resource Economics); Kriström, Bengt (CERE - the Center for Environmental and Resource Economics) |
| Abstract: | Standard elicitation approaches used to obtain quantitative information typically assumes that individuals can provide a precise value. For unfamiliar (as as well as familiar) goods, this is a strong assumption. We suggest they use of self-selected intervals, in which the shortest possible interval is a point, i.e. the standard case. To explore this idea we use a state-of-the-art psychophysics lab experiment (N=60), in which five "focal" sound environments were randomly inserted into a set of 30 pairwise comparisons to elicit the subjective value of reducing ambient noise. We found that valuation uncertainty, measured as the length of a self-selected interval, is independent of the psychophysical conditions. The length of the interval is determined mainly by the subjective value of improving the environment, independent of the level of noise. These results, according to our review of the literature, are new. Interval elicitation enable individuals to provide reasonably consistent rankings of environmental improvements, even if individuals find it difficult to pin down a precise value. Thus, self-selected interval elicitation seems to have merit. |
| Keywords: | self-selected interval; willingness to pay; elicitation surveys; psychophysics stimuli; sound experiment |
| JEL: | C91 D61 D91 Q59 |
| Date: | 2020–12–03 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:slucer:2020_016&r=all |
| By: | M. Guerra; A. B. de Moura |
| Abstract: | We consider the optimal reinsurance problem from the point of view of a direct insurerowning several dependent risks, assuming a maximal expected utility criterion and inde-pendent negotiation of reinsurance for each risk. Without any particular hypothesis onthe dependency structure, we show that optimal treaties exist in a class of independent randomized contracts. We derive optimality conditions and show that under mild assumptions the optimal contracts are of classical (non-randomized) type. A specific form of the optimality conditions applies in that case. We illustrate the results with some numerical examples. |
| Keywords: | Reinsurance, Dependent Risks, Premium Calculation Principles, Expected Utility, Randomized reinsurance treaties |
| Date: | 2020–12 |
| URL: | http://d.repec.org/n?u=RePEc:ise:remwps:wp01492020&r=all |
| By: | Shoka Hayaki (Graduate School of Business Administration, Kobe University and Junior Research Fellow, Research Institute for Economics and Business Administration, Kobe University, Japan) |
| Abstract: | We propose a new behavioral asset pricing model that can flexibly express the time-variability or state-dependence of aggregate risk attitude. We suppose that individual preferences are heterogeneous, and each preference changes depending on the state of the economy. While most previous studies, including Chan and Kogan (2002) which is the basis of our model, imply that aggregate risk aversion is counter-cyclical by assuming either heterogeneity or changeability of preferences, considering both of these can result in aggregate risk aversion being procyclical in a particular economic situation. The status quo hypothesis we propose suggests that the aggregate risk attitude is procyclical during recessions and counter-cyclical during booms and depressions. This stems from the fact that in our setting only risk-tolerant individuals face losses large enough to be loss-averse in order to maintain the status quo. We analyze the weekly returns of 10 major stock markets, including Canada, China, Eurozone, France, Germany, Hong Kong, India, Japan, the UK and the US, and provide some evidences to support our status quo hypothesis in Western stock markets, where stock markets are relatively mature. We conclude that it is essential at least in such matured stock markets to allow both heterogeneity and changeability of preferences in order to obtain an accurate aggregate risk attitude. |
| Keywords: | Risk attitude; Heterogeneous preferences; Status quo; Loss-aversion; Prospect theory |
| JEL: | G12 G15 G40 |
| URL: | http://d.repec.org/n?u=RePEc:kob:dpaper:dp2020-33&r=all |
| By: | Burin Gumjudpai (NAS Mahidol, IF Naresuan, ThEP) |
| Abstract: | We consider demand-side economy. Using Caratheodory's approach, we define empirical existence of equation of state (EoS) and coordinates. We found new insights of thermodynamics EoS, the {\it effect structure}. Rules are proposed as criteria in promoting and classifying an empirical law to EoS status. Four laws of thermodynamics are given for economics. We proposed a method to model the EoS with econometrics. Consumer surplus in economics can not be considered as utility. Concepts such as total wealth, generalized utility and generalized surplus are introduced. EoS provides solid foundation in statistical mechanics modelling of economics and finance. |
| Date: | 2020–12 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2012.01505&r=all |
| By: | Carlos Alós-Ferrer; Johannes Buckenmaier; Michele Garagnani |
| Abstract: | The preference reversal phenomenon is one of the most important, long-standing, and widespread anomalies contradicting economic models of decisions under risk. It describes the robust observation of frequent “standard reversals” where long-shot gambles are valued above moderate ones but then the latter are chosen, while the opposite “nonstandard reversals” happen rarely. This inconsistency casts severe doubts on commonly-used preference elicitation methods. Strikingly, alternative designs which should eliminate the phenomenon produce frequent nonstandard reversals instead, in a puzzling reversal of the phenomenon. We develop and test a model predicting when the phenomenon should occur, when its reversal should occur instead, and what determines the magnitude of the effects. The reversal of the phenomenon is predicted as a consequence of stochastic choice and risk aversion, without invoking any behavioral bias. The original phenomenon arises from stochastic choice and a systematic bias in monetary valuations, which is restricted to long-shot gambles. To validate the model, we conduct two experiments leading to the preference reversal phenomenon and its reversal, respectively. We employ a novel empirical approach allowing us to disentangle choice and valuation errors by relying on utilities estimated out of sample, and confirm that reversals are associated with errors in monetary valuations of long-shots, with the upward bias quantified at 293% in monetary terms. The data also confirms the model’s novel predictions, showing that a larger bias strengthens the phenomenon and higher risk aversion strengthens its reversal. Surprisingly, our analysis implies that the magnitude of the original phenomenon has been underestimated so far. |
| Keywords: | Preference reversals, lottery choice, stochastic choice, overpricing, risk aversion |
| JEL: | D01 D81 D91 |
| Date: | 2020–12 |
| URL: | http://d.repec.org/n?u=RePEc:zur:econwp:370&r=all |
| By: | Francesco Lancia; Alessia Russo; Tim Worrall |
| Abstract: | Optimal intergenerational insurance is examined in a stochastic overlapping generations endowment economy with limited enforcement of risk-sharing transfers. Transfers are chosen by a benevolent planner who maximizes the expected discounted utility of all generations while respecting the participation constraint of each generation. We show that the optimal sustainable intergenerational insurance is history dependent. The risk from a shock is unevenly spread into the future, generating heteroscedasticity and autocorrelation of consumption even in the long run. The optimum can be interpreted as a social security scheme characterized by a minimum welfare entitlement for the old and state-contingent entitlement thresholds. |
| Keywords: | Intergenerational insurance, Limited commitment, Risk sharing, Stochastic overlapping generations |
| JEL: | D64 E21 H55 |
| Date: | 2020–12 |
| URL: | http://d.repec.org/n?u=RePEc:edn:esedps:300&r=all |
| By: | Alvaro Gutierrez Vargas; Michel Meulders; Martina Vandebroek |
| Abstract: | In this article, we describe the randregret command, which imple-ments a variety of Random Regret Minimization (RRM) models. The command allows the user to apply the classic RRM model introduced in Chorus (2010, Eu-ropean Journal of Transport and Infrastructure Research 10: 181-196), the Gener-alized RRM model introduced in Chorus (2014, Transportation Research Part B: Methodological 68: 224-238), and also the µRRM and Pure RRM models, both introduced in van Cranenburgh et al. (2015, Transportation Research Part A: Pol-icy and Practice 74: 91-109). We illustrate the usage of the randregret command using stated choice data on route preferences. The command offers robust and cluster standard error correction using analytical expressions of the scores func-tions. It also offers likelihood ratio tests that can be used to assess the relevance of a given model speciï¬cation. Finally, users can obtain the predicted probabilities from each model using the randregretpred command. |
| Keywords: | randregret, randregret pure, randregretpred, discrete choice models, semi-compensatory behavior, random utility maximization, random regret mini-mization |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:ete:kbiper:664773&r=all |
| By: | Eren Gürer; Alfons Weichenrieder |
| Abstract: | This paper studies the implications of an increase in the price of necessities, which disproportionally hurts the poor, for optimal income taxation. Our analyses show that, when the government is utilitarian and disutility from labor supply is linear, the optimal net nominal tax schedule is unchanged and the government expects households to supply more labor in order to secure their consumption expenditures. Quantitative analyses with convex disutility of labor supply reveal that, because of positive labor supply effects, keeping average tax rates constant suffices to optimally react to the asymmetric price shock. However, the poorest agents are expected to increase their labor supply the most. Thus, optimal income tax policy in response to asymmetric price changes does not prevent the disproportional decline in the indirect utility of poorer households. |
| Keywords: | pro-rich inflation, optimal income taxation |
| JEL: | H21 E31 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_8796&r=all |
| By: | Sébastien Ménard (GAINS - Groupe d'Analyse des Itinéraires et des Niveaux Salariaux - UM - Le Mans Université) |
| Abstract: | This paper studies the optimal design of sickness benefits in a repeated principal-agent model, where the fraudsters are not observed by the principal. Sickness compensation protects workers against the income fluctuations implied by the risk of illness and its provision is limited by the presence of fraudsters using this protection to temporarily adjust their labour supply. We show that the slope of the optimal contract depends on the dynamics of the rate of fraudsters over time. When the duration of temporary shocks on the disutility of work is shorter than the average duration of diseases, the sickness benefits must increase over time. In addition, A tax dependent on the length of the sick leave makes it possible to minimise the cost for a given promise-keeping constraint. Contrary to intuition, this tax must be decreasing because the necessity to penalise the shortest sick leave to deter agents from cheating. |
| Keywords: | Sickness benefits,Absence rate,Recursive contracts. JEL: I13,I18,J24 |
| Date: | 2020–11–27 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-03027395&r=all |
| By: | Sakamoto, Norihito; Mori, Yuko |
| Abstract: | This study proposes a new class of social welfare orderings, stepwise rank-dependent utilitarianisms, which generalize rank-dependent utilitarianisms in the setting of social choice with variable population size. It is shown that the stepwise rank-dependent utilitarianism is equivalent to a social welfare ordering that satisfies the desirable axioms: strong Pareto, anonymity, Pigou-Dalton transfer equity, continuity, rank-separability, cardinal full comparability, and consistency for population replication. This social welfare ordering is a kind of rank-dependent utilitarianisms designed to have the same weight for each proportion of the population, with the obvious advantage that allows weights to be freely chosen for assessing well-being inequality. As a practical application of the stepwise rank-dependent utilitarianism, we propose a k-quantile mean comparison method, which evaluates social welfare by comparing each quantile’s average income in an approximate lexicographic manner. The method has a methodological advantage in that it makes flexible consideration on distributive justice possible compared with the traditional GDP per capita. Furthermore, we show a representation theorem of a social welfare function that generalizes the stepwise rank-dependent utilitarianism for the problem of optimal population size. In addition, the paper reexamines and reformulates several impossibility theorems with a variable population and shows that they are not so serious in the context of cardinal full comparability. Combining the previous results with our findings, theoretical correspondence between interpersonal comparability of individual well-being and acceptable social welfare orderings would be clarified. If cardinal partial comparability were admissible, stepwise rank-dependent Kolm-Pollack or Atkinson-Blackorby-Donaldson social welfare functions should be recommended. If ordinal full comparability were admissible, a stepwise leximin should be recommended. The stepwise rank-dependent utilitarianism should be used if cardinal full comparability were admissible. |
| Keywords: | Social Welfare Ordering, Stepwise Rank-Dependent Utilitarianism, k-Quantile Mean Comparison Method |
| JEL: | D63 D71 H43 I31 I32 J18 Q56 |
| Date: | 2020–09 |
| URL: | http://d.repec.org/n?u=RePEc:hit:rcnedp:8&r=all |
| By: | Kahouli, Sondes; Pautrel, Xavier |
| Abstract: | The aim of this paper is to investigate bi-directional spillovers into residential and industrial sectors induced by energy efficiency improvement (EEI) in both the short- and long-term, and the impact of nesting structure as well as the size of elasticities of substitution of production and utility functions on the magnitude and the transitional dynamic of rebound effect. Developing a dynamic general equilibrium model, we demonstrate that residential EEIs spillovers into the industrial sector through the labor supply channel and industrial EEIs spill-overs into the residential sector through the conventional income channel. Numerical simulations calibrated on the U.S. suggest that not taking into account these spillover effects could lead to mis-estimate the rebound effect especially of residential sector EEIs. We also demonstrate how the size and the duration of the rebound effect depend on the value of elasticities of substitution. Especially, the elasticity of substitution between energy and non-energy consumption in household utility and the elasticity of substitution between physical capital and labor in production play a major role. Numerical simulations suggest that alternative sets of value for the elasticities of substitution may give sizable different patterns of rebound effects in both the short- and long-term. In policy terms, our results suggest that energy effciency policies should be implemented simultaneously with rebound effect offsetting policies by considering short- and long-term wide-economy feedbacks. As a consequence, they recall for considering debates about what type of policy pathways is more effective in mitigating the rebound effect. |
| Keywords: | Resource /Energy Economics and Policy |
| Date: | 2020–12–17 |
| URL: | http://d.repec.org/n?u=RePEc:ags:feemfe:308024&r=all |
| By: | Ulrich Faigle |
| Abstract: | These lecture notes attempt a mathematical treatment of game theory akin to mathematical physics. A game instance is defined as a sequence of states of an underlying system. This viewpoint unifies classical mathematical models for 2-person and, in particular, combinatorial and zero-sum games as well as models for investing and betting. n-person games are studied with emphasis on notions of utilities, potentials and equilibria, which allows to subsume cooperative games as special cases. The represenation of a game theoretic system in a Hilbert space furthermore establishes a link to the mathematical model of quantum mechancis and general interaction systems. |
| Date: | 2020–12 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2012.01850&r=all |