nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2021‒02‒01
eleven papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Economics and duty-motivated choices By Giovanni Razzu
  2. Separable utility and taste-independence: an escape route from the opportunity paradox By Jun Matsui
  3. On Information and the Demand for Insurance By Gandhi, Amit; Samek, Anya; Serrano-Padia, Ricardo
  4. Self-Fulfilling Risk Panics: An Expected Utility Framework By Jess Benhabib; Xuewen Liu; Pengfei Wang
  5. Why do workers buy lottery tickets? A note on gambling, labour contracts and the utility of leisure By Omar Osvaldo Chisari
  6. Calculated Boldness: Optimizing Financial Decisions with Illiquid Assets By Stanislav Shalunov; Alexei Kitaev; Yakov Shalunov; Arseniy Akopyan
  7. Multi-object Auction Design Beyond Quasi-linearity: Leading Examples By Yu Zhou; Shigehiro Serizawa
  8. Estimating real-world probabilities: A forward-looking behavioral framework By Ricardo Cris\'ostomo
  9. Model Uncertainty and Policy Design By Anastasios G. Karantounias
  10. Endogenous inverse demand functions By Maxim Bichuch; Zachary Feinstein
  11. Residential and Industrial Energy Efficiency Improvement: A Dynamic General Equilibrium Analysis of the Rebound Effect By Sondes Kahouli; Xavier Pautrel

  1. By: Giovanni Razzu (Department of Economics, University of Reading)
    Abstract: We study the relationship between economics and duties, the latter considered as deep, intrinsic moral obligations that motivate individuals. We first define duty in a way that could be amenable to work within the tools of decision theory, distinguishing between perfect and imperfect duty-motivated choices. Finally, we apply standard decision theory to assess how duties relate to economics, particularly to rationality. Three main findings emerge. One, perfect duty-motivated choice is rational. Two, when imperfect duty is at play, rationality conditions can be violated. Third, by making use of the difference between two representations of the maximisation problem - the relational and the real valued utility function - we show that individuals motivated by duty can choose a maximal while optimising their preference rankings; instead, maximisation of utility may not be possible under duty-motivated choices that supervene the local non satiation assumption.
    Keywords: duties, decision theory, rationality, maximisation, optimisation
    JEL: B49 D01 D60 D91
    Date: 2021–01–22
  2. By: Jun Matsui (Waseda University)
    Abstract: We provide an escape route from the opportunity paradox, which is described as a conflict between the ex ante and the ex post perspectives of compensation, by restricting the preference domain. Taste-independent utility is introduced as a property of preferences such that individuals' maximized utility levels are the same regardless of their tastes for work. Using the optimal income taxation model, we demonstrate that if parametric utility functions are separable in consumption and labor supply, then they are taste-independent. We obtain a compatibility theorem when utility functions are quasilinear in consumption.
    Keywords: Opportunity, Compensation, Domain restriction
    JEL: D63
    Date: 2021–01
  3. By: Gandhi, Amit (University of Pennsylvania & Microsoft); Samek, Anya (University of California, San Diego); Serrano-Padia, Ricardo (School of Economics)
    Abstract: Technological advances in the insurance industry mean that insurers may be better informed about underlying risks than consumers. We evaluate the impact of these information frictions by combining demand elicitation surveys with insurance claim data. We find an ‘information premium’ - i.e., consumers are willing to pay more for insurance when risks are uncertain. Importantly, we find that the information premium is negatively correlated with risk aversion. This leads to a selection effect: individuals who purchase insurance are not necessarily the most risk averse. The resulting misallocation of insurance can lead to large welfare losses and biased risk preference estimates.
    Keywords: risk; uncertainty; ambiguity; insurance; compound risk; demand analysis; information disclosure; incentivized survey; laboratory experiment; frictions
    JEL: D12 D14 D81 G22 J33
    Date: 2021–01–11
  4. By: Jess Benhabib; Xuewen Liu; Pengfei Wang
    Abstract: Even if an asset has no fundamental uncertainty with a constant dividend process, a stochastic sentiment-driven equilibrium for the asset price exists besides the well-known fundamental equilibrium. Our paper constructs such sentiment-driven equilibria under general utility functions within an OLG structure. Our paper further shows that the existence of sentiment-driven equilibria is robust in a standard infinite-period model as long as the pricing kernel is affected by the asset price.
    JEL: E44 G01 G11
    Date: 2020–12
  5. By: Omar Osvaldo Chisari (Instituto Interdisciplinario de Economía Política de Buenos Aires - UBA - CONICET)
    Abstract: When asked why they buy lotteries tickets, many people say that if they were to win, they would quit their jobs and enjoy life with the money. Curiously enough, the value of quitting the job, that is the gains of additional free time, has not been taken into account as a reason to understand gambling. That is, the utility of leisure has not been paid the attention it deserves to explain why people bet and the focus has always been put only on the utility of wealth or income. It will be shown here that a combination of value of leisure and inflexibility of (voluntary) labour contracts can be a sufficient condition to explain the preference of workers for gambling.
    Keywords: Workers, Gambling, Leisure
    JEL: D11 N81 D86
  6. By: Stanislav Shalunov; Alexei Kitaev; Yakov Shalunov; Arseniy Akopyan
    Abstract: We consider games of chance played by someone with external capital that cannot be applied to the game and determine how this affects risk-adjusted optimal betting. Specifically, we focus on Kelly optimization as a metric, optimizing the expected logarithm of total capital including both capital in play and the external capital. For games with multiple rounds, we determine the optimal strategy through dynamic programming and construct a close approximation through the WKB method. The strategy can be described in terms of short-term utility functions, with risk aversion depending on the ratio of the amount in the game to the external money. Thus, a rational player's behavior varies between conservative play that approaches Kelly strategy as they are able to invest a larger fraction of total wealth and extremely aggressive play that maximizes linear expectation when a larger portion of their capital is locked away. Because you always have expected future productivity to account for as external resources, this goes counter to the conventional wisdom that super-Kelly betting is a ruinous proposition.
    Date: 2020–12
  7. By: Yu Zhou; Shigehiro Serizawa
    Abstract: In multi-object auction models with unitary demand agents, if agents' utility functions satisfy quasi-linearity, three auction formats, sealed-bid auction, exact ascending auction, and approximate ascending auction, are known to identify the minimum price equilibrium (MPE), and exhibit elegant efficiency and incentive-compatibility. These auctions are conjured to preserve their properties beyond quasi-linearity. Nevertheless, we exemplify that with general utility functions, these auctions fail to identify the MPEs and are substantially inefficient and manipulatable. The implications of our negative results for multi-object auction models with agents with multi-unit demand, and matching with contracts models are also discussed.
    Date: 2021–01
  8. By: Ricardo Cris\'ostomo
    Abstract: We show that disentangling sentiment-induced biases from fundamental expectations significantly improves the accuracy and consistency of probabilistic forecasts. Using data from 1994 to 2017, we analyze 15 stochastic models and risk-preference combinations and in all possible cases a simple behavioral transformation delivers substantial forecast gains. Our results are robust across different evaluation methods, risk-preference hypotheses and sentiment calibrations, demonstrating that behavioral effects can be effectively used to forecast asset prices. Further analyses confirm that our real-world densities outperform densities recalibrated to avoid past mistakes and improve predictive models where risk aversion is dynamically estimated from option prices.
    Date: 2020–12
  9. By: Anastasios G. Karantounias
    Abstract: This article illustrates the main challenges and forces that emerge in optimal policy design when there are doubts about the probability model of uncertainty. Model doubts can stem from either the side of the public or the side of the policymaker, and they can give rise to cautious probabilistic assessments. A basic idea that surfaces in setups with model uncertainty is the management of the public's pessimistic expectations by the policymaker. The article also presents several implications of this idea.
    Keywords: Model uncertainty; ambiguity aversion; multiplier preferences; misspecification; pessimistic expectations; paternalism; taxation; austerity; competitive fringe
    JEL: D80 E62 H21 H63
    Date: 2020–12–22
  10. By: Maxim Bichuch; Zachary Feinstein
    Abstract: In this work we present an equilibrium formulation for price impacts. This is motivated by the Buhlmann equilibrium in which assets are sold into a system of market participants and can be viewed as a generalization of the Esscher premium. Existence and uniqueness of clearing prices for the liquidation of a portfolio are studied. We also investigate other desired portfolio properties including monotonicity and concavity. Price per portfolio unit sold is also calculated. In special cases, we study price impacts generated by market participants who follow the exponential utility and power utility.
    Date: 2020–12
  11. By: Sondes Kahouli (Université de Bretagne Occidentale); Xavier Pautrel (Université d’Angers)
    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: Energy Efficiency, Rebound Effect, Transitional Dynamics, Residential Energy Consumption, Industrial Energy Consumption
    JEL: D58 Q43
    Date: 2020–12

This nep-upt issue is ©2021 by Alexander Harin. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.