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on Utility Models and Prospect Theory |
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Issue of 2021‒02‒08
eighteen papers chosen by |
| By: | Takashi Nishiwaki (Graduate School of Economics, Waseda University) |
| Abstract: | This study examinesthe optimal investment strategies for risk-and-ambiguity averse investors and characterizes conditions under which ambiguity induces investors to buy or sell options. Under identical constant relative risk aversion utility functions, we show that ambiguity-averse investors should sell portfolio insurance. In particular, when investors' relative risk aversion is less than or equal to two, ambiguity-averse investors should sell options at any realization values of a reference asset. In addition, if the relative risk aversion is greater than two, we demonstrate that ambiguity-averse investors should sell options at smaller and buy them at higher realization values of the reference portfolio. |
| Keywords: | Ambiguity; Multiple prior model; Options demand; Kullback-Leibler divergence |
| JEL: | G11 G22 |
| Date: | 2020–09 |
| URL: | http://d.repec.org/n?u=RePEc:wap:wpaper:2011&r=all |
| By: | Chopra, Felix (University of Bonn); Eisenhauer, Philipp (University of Chicago); Falk, Armin (briq, University of Bonn); Graeber, Thomas W (Harvard Business School) |
| Abstract: | Standard consumption utility is linked in time to a consumption event, whereas the timing of prosocial utility flows is ambiguous. Prosocial utility may depend on the actual utility consequences for others – it is consequence-dated – or it may be related to the act of giving and is thus choice-dated. Even though most prosocial decisions involve intertemporal trade-offs, existing models of other-regarding preferences abstract from the time signature of utility flows, limiting their explanatory scope. Building on a canonical intertemporal choice framework, we characterize the behavioral implications of the time structure of prosocial utility. We conduct a high-stakes donation experiment that allows us to identify non-parametrically and calibrate structurally the different motives from their unique time profiles. We find that the universe of our choice data can only be explained by a combination of choice- and consequence-dated prosocial utility. Both motives are pervasive and negatively correlated at the individual level. |
| Keywords: | altruism, donation, intertemporal decision-making, time inconsistency |
| JEL: | C91 D12 D64 D90 |
| Date: | 2021–01 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp14059&r=all |
| By: | Takashi Nishiwaki (Graduate School of Economics, Waseda University) |
| Abstract: | This study compares the optimal consumption amount for a risk-averse agent under different uncertainty resolution times in a time-separable utility setting. We show that an agent with a positive third derivative utility function (i.e., a prudent agent) reduces his/her consumption amount when the uncertainty resolution is postponed. We also demonstrate that an agent does not change consumption behavior under different uncertainty resolution times if and only if the agent has a quadratic utility. |
| Keywords: | Background risk; Time-separable utility; Prudence, Optimal consumption; Timing of uncertainty resolution |
| JEL: | G11 G22 G51 |
| Date: | 2020–08 |
| URL: | http://d.repec.org/n?u=RePEc:wap:wpaper:2009&r=all |
| By: | Zongxia Liang; Yang Liu; Litian Zhang |
| Abstract: | Benchmarks in the utility function have various interpretations, including performance guarantees and risk constraints in fund contracts and reference levels in cumulative prospect theory. In most literature, benchmarks are a deterministic constant or a fraction of the underlying wealth; as such, the utility is still a univariate function of the wealth. In this paper, we propose a framework of multivariate utility optimization with general benchmark variables, which include stochastic reference levels as typical examples. The utility is state-dependent and the objective is no longer distribution-invariant. We provide the optimal solution(s) and fully investigate the issues of well-posedness, feasibility, finiteness and attainability. The discussion does not require many classic conditions and assumptions, e.g., the Lagrange multiplier always exists. Moreover, several surprising phenomena and technical difficulties may appear: (i) non-uniqueness of the optimal solutions, (ii) various reasons for non-existence of the Lagrangian multiplier and corresponding results on the optimal solution, (iii) measurability issues of the concavification of a multivariate utility and the selection of the optimal solutions, and (iv) existence of an optimal solution not decreasing with respect to the pricing kernel. These issues are thoroughly addressed, rigorously proved, completely summarized and insightfully visualized. As an application, the framework is adopted to model and solve a constraint utility optimization problem with state-dependent performance and risk benchmarks. |
| Date: | 2021–01 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2101.06675&r=all |
| By: | Pretnar, Nick; Olivola, Christopher Y.; Montgomery, Alan |
| Abstract: | We construct a unifying theory of two-stage budgeting and bounded rationality with mental accounting features. Mental accounting and rational inattention induce behavioral wedges between first-stage and second-stage expenditure budgets. Because reviewing one’s financial activities is cognitively costly, consumers might reassess only a subset of their spending budgets every period. Over- or under-spending affects future budgeting and expenditure decisions. We apply latent Bayesian inference to agent-level weekly expenditure data in order to structurally estimate the degree to which low-income consumers appear rationally constrained with respect to budgeting. Our findings provide insight into how consumers may respond to interventions that encourage more disciplined budgeting behavior, like push notifications in budgeting apps. If consumers are acutely aware of budget misses, they may adjust budgets upward to avoid the dis-utility of over-expenditure, driving savings rates and balances downward. In this manner, push notifications that warn consumers about budget thresholds could backfire and actually lead to budgeting behavior that reduces savings and wealth in the long-run. |
| Keywords: | budgeting, mental accounting, bounded rationality, expenditure, savings |
| JEL: | D11 D12 D91 |
| Date: | 2021–01–15 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:105356&r=all |
| By: | Mamoru Kaneko (Emeritus Professor, Waseda University and University of Tsukuba) |
| Abstract: | We study the St.Petersburg paradox from the viewpoint of bounded intelligence. Following Llyod Shapley, we reformulate its coin-tossing gamble introducing a finite budget of the banker, while this is as a resolution in the narrow sense as long as the standard expected reward criterion is adopted. It is still impossible for both banker and people to participate and to generate positive profits. We introduce cognitive bounds to people to modify the expected reward criterion and show that many people are incomparable to between participation and not. This is a rationalistic though people have cognitive bounds, and we take one more step of going to semi-rationalistic behavioral-probability for incomparable alternatives. This shows that some people show positive probabilities of participation in the coin-tossing with a fee producing positive profits for the banker. The last part is formulated as a monopoly market and its activeness is shown by the Mote Carlo simulation method. |
| Keywords: | St.Petersburg Paradox; Shapley's Modification; Expected Utility Theory with Probability Grids; Cognitive Bounds; Bounded Intelligence; Incomparability; behavioralprobability; Monte Carlo Method |
| Date: | 2020–10 |
| URL: | http://d.repec.org/n?u=RePEc:wap:wpaper:2014&r=all |
| By: | Takashi Hayashi (Adam Smith Business School, University of Glasgow); Ritesh Jain (Institute of Economics, Academia Sinica); Ville Korpela (Turku School of Economics, University of Turku FI-20014, Finland); Michele Lombardi (Adam Smith Business School, University of Glasgow; Department of Economics and Statistics, University of Naples "Federico II") |
| Abstract: | Choice behavior is rational if it is based on the maximization of some context-independent preference relation. This study re-examines the questions of implementation theory in a setting where players’ choice behavior need not be rational and coalition formation must be taken into account. Our model implies that with boundedly rational players, the formation of groups greatly affects the design exercise. As a by-product, we also propose a notion of behavioral efficiency and we compare it with existing notions. |
| Keywords: | Strong equilibrium, implementation, state-contingent choice rules, bounded rationality |
| JEL: | D11 D60 D83 |
| Date: | 2021–01 |
| URL: | http://d.repec.org/n?u=RePEc:tkk:dpaper:dp141&r=all |
| By: | Shohei Yamamoto (Hitotsubashi University Business School); Shotaro Shiba (Waseda University); Nobuyuki Hanaki (Osaka University) |
| Abstract: | Present-biased preferences in intertemporal decisions have been actively investigated. While these preferences have been elicited through incentivized experiments in the gain domain to avoid potential hypothetical bias, they have been elicited only through hypothetical experiments in the loss domain. We conducted a two-stage experiment that enabled us to elicit these preferences in the gain and loss domains in an incentive-compatible way. We found that present bias, which is exhibited in both domains, is more severe in the loss domain. |
| Keywords: | Intertemporal choice; Present bias; Gains and losses |
| JEL: | C91 D91 |
| Date: | 2020–09 |
| URL: | http://d.repec.org/n?u=RePEc:wap:wpaper:2012&r=all |
| By: | Yuta Inoue (Graduate School of Economics, Waseda University) |
| Abstract: | This paper develops revealed preference analysis of an individual choice model where an agent is a weak preference maximizer, under the assumption that a choice function, rather than a choice correspondence, is observed. In particular, we provide a revealed preference test for such model, and then provide conditions under which we can surely say whether some alternative is indifferent / weakly preferred / strictly preferred to another, solely from the information of the choice function. Furthermore, interpreting a choice correspondence as sets of potential candidates of alternatives that could be chosen from each feasible set, we analyze which alternatives must be, or cannot be a member of the choice correspondence: sharp lower and upper bounds of this underlying choice correspondence are given. As an assumption on observability of data, we assume that the choice function is defined on a non-exhaustive domain, so our results are applicable to data analysis even when only a limited data set is available. |
| Keywords: | Revealed preference; Choice function; Choice correspondence; Weak preference; Bounded rationality |
| JEL: | D1 D6 |
| Date: | 2020–05 |
| URL: | http://d.repec.org/n?u=RePEc:wap:wpaper:2004&r=all |
| By: | Knapp, Martin; Wong, Gloria |
| Abstract: | Economics and mental health are intertwined. Apart from the accumulating evidence of the huge economic impacts of mental ill-health, and the growing recognition of the effects that economic circumstances can exert on mental health, governments and other budget-holders are putting increasing emphasis on economic data to support their decisions. Here we consider how economic evaluation (including cost-effectiveness analysis, cost-utility analysis and related techniques) can contribute evidence to inform the development of mental health policy strategies, and to identify some consequences at the treatment or care level that are of relevance to service providers and funding bodies. We provide an update and reflection on economic evidence relating to mental health using a lifespan perspective, analyzing costs and outcomes to shed light on a range of pressing issues. The past 30 years have witnessed a rapid growth in mental health economics, but major knowledge gaps remain. Across the lifespan, clearer evidence exists in the areas of perinatal depression identification-plus-treatment; risk-reduction of mental health problems in childhood and adolescence; scaling up treatment, particularly psychotherapy, for depression; community-based early intervention and employment support for psychosis; and cognitive stimulation and multicomponent carer interventions for dementia. From this discussion, we pull out the main challenges that are faced when trying to take evidence from research and translating it into policy or practice recommendations, and from there to actual implementation in terms of better treatment and care. |
| Keywords: | Economic evaluation; cost-benefit; cost-effectiveness; cost-utility; dementia; depression; mental health policy; psychosis; return on investment |
| JEL: | N0 |
| Date: | 2020–02–01 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:102717&r=all |
| By: | Prateek Bansal; Rajeev Ranjan Kumar; Alok Raj; Subodh Dubey; Daniel J. Graham |
| Abstract: | Consumer preference elicitation is critical to devise effective policies for the diffusion of electric vehicles in India. For this purpose, we use stated preferences of over 1000 Indian consumers and present the first estimates of the additional purchase price that Indian consumers are willing to pay to improve the electric vehicle attributes (e.g., driving range). We adopt a hybrid choice modelling framework to simultaneously model the willingness to pay and the effect of consumers' latent attitudes (e.g., hedonic and symbolic values) on their likelihood to adopt electric vehicles. We also account for reference dependence by considering a conventional vehicle as the reference alternative and illustrate that the resulting willingness to pay estimates are more realistic. Based on our results, Indian consumers are willing to pay additional USD 10-34 in purchase price to reduce the fast charging time by 1 minute, USD 7-40 to add a kilometre to the driving range of electric vehicle at 200 kilometres, and USD 104-692 to save USD 1 per 100 kilometres in operating cost. These estimates and the effect of attitudes on the likelihood to adopt electric vehicles provide insights about electric vehicle design, marketing strategies, and pro-electric-vehicle policies (e.g., specialised lanes and reserved parking for electric vehicles) to expedite the adoption of electric vehicles in India. |
| Date: | 2021–01 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2101.08008&r=all |
| By: | Syarifuddin, Ferry |
| Abstract: | In this work, the possibility of cross-border activities between two regions in the framework of the investment contract is viewed as optimal allocation problems. The problems of determining the optimal proportion of funds to be invested in liquidity and technology are analyzed in two different environments. In the first case, we consider a two-region and two-technology economy in which both regions possess the same productive technology or project, but a different stream of return. While in the second case, we examine an economy where two regions (Indonesia and Malaysia) hold different Islamic productive projects with identical returns. Allocation models are formulated in terms of investors’ expected utility maximization problem under budget constraints with respect to regional and sectoral shocks. It is revealed that optimal parameters for liquidity ratio, technological investment profile, and bank repayment are analytically characterized by the return of a more productive project and the proportion of impatient and patient investors in the region. Even though both cases employ different assumptions, they provide the same expressions of optimal parameters. The model suggests that cross-border Islamic investment activities between two regions might be realized, provided both regions hold productive projects with an identical stream of return. This paper also shows that by increasing the lower return of the project approaching the higher return, a room for inter-region investment can be created. An analytical framework of an investment contract in terms of optimal allocation model is provided. |
| Keywords: | Investment contract; Optimal allocation model; Two-region economy. |
| JEL: | C61 F36 G11 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:104809&r=all |
| By: | Batabyal, Amitrajeet; Yoo, Seung Jick |
| Abstract: | We study decision-making by a regional authority (RA) that uses enterprise zones to attract members of the creative class---referred to as entrepreneurs---to its region. The enterprise zones provide a local public good (LPG) L to entrepreneurs who become members. First, we compute the utility maximizing number of entrepreneurs N to attract and the optimal provision level of the LPG. Second, if the LPG L is chosen optimally, then, given N, we determine an expression for the utility of an entrepreneur. Third, we calculate how much an entrepreneur would be willing to pay to become a member of an enterprise zone and then discuss the potential existence of an efficient and revenue-neutral equilibrium. Finally, we comment on some theoretical difficulties stemming from the twin facts that the number of enterprise zones created and the number of entrepreneurs attracted to these zones have to be integers. |
| Keywords: | Creative Class, Enterprise Zone, Entrepreneur, Local Public Good, Membership |
| JEL: | R11 R58 |
| Date: | 2020–12–03 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:105414&r=all |
| By: | Grancini, Stefano |
| Abstract: | In this paper we provide evidence that there are statistical and economically meaningful differences in terms of attitudes towards risk at the aggregate level across countries, as captured by country-specific estimations of the coefficient of relative risk aversion. This has important implications for fiscal policy as it leads to large differences in the output response to the same fiscal policy shock. When calibrating the risk aversion at the country level, using country-specific estimates of the coefficient of relative risk aversion, we find multipliers to the same fiscal consolidation shock to differ as much as between 0.35 and 0.55. |
| Keywords: | CRRA, Fiscal Multipliers, Risk Aversion, Fiscal Consolidation Programs. |
| JEL: | D81 E21 E62 H63 O57 |
| Date: | 2021–01–18 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:105500&r=all |
| By: | Teglio, Andrea |
| Abstract: | The aim of this paper is to explore under which conditions a representative agent (RA) model is able to correctly approximate the output of a more realistic model based on the "true" assumption of many interacting agents. The starting point is the widespread Keynesian cross diagram, which is compared to an extended versions that explicitly considers a multiplicity of interacting households and firms, and collapses into the original model when the number of agents is one per type. Results show that the RA Keynesian cross diagram model is not a good approximation of the extended model when (i) the network structure of the economy is not symmetric enough, e.g. firms have different sizes, or (ii) the rationality of agents is not high enough. When income inequality is considered, through the introduction of capitalists, the representative agent model is no more a good approximation, even if the agents are rational. A fiscal policy that targets income redistribution improves the prediction of the RA model. In general, all features that increase overall rationality in the economy and decrease its heterogeneity, tend to improve the performance of the RA approximation. |
| Keywords: | macroeconomics; rationality; inequality; Keynesian cross-diagram; representative agent; agent-based models; networks; simulation; complex adaptive systems |
| JEL: | C63 E00 E12 |
| Date: | 2020–10–10 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:105407&r=all |
| By: | Hammitt, James K.; Treich, Nicolas |
| Abstract: | Environmental, transportation, occupational, and other regulations that reduce fatality risk are frequently evaluated using benefit-cost analysis (BCA). We examine how risk reductions are valued under BCA, utilitarian and prioritarian SWFs. The social value of risk reduction (SVRR) to an individual is the rate of increase of social welfare for a small decrease to the individual’s current-period fatality risk. Under BCA, the SVRR is the individual’s value per statistical life (VSL), which is increasing in wealth and baseline risk. Under utilitarian and prioritarian SWFs, the SVRR is far less sensitive to income; it can decrease with income for prioritarian SWFs that exhibit sufficient inequality aversion. The SVRR increases with or is independent of baseline risk. Like VSL, it can increase or decrease with age, but prioritarian SWFs assign larger SVRR to younger relative to older individuals than does the utilitarian SWF. Extensions to catastrophe aversion and nonfatal health risks are discussed. |
| Keywords: | mortality; regulation; benefit-cost analysis; value of a statistical life; fair innings; age; income; catastrophe aversion; prioritarian; utilitarian |
| Date: | 2021–01 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:125139&r=all |
| By: | Thomas Crossley; Yifan Gong; Todd R. Stinebrickner; Ralph Stinebrickner |
| Abstract: | Unique longitudinal probabilistic expectations data from the Berea Panel Study, which cover both the college and early post-college periods, are used to examine young adults’ beliefs about their future incomes. We introduce a new measure of the ex post accuracy of beliefs, and two new approaches to testing whether, ex ante, agents exhibit Rational Expectations. We show that taking into account the additional information about higher moments of individual belief distributions contained in probabilistic expectations data is important for detecting types of violations of Rational Expectations that are not detectable by existing mean-based tests. Beliefs about future income are found to become more accurate as students progress through school and then enter the post-college period. Tests of Rational Expectations almost always reject for the in-school period, but the evidence against Rational Expectations is much weaker in the post-college period. |
| JEL: | D84 J0 |
| Date: | 2021–01 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:28353&r=all |
| By: | Zijin Xie (Graduate School of Economics, Keio University); Ayumi Onuma (Faculty of Economics, Keio University) |
| Abstract: | Integrated conservation development projects (ICDPs) are considered important for enhancing biodiversity conservation and local development in developing countries. These projects usually share benefits with local communities and incorporate locals in biodiversity management. While some studies shed light on the effectiveness of ICDPs in biodiversity conservation, most of them do not consider the employment of locals in biodiversity management. Moreover, existing literature assumes that national parks are for-profit organizations whereas they are generally nonprofit entities. We develop a bioeconomic model to investigate the effect of introducing ICDPs in nonprofit as well as for- profit national parks with the employment of local labor in tourism on biodiversity conservation. We demonstrate that there are conditions for the ICDP to be successful in enhancing biodiversity. Under these conditions, if biodiversity improves or has no impact on agricultural productivity, the nonprofit national parks invariably bring higher utility to locals and improve biodiversity than for-profit national parks. Otherwise, nonprofit national parks do not necessarily bring higher utility to locals or improve biodiversity, as compared to for-profit national parks. Moreover, the ICDP is evaluated in terms of social welfare, and we show that a subsidy/taxation on wage rates will bring the market equilibrium to a social optimum. |
| Keywords: | Bioeconomic modeling, Biodiversity conservation, National park, ICDPs |
| JEL: | Q29 Q56 Q57 |
| Date: | 2021–01–04 |
| URL: | http://d.repec.org/n?u=RePEc:keo:dpaper:2021-001&r=all |