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on Utility Models and Prospect Theory |
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Issue of 2021‒04‒05
seventeen papers chosen by |
| By: | Loïc Berger (IÉSEG School Of Management [Puteaux], EIEE - European Institute on Economics and the Environment, CMCC - Centro Euro-Mediterraneo per i Cambiamenti Climatici [Bologna], LEM - Lille économie management - UMR 9221 - UA - Université d'Artois - UCL - Université catholique de Lille - Université de Lille - CNRS - Centre National de la Recherche Scientifique); Valentina Bosetti (Bocconi University [Milan, Italy]) |
| Abstract: | We report the results of an experiment eliciting individuals' attitudes toward risk and model uncertainty. Using a joint elicitation procedure, we then precisely quantify the strength of individuals' attitude toward ambiguity in the context of the smooth model and characterize its main properties. Our results provide empirical evidence of decreasing absolute ambiguity aversion (DAAA) and constant relative ambiguity aversion (CRAA). These results shed new light on the way ambiguity attitudes may affect important decisions, such as the choice of health insurance policies or the optimal investment strategy in the face of climate change. |
| Keywords: | Ambiguity aversion,Laboratory experiment,Non-expected utility,Subjective probabilities,Decreasing absolute ambiguity aversion |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-03031502&r=all |
| By: | Gaston Clément Nyassoke Titi (Université de Douala); Jules Sadefo Kamdem (MRE - Montpellier Recherche en Economie - UM - Université de Montpellier); Louis Aimé Fono (Université de Douala); Nyassoke Titi; Gaston Clément; Sadefo Kamdem; Louis Fono (Université de Douala) |
| Abstract: | In this article, we provide a general framework for analyzing the optimal harvest of a renewable resource(i.e. fish, shrimp) assuming that the price and biomass evolve stochastically and harvesters have a constantrelative risk aversion (CRRA) . In order to take into account the impact of a sudden change in the environ-ment linked to the ecosystem, we assume that the biomass are governed by a stochastic differential equationof the ‘Gilpin-Ayala' type, with regime change in the parameters of the drift and variance. Under the aboveassumptions, we find the optimal effort to be deployed by the collector (fishery for example) in order tomaximize the expected utility of its profit function. To do this, we give the proof of the existence anduniqueness of the value function, which is derived from the Hamilton-Jacobi-Bellman equations associatedwith this problem, by resorting to a definition of the viscosity solution. |
| Keywords: | Stochastic Gilpin-Ayala,CRRA utility,Viscosity solutions,Renewable Resources,Optimal Effort |
| Date: | 2021 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-03169348&r=all |
| By: | Sumru Altug (AUB - American University of Beirut [Beyrouth]); Fabrice Collard; Cem Çakmaklı (Koç University); Sujoy Mukerji (QMUL - Queen Mary University of London); Han Özsöylev (Koç University, University of Oxford [Oxford]) |
| Abstract: | In this paper, we examine the cyclical dynamics of a Real Business Cycle model with ambiguity averse consumers and investment irreversibility using the smooth ambiguity model of Klibanoff et al. (2005, 2009). Ambiguity of belief about the productivity process arises as agents do not know the process driving variation in aggregate TFP, and they must make inferences regarding the true process at the same time as they infer the behavior of the unobserved temporary component using a Kalman filtering algorithm. Our findings may be summarized as follows. First, the standard business cycle facts hold in our framework, which are not altered significantly by changes in the degree of ambiguity aversion. Second, we demonstrate a role for information and learning effects, and show that lower initial ambiguity or greater confidence coupled with learning dynamics lowers the volatility and increases the persistence in all of the key macroeconomic variables. Third, comparing the performance of our model to the New Keynesian business cycle model of Ilut and Schneider (2014) with maxmin expected utility, we find that the version of their model without nominal and real frictions turns out to have limited success at matching the moments for the quantity variables. In the maxmin expected utility framework, the worst case scenario instills too much caution on the part of agents who, in the absence of a key set of nominal and real frictions, end up excessively reducing their responses to TFP shocks. |
| Keywords: | information and learning,ambiguity aversion,Ambiguity,investment irreversibility,Real Business Cycles,New Keynesian model. |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-03039262&r=all |
| By: | Christophe Bontemps (TSE - Toulouse School of Economics - UT1 - Université Toulouse 1 Capitole - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement); Douadia Bougherara (CEE-M - Centre d'Economie de l'Environnement - Montpellier - UMR 5211 - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique - Montpellier SupAgro - Institut national d’études supérieures agronomiques de Montpellier - Institut Agro - Institut national d'enseignement supérieur pour l'agriculture, l'alimentation et l'environnement - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement); Celine Nauges (TSE - Toulouse School of Economics - UT1 - Université Toulouse 1 Capitole - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement) |
| Abstract: | Even if there exists an extensive literature on the modeling of farmers' behavior under risk, actual measurements of the quantitative impact of risk aversion on input use are rare. In this article, we use simulations to quantify the impact of risk aversion on the optimal quantity of input and farmers' welfare when production risk depends on how much of the input is used. The assumptions made on the technology and form of farmers' risk preferences were chosen such that they are fairly representative of crop farming conditions in the USA and Western Europe. In our benchmark scenario featuring a traditional expected utility model, we find that less than 4% of the optimal pesticide expenditure is driven by risk aversion and that risk induces a decrease in welfare that varies from −1.5 to −3.0% for individuals with moderate to normal risk aversion. We find a stronger impact of risk aversion on quantities of input used when farmers' risk preferences are modeled under the cumulative prospect theory framework. When the reference point is set at the median or maximum profit, and for some levels of the parameters that describe behavior toward losses, the quantity of input used that is driven by risk preferences represents up to 19% of the pesticide expenditure. |
| Keywords: | Pesticides,Production risk,Risk preferences |
| Date: | 2021–03–25 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-03182253&r=all |
| By: | Carlos Alós-Ferrer; Maximilian Mihm |
| Abstract: | When an economic agent makes a choice, stochastic models predicting those choices can be updated. The structural assumptions embedded in the prior model condition the updated one, to the extent that the same evidence produces different predictions even when previous ones were identical. We provide a general framework for models of stochastic choice allowing for arbitrary forms of (structural) updating and show that different models can be sharply separated by their structural properties, leading to axiomatic characterizations. Our framework encompasses Bayesian updating given beliefs over deterministic preferences (as implied by popular random utility models) and standard neuroeconomic models of choice, which update decision values in the brain through reinforcement learning. |
| Keywords: | Stochastic preferences, Bayesian learning, logit choice, reinforcement, neuroeconomic theory |
| JEL: | D01 D81 |
| Date: | 2021–03 |
| URL: | http://d.repec.org/n?u=RePEc:zur:econwp:381&r=all |
| By: | Sapre, Nikhil |
| Abstract: | The concept of utility is the core component of many foundational theories in social sciences. It has evolved from a philosophical belief that people seek happiness and satisfaction to a mathematically derived theory in economics and finance. Beginning with a brief review of the developments in the Expected Utility Theory (EUT) and its applicability in equity pricing, this paper includes a critical appraisal of relevant theoretical and empirical studies from the fields of financial economics and behavioural studies, with a particular focus on the the Consumption Capital Asset Pricing Model (CCAPM). |
| Keywords: | Expected Utility, Choice Behaviour, Equity Pricing, CCAPM |
| JEL: | G10 G11 G12 |
| Date: | 2021–02–18 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:106668&r=all |
| By: | Akifumi Kira; Kiyohito Nagano; Manabu Sugiyama; Naoyuki Kamiyama |
| Abstract: | In this study, we consider the real-world problem of assigning students to classes, where each student has a preference list, ranking a subset of classes in order of preference. Though we use existing approaches to include the daily class assignment of Gunma University, new concepts and adjustments are required to find improved results depending on real instances in the field. Thus, we propose minimax-rank constrained maximum-utility matchings and a compromise between maximum-utility matchings and fair matchings, where a matching is said to be fair if it lexicographically minimizes the number of students assigned to classes not included in their choices, the number of students assigned to their last choices, and so on. In addition, we also observe the potential inefficiency of the student proposing deferred acceptance mechanism with single tie-breaking, which a hot topic in the literature on the school choice problem. |
| Date: | 2021–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2103.16879&r=all |
| By: | Cuong Le Van (IPAG Business School, CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics - ENPC - École des Ponts ParisTech - ENS Paris - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique - EHESS - École des hautes études en sciences sociales - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement); Ngoc-Sang Pham (Métis Lab EM Normandie - EM Normandie - École de Management de Normandie, EM Normandie - École de Management de Normandie) |
| Abstract: | We study the existence of equilibrium when agents' preferences may not be convex. For some specific utility functions, we provide a necessary and sufficient condition under which there exists an equilibrium. The standard approach cannot be directly applied to our examples because the demand correspondence of some agents is neither single valued nor convex valued. |
| Keywords: | general equilibrium.,Non-convex preferences |
| Date: | 2021–03–23 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-03177843&r=all |
| By: | Yanzhao Li; Ju'e Guo; Yongwu Li; Xu Zhang |
| Abstract: | This paper proposes two kinds of time-inconsistent preferences (i.e. time flow inconsistency and critical time point inconsistency) to further advance the research on the exit decision of venture capital. Time-inconsistent preference, different from time-consistent preference, assumes that decision makers prefer recent returns rather than future returns. Based on venture capitalists' understanding of future preferences, we consider four types of venture capitalists, namely time-consistent venture capitalists, venture capitalists who only realize critical time point inconsistency, naive venture capitalists and sophisticated venture capitalists, of which the latter three are time-inconsistent. All types of time-inconsistent venture capitalists are aware of critical time point inconsistency. Naive venture capitalists misunderstand time flow inconsistency while sophisticated ones understand it correctly. We propose an optimal exit timing of venture capital model. Then we derive and compare the above four types of venture capitalists' exit thresholds. The main results are as follows: (1) all types of time-inconsistent venture capitalists tend to exit earlier than time-consistent venture capitalists. (2) The longer the expire date are, the more likely venture capitalists are to delay the exit, but the delay degree decreases successively (venture capitalists who only realize critical time point inconsistency > naive venture capitalists > sophisticated venture capitalists). |
| Date: | 2021–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2103.11557&r=all |
| By: | Philippe Le Coent (BRGM - Bureau de Recherches Géologiques et Minières (BRGM)); Raphaële Preget (CEE-M - Centre d'Economie de l'Environnement - Montpellier - UMR 5211 - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique - Montpellier SupAgro - Institut national d’études supérieures agronomiques de Montpellier - Institut Agro - Institut national d'enseignement supérieur pour l'agriculture, l'alimentation et l'environnement - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement); Sophie Thoyer (CEE-M - Centre d'Economie de l'Environnement - Montpellier - UMR 5211 - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique - Montpellier SupAgro - Institut national d’études supérieures agronomiques de Montpellier - Institut Agro - Institut national d'enseignement supérieur pour l'agriculture, l'alimentation et l'environnement - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement) |
| Abstract: | This article analyses the role played by social norms in farmers' decisions to enroll into an agri-environmental scheme (AES). First, it develops a simple theoretical model highlighting the interplay of descriptive and injunctive norms in farmers' utility functions. Second, an empirical valuation of the effect of social norms is provided based on the results of a stated preference survey conducted with 98 wine-growers in the South of France. Proxies are proposed to capture and measure the weight of social norms in farmers' decision to sign an agri-environmental contract. Our empirical results indicate that the injunctive norm seems to play a stronger role than the descriptive norm. |
| Keywords: | social norms,behaviour,agri-environmental contracts,payments for environmental services,voluntary contribution to a public good,farmers |
| Date: | 2020–12–11 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-03060492&r=all |
| By: | Mogens Fosgerau; Mads Paulsen; Thomas Kj{\ae}r Rasmussen |
| Abstract: | We propose a model in which a utility maximizing traveler assigns flow across an entire network under a flow conservation constraint. Substitution between routes depends on how much they overlap. This model can be estimated from route choice data, where the full set of route alternatives is included and no choice set generation is required. Nevertheless, estimation requires only linear regression and is very fast. Predictions from the model can be computed using convex optimization and is straightforward even for large networks. |
| Date: | 2021–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2103.13784&r=all |
| By: | Philippe Bergault; Fay\c{c}al Drissi; Olivier Gu\'eant |
| Abstract: | In recent years, academics, regulators, and market practitioners have increasingly addressed liquidity issues. Amongst the numerous problems addressed, the optimal execution of large orders is probably the one that has attracted the most research works, mainly in the case of single-asset portfolios. In practice, however, optimal execution problems often involve large portfolios comprising numerous assets, and models should consequently account for risks at the portfolio level. In this paper, we address multi-asset optimal execution in a model where prices have multivariate Ornstein-Uhlenbeck dynamics and where the agent maximizes the expected (exponential) utility of her P\&L. We use the tools of stochastic optimal control and simplify the initial multidimensional Hamilton-Jacobi-Bellman equation into a system of ordinary differential equations (ODEs) involving a Matrix Riccati ODE for which classical existence theorems do not apply. By using \textit{a priori} estimates obtained thanks to optimal control tools, we nevertheless prove an existence and uniqueness result for the latter ODE, and then deduce a verification theorem that provides a rigorous solution to the execution problem. Using numerical methods we eventually illustrate our results and discuss their implications. In particular, we show how our model can be used to build statistical arbitrage strategies. |
| Date: | 2021–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2103.13773&r=all |
| By: | Aras, Atilla |
| Abstract: | This study provides a solution of the equity premium puzzle. Questioning the validity of the Arrow-Pratt measure of relative risk aversion for detecting the risk behavior of investors, a new tool in the form of the sufficiency factor of the model was developed to analyze the risk behavior of investors. The calculations of this newly tested model show that the value of the coefficient of relative risk aversion is 1.033526 by assuming the value of the subjective time discount factor as 0.99. Since these values are compatible with the existing empirical studies, they confirm the validity of the newly derived model that provides a solution to the equity premium puzzle. |
| Date: | 2021–02–02 |
| URL: | http://d.repec.org/n?u=RePEc:osf:osfxxx:gj3n2&r=all |
| By: | Nicolas Taconet (ENPC - École des Ponts ParisTech, CIRED - Centre International de Recherche sur l'Environnement et le Développement - Université Paris-Saclay - AgroParisTech - EHESS - École des hautes études en sciences sociales - Cirad - Centre de Coopération Internationale en Recherche Agronomique pour le Développement - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique); Céline Guivarch (ENPC - École des Ponts ParisTech, CIRED - Centre International de Recherche sur l'Environnement et le Développement - Université Paris-Saclay - AgroParisTech - EHESS - École des hautes études en sciences sociales - Cirad - Centre de Coopération Internationale en Recherche Agronomique pour le Développement - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique); Antonin Pottier (EHESS - École des hautes études en sciences sociales, CIRED - Centre International de Recherche sur l'Environnement et le Développement - Université Paris-Saclay - AgroParisTech - EHESS - École des hautes études en sciences sociales - Cirad - Centre de Coopération Internationale en Recherche Agronomique pour le Développement - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique) |
| Abstract: | Is climate change concerning because of its expected damages, or because of the risk that damages could be very high? Climate damages are uncertain, in particular they depend on whether the accumulation of greenhouse gas emissions will trigger a tipping point. In this article, we investigate how much risk contributes to the Social Cost of Carbon in the presence of a tipping point inducing a higher-damage regime. To do so, we decompose the eect of a tipping point as an increase in expected damages plus a zero-mean risk on damages. First, using a simple analytical model, we show that the SCC is primarily driven by expected damages, while the eect of pure risk is only of second order. Second, in a numerical experiment using a stochastic Integrated Assessment Model, we show that expected damages account for most of the SCC when the tipping point induces a productivity shock lower than 10%, the high end of the range commonly used in the literature. It takes both a large productivity shock and high risk aversion for pure risk to signicantly contribute to the SCC. Our analysis suggests that the risk aversion puzzle, which is the usual nding that risk aversion has a surprisingly little eect on the SCC, occurs since the SCC is well estimated using expected damages only. However, we show that the risk aversion puzzle does not hold for large productivity shocks, as pure risk greatly contributes to the SCC in these cases. Keywords Climate change • Tipping points • Expected utility • Integrated Assessment Models • |
| Date: | 2021–03–12 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-03167567&r=all |
| By: | Hernán Vallejo |
| Abstract: | This article presents a theory of labor discrimination based on the behavior of economic agents that maximize utility and profits. The article makes use of a monopsony that hires workers that have the same labor productivity, to focus on perfect discrimination; discrimination by quantities of labor hired; and discrimination by types of labor hired. The article concludes that in such contexts, workers with the same productivity may be discriminated in wages and quantities of labor hired, when firms make use of their market power; when there are differences in the opportunity costs and the wage elasticities of labor supply among workers; when there is asymmetric information, self-selection and adverse selection; and when firms or governments decide not to allow for wage discrimination. First best minimum wages may contribute to improve employment and welfare, but higher minimum wages may not. |
| Keywords: | Monopsony, labor discrimination, asymmetric information, self-selection, adverse selection, market power |
| JEL: | J31 J42 J71 |
| Date: | 2021–03–24 |
| URL: | http://d.repec.org/n?u=RePEc:col:000089:019139&r=all |
| By: | Alex Evans; Guillermo Angeris; Tarun Chitra |
| Abstract: | Constant Function Market Makers (CFMMs) are a family of automated market makers that enable censorship-resistant decentralized exchange on public blockchains. Arbitrage trades have been shown to align the prices reported by CFMMs with those of external markets. These trades impose costs on Liquidity Providers (LPs) who supply reserves to CFMMs. Trading fees have been proposed as a mechanism for compensating LPs for arbitrage losses. However, large fees reduce the accuracy of the prices reported by CFMMs and can cause reserves to deviate from desirable asset compositions. CFMM designers are therefore faced with the problem of how to optimally select fees to attract liquidity. We develop a framework for determining the value to LPs of supplying liquidity to a CFMM with fees when the underlying process follows a general diffusion. Focusing on a popular class of CFMMs which we call Geometric Mean Market Makers (G3Ms), our approach also allows one to select optimal fees for maximizing LP value. We illustrate our methodology by showing that an LP with mean-variance utility will prefer a G3M over all alternative trading strategies as fees approach zero. |
| Date: | 2021–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2104.00446&r=all |
| By: | Yuan Gao; Christian Kroer; Alex Peysakhovich |
| Abstract: | Computing market equilibria is a problem of both theoretical and applied interest. Much research focuses on the static case, but in many markets items arrive sequentially and stochastically. We focus on the case of online Fisher markets: individuals have linear, additive utility and items drawn from a distribution arrive one at a time in an online setting. We define the notion of an equilibrium in such a market and provide a dynamics which converges to these equilibria asymptotically. An important use-case of market equilibria is the problem of fair division. With this in mind, we show that our dynamics can also be used as an online item-allocation rule such that the time-averaged allocations and utilities converge to those of a corresponding static Fisher market. This implies that other good properties of market equilibrium-based fair division such as no envy, Pareto optimality, and the proportional share guarantee are also attained in the online setting. An attractive part of the proposed dynamics is that the market designer does not need to know the underlying distribution from which items are drawn. We show that these convergences happen at a rate of $O(\tfrac{\log t}{t})$ or $O(\tfrac{(\log t)^2}{t})$ in theory and quickly in real datasets. |
| Date: | 2021–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2103.12936&r=all |