nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2021‒07‒12
fourteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Taking risks by flying paper airplanes By Alfonso-Costillo, Antonio
  2. From Decision in Risk to Decision in Time - and Return: A Restatement of Probability Discounting By Marc-Arthur Diaye; André Lapidus; Christian Schmidt
  3. Consistent Investment of Sophisticated Rank-Dependent Utility Agents in Continuous Time By Ying Hu; Hanqing Jin; Xun Yu Zhou
  4. The Neoclassical Growth Model with Time-Inconsistent Decision Making and Perfect Foresight By Kirill Borissov; Mikhail Pakhnin; Ronald Wendner
  5. Psychological Nash Equilibria under Ambiguity By Giuseppe De Marco; Maria Romaniello; Alba Roviello
  6. The incremental information in the yield curve about future interest rate risk By Bent Jesper Christensen; Mads Markvart Kjær; Bezirgen Veliyev
  7. Reference Dependence and Random Attention By Matthew Kovach; Elchin Suleymanov
  8. Of two minds: An experiment on how time scarcity shapes risk-taking behavior By Sergio Almeida; Mauro Rodrigues
  9. Predicting choice-averse and choice-loving behaviors in a field experiment with actual shoppers By Ong, David
  10. Reconciling Normative and Behavioural Economics: The Problem that Cannot be Solved By Guilhem Lecouteux
  11. Incentive-Compatible Kidney Exchange in a Slightly Semi-Random Model By Avrim Blum; Paul G\"olz
  12. People-focused and Near-term Public Transit Performance Analysis By Karner, Alex
  13. The Identification of Non-Rational Risk Shocks By Böck, Maximilian
  14. Subjective income risk and precautionary saving By Castaldo, Stefano; Tirelli, Mario

  1. By: Alfonso-Costillo, Antonio
    Abstract: We report the results of an outdoor activity conducted in game theory courses where students were invited to throw airplanes in order to win a prize. They flew self-made paper airplanes to earn points in three trials. The main purpose of these outdoor classroom experiments was to incentive students to learn by experiencing concepts of uncertainty in the gain domain (risk aversion). After throwing the airplanes, the students thought about decisions under uncertainty. Specifically, we provide a theoretical model to explain the subjects’ decisions, optimal behavior, and deviations from that behavior. Overall, our activity creates a setting to foster students’ interest in the study of decision making under uncertainty.
    Keywords: Classroom experiments, flipped classroom, expected utility theory, risk taking
    JEL: A22 C70 C99
    Date: 2021–06
  2. By: Marc-Arthur Diaye (CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); André Lapidus (PHARE - Philosophie, Histoire et Analyse des Représentations Économiques - UP1 - Université Paris 1 Panthéon-Sorbonne); Christian Schmidt (PHARE - Philosophie, Histoire et Analyse des Représentations Économiques - UP1 - Université Paris 1 Panthéon-Sorbonne)
    Abstract: This paper aims at restating, in a decision theory framework, the results of some signicant contributions of the literature on probability discounting that followed the publication of the pioneering article by Rachlin et al. (1991). We provide a restatement of probability discounting in terms of rank-dependent utility, in which the utilities of the outcomes of n-issues lotteries are weighted by probabilities transformed after their transposition into time-delays. This formalism makes the typical cases of rationality in time and in risk mutually exclusive, but allows looser types of rationality. The resulting attitude toward probability and toward risk are then determined in relation to the values of the two parameters involved in the procedure of probability discounting.
    Keywords: time discounting,Probability discounting,logarithmic time perception,rank-dependent utility,rationality,attitude toward probabilities,attitude toward risk
    Date: 2021–06–10
  3. By: Ying Hu (IRMAR - Institut de Recherche Mathématique de Rennes - UR1 - Université de Rennes 1 - UNIV-RENNES - Université de Rennes - AGROCAMPUS OUEST - Institut Agro - Institut national d'enseignement supérieur pour l'agriculture, l'alimentation et l'environnement - INSA Rennes - Institut National des Sciences Appliquées - Rennes - INSA - Institut National des Sciences Appliquées - UNIV-RENNES - Université de Rennes - ENS Rennes - École normale supérieure - Rennes - UR2 - Université de Rennes 2 - UNIV-RENNES - Université de Rennes - CNRS - Centre National de la Recherche Scientifique); Hanqing Jin (University of Oxford [Oxford]); Xun Yu Zhou
    Abstract: We study portfolio selection in a complete continuous-time market where the preference is dictated by the rank-dependent utility. As such a model is inherently time inconsistent due to the underlying probability weighting, we study the investment behavior of sophisticated consistent planners who seek (subgame perfect) intra-personal equilibrium strategies. We provide sufficient conditions under which an equilibrium strategy is a replicating portfolio of a final wealth. We derive this final wealth profile explicitly, which turns out to be in the same form as in the classical Merton model with the market price of risk process properly scaled by a deterministic function in time. We present this scaling function explicitly through the solution to a highly nonlinear and singular ordinary differential equation, whose existence of solutions is established. Finally, we give a necessary and sufficient condition for the scaling function to be smaller than 1 corresponding to an effective reduction in risk premium due to probability weighting.
    Keywords: Rank-dependent utility,probability weighting,portfolio selection,con- tinuous time,time inconsistency,intra-personal equilibrium strategy,market price of risk
    Date: 2021–05–28
  4. By: Kirill Borissov (European University at St. Petersburg, Russia); Mikhail Pakhnin (European University at St. Petersburg, Russia); Ronald Wendner (University of Graz, Austria)
    Abstract: In this paper, we propose an approach to describe the behavior of naïve agents with quasi-hyperbolic discounting in the neoclassical growth model. To study time-inconsistent decision making of an agent who cannot commit to future actions, we introduce the notion of sliding equilibrium and distinguish between pseudo-perfect foresight and perfect foresight. The agent with pseudo-perfect foresight revises both the consumption path and expectations about prices; the agent with perfect foresight correctly foresees prices in a sliding equilibrium and is naive only about their time inconsistency. We prove the existence of sliding equilibria for the class of isoelastic utility functions and show that generically consumption paths are not the same under quasi-hyperbolic and exponential discounting. Observational equivalence only holds in the well-known cases of a constant interest rate or logarithmic utility. Our results suggest that perfect foresight implies a higher long-run capital stock and consumption level than pseudo-perfect foresight.
    Keywords: Quasi-hyperbolic discounting; Observational equivalence; Time inconsistency; Naive agents; Sliding equilibrium; Perfect foresight.
    JEL: D15 D91 E21 O40
    Date: 2021–08
  5. By: Giuseppe De Marco (Università di Napoli Parthenope, Università di Napoli Federico II and CSEF); Maria Romaniello (Università della Campania Luigi Vanvitelli); Alba Roviello (Università della Campania Luigi Vanvitelli)
    Abstract: Psychological games aim to represent situations in which players have belief-dependent motivations or believe that their opponents have belief-dependent motivations. In this setting, utility functions are directly dependent on the entire hierarchy of beliefs of each player. On the other hand, the literature on strategic ambiguity in classical games highlights that players may have ambiguous (or imprecise) beliefs about opponents' strategy choices. In this paper, we look at the issue of strategic ambiguity in the framework of psychological games by taking into account ambiguous hierarchies of beliefs and we study the natural generalization of the psychological Nash equilibrium concept to this framework. We give an existence result for this new concept of equilibrium and provide examples that show that even an infinitesimal amount of ambiguity may alter significantly the equilibria of the game or can work as an equilibrium selection device. Finally, we look at the problem of stability of psychological equilibria with respect to ambiguous trembles on the entire hierarchy of correct beliefs and we provide a limit result that gives conditions so that sequences of psychological equilibria under ambiguous perturbation converge to psychological equilibria of the unperturbed game.
    Keywords: Psychological Games, Ambiguous Beliefs, Equilibrium Existence, Equilibrium Selection.
    Date: 2021–06–28
  6. By: Bent Jesper Christensen (Aarhus University and CREATES and the Dale T. Mortensen Center); Mads Markvart Kjær (Aarhus University and CREATES); Bezirgen Veliyev (Aarhus University and CREATES and the Danish Finance Institute)
    Abstract: Using high-frequency intraday futures prices to measure yield volatility at selected maturities, we find that daily yield curves carry incremental information about future interest rate risk at the long end, relative to that contained in the time series of historical volatilities. Some of the information in the yield curves is not captured by standard affine models. At the short end, time series based forecasts outperform yield curve based forecasts. Both provide utility to a risk averse investor in longerterm instruments, not in short, relative to a random walk. Our results point to the existence of an unspanned volatility factor.
    Keywords: Term structure models, Volatility, Forecasting, Kalman filtering, Yield curve
    JEL: C58 E43 G12
    Date: 2021–07–01
  7. By: Matthew Kovach; Elchin Suleymanov
    Abstract: We explore the ways that a reference point may direct attention. Utilizing a stochastic choice framework, we provide behavioral foundations for the Reference- Dependent Random Attention Model (RD-RAM). Our characterization result shows that preferences may be uniquely identified even when the attention process depends arbitrarily on both the menu and the reference point. The RD-RAM is able to capture rich behavioral patterns, including frequency reversals among non-status quo alternatives and choice overload. We also analyze specific attention processes, characterizing reference-dependent versions of several prominent models of stochastic consideration.
    Date: 2021–06
  8. By: Sergio Almeida; Mauro Rodrigues
    Abstract: Several studies report that the brain evaluates prospects and executes decisions as the outcome of two mental processing types: one described as slow and reflective and the other as fast and intuitive. We investigate how these two mental processes affect risk-taking behavior by using time pressure to establish an intuitive response. We observe that time constraints do not change risk attitudes. Furthermore, it is only when subjects are given ample time to decide and instructed to reflect that they show the well-documented shift of risk preferences across the domain of losses and gains.
    Keywords: Risk-taking; time scarcity; dual-process cognition; fast-thinking; gain-loss framing
    JEL: D91 D90 C91 D81
    Date: 2021–07–01
  9. By: Ong, David
    Abstract: A large body of chiefly laboratory research has attempted to demonstrate that people can exhibit choice-averse behavior from cognitive overload when faced with many options. However, meta-analyses of these studies, which are generally of one or two product lines, reveal conflicting results. Findings of choice-averse behavior are balanced by findings of choice-loving behavior. Unexplored is the possibility that many consumers may purchase to reveal their tastes for unfamiliar products, rather than attempt to forecast their tastes before purchase. I model such ‘sampling-search’ behavior and predict that the purchases of unfamiliar consumers increase with the available number of varieties for popular/mainstream product lines and decrease for niche product lines. To test these predictions, I develop a measure of popularity based on a survey of 1,440 shoppers for their preferences over 24 product lines with 339 varieties at a large supermarket in China. 35,694 shoppers were video recorded after the varieties they faced on shelves were randomly reduced. As found in the meta-studies, choice-averse behavior was balanced by choice-loving behavior. However, as predicted, the probability of choice-loving behavior increases with the number of available varieties for popular product lines, whereas choice-averse behavior increases with available varieties for niche product lines. These findings suggest that increasing the number of varieties has predictable opposing effects on sales, depending upon the popularity of the product line, and opens the possibility of reconciling apparently conflicting prior results.
    Keywords: field experiment, choice overload, choice-aversion, consumer search
    JEL: C93 D83 M31
    Date: 2021–06–21
  10. By: Guilhem Lecouteux (Université Côte d'Azur; GREDEG CNRS)
    Abstract: Behavioural economics has challenged the normative consensus that agents ought to choose following their own preferences. I argue that normative economists implicitly defended a criterion of the sovereignty of the autonomous consumer, and that current debates in normative behavioural economics arise from disagreements about the nature of the threats to autonomy that are highlighted by behavioural economics. I argue that those disagreements result from diverging ontological conceptions of the ‘self’ in the literature. I distinguish between the unitary, psychodynamic, and socio-historical conceptions of the self, and show how different positive theories about preferences and the nature of the agent may determine normative positions in normative behavioural economics.
    Keywords: preference satisfaction, autonomy, welfare, reconciliation problem, sociohistorical self
    JEL: B40 D02 D60 D91
    Date: 2021–06
  11. By: Avrim Blum; Paul G\"olz
    Abstract: Motivated by kidney exchange, we study the following mechanism-design problem: On a directed graph (of transplant compatibilities among patient-donor pairs), the mechanism must select a simple path (a chain of transplantations) starting at a distinguished vertex (an altruistic donor) such that the total length of this path is as large as possible (a maximum number of patients receive a kidney). However, the mechanism does not have direct access to the graph. Instead, the vertices are partitioned over multiple players (hospitals), and each player reports a subset of her vertices to the mechanism. In particular, a player may strategically omit vertices to increase how many of her vertices lie on the path returned by the mechanism. Our objective is to find mechanisms that limit incentives for such manipulation while producing long paths. Unfortunately, in worst-case instances, competing with the overall longest path is impossible while incentivizing (approximate) truthfulness, i.e., requiring that hiding nodes cannot increase a player's utility by more than a factor of $1 + o(1)$. We therefore adopt a semi-random model where a small ($o(n)$) number of random edges are added to worst-case instances. While it remains impossible for truthful mechanisms to compete with the overall longest path, we give a truthful mechanism that competes with a weaker but non-trivial benchmark: the length of any path whose subpaths within each player have a minimum average length. In fact, our mechanism satisfies even a stronger notion of truthfulness, which we call matching-time incentive compatibility. This notion of truthfulness requires that each player not only reports her nodes truthfully but also does not stop the returned path at any of her nodes in order to divert it to a continuation inside her own subgraph.
    Date: 2021–06
  12. By: Karner, Alex
    Abstract: Public transit ridership forecasts have long played a role in understanding the potential success of a policy or investment, but their limitations have led researchers and practitioners to identify other performance analysis approaches. Accessibility, or the ease of reaching opportunities, has become very popular and widely used for this purpose. But commonly used accessibility measures also embody weaknesses that are seldom acknowledged; these limit their utility for truly understanding the benefits of transit investments. In this paper, we identify the pros and cons of these competing approaches and offer a third strategy. Specifically, we describe how revealed travel behavior data, potentially combined with near-term forecasts, can provide information about how current public transit users will be affected by a new project. While acknowledging the limitations of this approach, we demonstrate how accessibility can be misleading when applied without an understanding of ridership patterns.
    Date: 2021–06–30
  13. By: Böck, Maximilian
    Abstract: This paper studies how non-rational risk shocks affect the macroeconomy. Using a novel identification design which exploits survey data on expectations of financial executives in the US, I identify non-rational risk shocks via distortions in beliefs. Belief distortions are measured through surprises in beliefs of credit spreads, defined as the difference between subjective and objective forecasts. They are then used as a proxy for exogenous variation in the risk premium. Belief distortions elicit due to overreaction of credit spreads, eventually leading to exaggerated beliefs on financial markets. Results indicate that the constructed shocks have statistically and economically meaningful effects. This has sizeable consequences for the U.S. economy: A positive non-rational risk shock moves credit spreads remarkably while real activity and the stock market decline.
    Keywords: Business Cycles, Risk Shocks, Belief Distortions
    Date: 2021–06
  14. By: Castaldo, Stefano; Tirelli, Mario
    Abstract: Econometric studies have produced conflicting results on the relevance of precautionary saving. This ambiguity has been often ascribed to i) the difficulty of measuring key variables, like households' subjective risk in income and permanent income; ii) the occurrence of certain kinds of endogeneity bias associated to the unobservability of individual characteristics, like preferences and insurance possibilities. In the present work we investigate these estimation problems exploiting a particular wave of the Italian Survey of Household Income and Wealth which contains both type of information. Our results quantify the average precautionary saving as 4-5 percent of total net wealth. Moreover, excluding illiquid assets like the primary home and business equities, a figure of about 5 percent is statistically invariant to the alternative measures of wealth considered. This 'invariance' reveals a tendency of households to respond to a change in their perceived income risk by rescaling their (liquid) portfolio. We also discuss how the use of richer information on the household characteristics unveils how various kinds of 'bias' might affect estimates in opposite directions and with different intensities.
    Keywords: Precautionary saving; wealth accumulation; preferences; liquidity constraints
    JEL: C21 D12 D91
    Date: 2021–06–10

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