
on Utility Models and Prospect Theory 
Issue of 2021‒09‒06
seventeen papers chosen by 
By:  Marc Fleurbaey (Paris School of Economics); Stéphane Zuber (Centre d'Economie de la Sorbonne, Paris School of Economics) 
Abstract:  How to evaluate and compare social prospects when there may be a risk on i) the actual allocation people will receive; ii) the existence of these future people; and iii) their preferences? This paper investigate this question that may arise when considering policies that endogenously affect future people, for instance climate policy. We show that there is no social ordering that meets minimal requirements of fairness, social rationality, and respect for people's ex ante preferences. We explore three ways to avoid this impossibility. First, if we drop the ex ante Pareto requirement, we can obtain fair ex post criteria that take an (arbitrary) expected utility of an equallydistributed equivalent level of wellbeing. Second, if the social ordering is not an expected utility, we can obtain fair ex ante criteria that assess uncertain individual prospects with a certaintyequivalent measure of wellbeing. Third, if we accept that interpersonal comparisons rely on VNM utility functions even in absence of risk, we can construct expected utility social orderings that satisfy of some version of Pareto ex ante 
Keywords:  Fairness; social risk; intergenerational equity 
JEL:  D63 D81 
Date:  2021–06 
URL:  http://d.repec.org/n?u=RePEc:mse:cesdoc:21018&r= 
By:  Pedro Polvora; Daniel Sevcovic 
Abstract:  Our goal is to analyze the system of HamiltonJacobiBellman equations arising in derivative securities pricing models. The European style of an option price is constructed as a difference of the certainty equivalents to the value functions solving the system of HJB equations. We introduce the transformation method for solving the penalized nonlinear partial differential equation. The transformed equation involves possibly nonconstant the risk aversion function containing the negative ratio between the second and first derivatives of the utility function. Using comparison principles we derive useful bounds on the option price. We also propose a finite difference numerical discretization scheme with some computational examples. 
Date:  2021–08 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:2108.12598&r= 
By:  Ho Ka Chan; Taro Toyoizumi 
Abstract:  Many experimental observations have shown that the expected utility theory is violated when people make decisions under risk. Here, we present a decisionmaking model inspired by the prediction of error signals reported in the brain. In the model, we choose the expected value across all outcomes of an action to be a reference point which people use to gauge the value of different outcomes. Action is chosen based on a nonlinear average of anticipated surprise, defined by the difference between individual outcomes and the abovementioned reference point. The model does not depend on nonlinear weighting of the probabilities of outcomes. It is also straightforward to extend the model to multistep decisionmaking scenarios, in which new reference points are created as people update their expectation when they evaluate the outcomes associated with an action in a cascading manner. The creation of these new reference points could be due to partial revelation of outcomes, ambiguity, or segregation of probable and improbable outcomes. Several economic paradoxes and gambling behaviors can be explained by the model. Our model might help bridge the gap between theories on decisionmaking in quantitative economy and neuroscience. 
Date:  2021–08 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:2108.12347&r= 
By:  Dean Spears (University of Texas at Austin  USA, Indian Statistical Institute Delhi Centre  India, IZA  Germany, IFFS  Sweden); Stéphane Zuber (Centre d'Economie de la Sorbonne, Paris School of Economics) 
Abstract:  Utilitarianism is the most prominent family of social welfare functions. We present three new axiomatic characterizations of utilitarian (that is, additively separable) social welfare functions in a setting where there is risk over both population size and the welfares of individuals. First, we show that, given uncontroversial basic axioms, Blackorby et al.'s (1998) Expected CriticalLevel Generalized Utilitarianism (ECLGU) is equivalent to a new axiom holding that it is better to allocate higher utilityconditionalonexistence to possible people who have a higher probability of existence. The other two novel characterizations extend classic axiomatizations of utilitarianism from settings with either social risk or variablepopulation, considered alone. By considering both social risk and variable population together, we clarify the fundamental normative considerations underlying utilitarian policy evaluation 
Keywords:  Social risk; population ethics; utilitarianism; expected criticallevel generalized utilitarianism; prioritarianism 
JEL:  D63 D81 J10 
Date:  2021–05 
URL:  http://d.repec.org/n?u=RePEc:mse:cesdoc:21017&r= 
By:  Martin Browning; Laurens Cherchye; Thomas Demuynck; Bram De Rock; Frederic Vermeulen 
Abstract:  We present a methodology for the structural empirical analysis of household consumption and time use behaviour under marital stability. Our approach is of the revealed preference type and nonparametric, meaning that it does not require a prior functional specification of individual utilities. Without making use of the transferable utility assumption, but still allowing for monetary transfers, our method can identify individuals' unobserved match qualities and quantify them in money metric terms. We can include both preference factors, affecting individuals' preferences over private and public goods, and match quality factors, driving differences in unobserved match quality. We demonstrate the practical usefulness of our methodology through an application to the Belgian MEqIn data. Our results reveal intuitive patterns of unobserved match quality that allow us to rationalize both the observed matches and the withinhousehold allocations of time and money. 
Keywords:  household consumption, marital stability, unobserved match quality, revealed preference analysis, intrahousehold allocation 
Date:  2021–08–24 
URL:  http://d.repec.org/n?u=RePEc:ete:ceswps:679647&r= 
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) 
Abstract:  The risky investment game of Gneezy and Potters (1997) has been a popular tool used to estimate risk tolerance and myopic loss aversion. Holden and Tilahun (2021) tested and found that the simple oneshot version of this game that is attractive as a simple tool to elicit risk tolerance among respondents with limited education, produce significant endowment effects in two variants of the game where alternatively safe and risky initial monetary endowments are allocated. In this paper, we use an alternative treatment that does not induce endowment effects. This allows us to establish a benchmark to assess the relative size of the endowment effects when initial safe and risky endowments are provided (contribution 1). While Prospect Theory could predict endowment effects in the game, it fails to explain the dominance of interior choices (partial investment). We propose an alternative endowment effect theory that gives predictions that are more consistent with the observed partial investment behavior (contribution 2). 
Keywords:  Risky investment game; Endowment effects; Loss aversion; Utility curvature; Field experiment; Ethiopia 
JEL:  C93 D91 H23 
Date:  2021–09–02 
URL:  http://d.repec.org/n?u=RePEc:hhs:nlsclt:2021_004&r= 
By:  Gordon John Anderson; Teng Wah Leo 
Abstract:  In response to the increasing use of discrete cardinal data with limited numbers of outcomes, Stochastic Dominance Theory is here extended to facilitate its application. Formulae, convenient for analysis, along with necessary and sufficient conditions for different orders of dominance are derived which reveal some key facts which have eluded general attention. In this paradigm, there is a loss of degrees of freedom as the dominance order increases with a concomitant upper bound to the order of dominance that can be considered, both engendered by the restrictions on finite differences between utility functions and the limited number of outcomes. Simple formulae for computing successive sums of cumulative distributions are found, and the relationship between lower and higher order dominance is proven in this discrete cardinal case. 
Keywords:  Stochastic Dominance; Discrete Variables; Cardinal Variables 
JEL:  C14 D63 I32 
Date:  2021–09–01 
URL:  http://d.repec.org/n?u=RePEc:tor:tecipa:tecipa704&r= 
By:  François Gardes (Centre d'Economie de la Sorbonne, Paris School of Economics & Western Catholic University) 
Abstract:  The opportunity cost of time is estimated using a model based on domestic production (depending on monetary and time expenditures) and direct utility (depending on produced commodities). These factors of domestic production are measured by the matching of a Family Budget survey with a Time Use survey. The new model is estimated on Canadian, French, Polish, US and BurkinaFaso statistics. It allows the economic value of human life to be estimated, based on the integration of the marginal value of each instant during an individual's life cycle. This value is shown to give a different pattern across countries compared to their per capita GDP. Finally, the opportunity cost of time is shown to vary between commodities according to the possibility of substituting money and time in domestic production. It also increases between countries relatively to the average wage rate, according to the degree of liberalization of the labor markets 
Keywords:  Opportunity cost of time; value of human life; elasticity of substitution 
JEL:  D13 D91 J17 
Date:  2021–03 
URL:  http://d.repec.org/n?u=RePEc:mse:cesdoc:21023&r= 
By:  Isager, Peder Mortvedt (Eindhoven University of Technology); van 't Veer, Anna Elisabeth (Leiden University); Lakens, Daniel (Eindhoven University of Technology) 
Abstract:  Researchers seeking to replicate original research often need to decide which of several relevant candidates to select for replication. Several strategies for study selection have been proposed, utilizing a variety of observed indicators as criteria for selection. However, few strategies clearly specify the goal of study selection and how that goal is related to the indicators that are utilized. We have previously formalized a decision model of replication study selection in which the goal of study selection is to maximize the expected utility gain of the replication e?ort. We further define the concept of replication value as a proxy for expected utility gain (Isager et al., 2020). In this article, we propose a quantitative operationalization of replication value. We first discuss how value and uncertainty  the two concepts used to determine replication value – could be estimated via information about citation count and sample size. Second, we propose an equation for combining these indicators into an overall estimate of replication value, which we denote RVCn. Third, we suggest how RVCn could be implemented as part of a broader study selection procedure. Finally, we provide preliminary data suggesting that studies that were in fact selected for replication tend to have relatively high RVCn estimates. The goal of this article is to explain how RVCn is intended to work and, in doing so, demonstrate the many assumptions that should be explicit in any replication study selection strategy. 
Date:  2021–08–24 
URL:  http://d.repec.org/n?u=RePEc:osf:metaar:knjea&r= 
By:  Olkhov, Victor 
Abstract:  Asset pricing crucially depends on an averaging time interval Δ of the market trade timeseries. The choice of Δ changes the basic pricing equation and determines Taylor series of investor’s utility functions over current and future values of consumption. We present current and future values of random consumption as sums of the mean values during the interval Δ and perturbations determined by random variations of the price at current moment t and the payoff at day t+1. Linear and quadratic Taylor series’ approximations of the basic pricing equation describe mean price, mean payoff, their volatilities, skewness and the amount of asset ξmax that delivers max to investor’s utility. We believe that the stochasticity of the market trade timeseries must define the random properties of the price and introduce the new price probability measure entirely determined by the probability measures of trading value and volume. We define the set of nth statistical moments of the price as ratio of the nth statistical moment of the value to nth statistical moment of the volume of the market trades performed during the averaging interval Δ. The set of price statistical moments determines the price characteristic function and its Fourier transform defines the new price probability measure. Prediction of the price probability measure requires forecasts of all statistical moments of the trades. Definition of the price probability expresses the catch phrase “You can’t beat the market”. 
Keywords:  asset pricing, volatility, price probability, market trades 
JEL:  C02 D40 D53 G10 G12 
Date:  2021–07–24 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:109238&r= 
By:  François Gardes (CES  Centre d'économie de la Sorbonne  UP1  Université Paris 1 PanthéonSorbonne  CNRS  Centre National de la Recherche Scientifique, UP1  Université Paris 1 PanthéonSorbonne, 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 PanthéonSorbonne  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, UCO  Université Catholique de l'Ouest) 
Abstract:  The opportunity cost of time is estimated using a model based on domestic production (depending on monetary and time expenditures) and direct utility (depending on produced commodities). These factors of domestic production are measured by the matching of a Family Budget survey with a Time Use survey. The new model is estimated on Canadian, French, Polish, US and BurkinaFaso statistics. It allows the economic value of human life to be estimated, based on the integration of the marginal value of each instant during an individual's life cycle. This value is shown to give a different pattern across countries compared to their per capita GDP. Finally, the opportunity cost of time is shown to vary between commodities according to the possibility of substituting money and time in domestic production. It also increases between countries relatively to the average wage rate, according to the degree of liberalization of the labor markets. 
Keywords:  opportunity cost of time,value of human life,elasticity of substitution 
Date:  2021–03 
URL:  http://d.repec.org/n?u=RePEc:hal:journl:halshs03325332&r= 
By:  Hamed Amini; Maxim Bichuch; Zachary Feinstein 
Abstract:  In this paper, we construct a decentralized clearing mechanism which endogenously and automatically provides a claims resolution procedure. This mechanism can be used to clear a network of obligations through blockchain. In particular, we investigate default contagion in a network of smart contracts cleared through blockchain. In so doing, we provide an algorithm which constructs the blockchain so as to guarantee the payments can be verified and the miners earn a fee. We, additionally, consider the special case in which the blocks have unbounded capacity to provide a simple equilibrium clearing condition for the terminal net worths; existence and uniqueness are proven for this system. Finally, we consider the optimal bidding strategies for each firm in the network so that all firms are utility maximizers with respect to their terminal wealths. We first look for a mixed Nash equilibrium bidding strategies, and then also consider Pareto optimal bidding strategies. The implications of these strategies, and more broadly blockchain, on systemic risk are considered. 
Date:  2021–09 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:2109.00446&r= 
By:  Brams, Steven J.; Kilgour, Marc; Klamler, Christian 
Abstract:  Suppose two players wish to divide a finite set of indivisible items, over which each distributes a specified number of points. Assuming the utility of a player’s bundle is the sum of the points it assigns to the items it contains, we analyze what divisions are fair. We show that if there is an envyfree (EF) allocation of the items, two other desirable properties—Paretooptimality (PO) and maximinality (MM)—can also be satisfied, rendering these three properties compatible, but other properties—balance (BL), maximum Nash welfare (MNW), maximum total welfare (MTW), and lexicographic optimality (LO)—may fail. If there is no EF division, as is likely, it is always possible to satisfy EFx, a weaker form of EF, but an EFx allocation may not be PO, BL, MNW, MTW, or LO. Moreover, if one player considers an item worthless (i.e., assigns zero points to it), an EFx division may be Pareto dominated by a nonEFx allocation that is MNW. Although these incompatibilities suggest that there is no “perfect” 2person fair division of indivisible items, EFx and MNW divisions—if they give different allocations when there is no EFPOMM division—seem the most compelling alternatives, with EFx, we conjecture, satisfying the Rawlsian objective of helping the worseoff player and MNW, a modification of MTW, suggesting a more Benthamite view. 
Keywords:  Twoperson fair division; indivisible items; envyfreeness 
JEL:  C7 C71 D6 D61 D63 
Date:  2021–08 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:109395&r= 
By:  Pierlauro Lopez 
Abstract:  More than 20 years of financial market data suggest a term structure of the welfare cost of economic uncertainty that is downwardsloping on average, especially during downturns. This evidence offers guidance in selecting a model to study the benefits of macroeconomic stabilization from a structural perspective. The addition of nonlinear external habit formation to a textbook monetary model can rationalize the evidence. The model is observationally equivalent in its quantity implications to a standard New Keynesian model with CRRA utility, but the optimal policy prescription is overturned. In the model the central bank should prioritize removing consumption volatility (a targeting of risk premia) over filling the gap between consumption and its flexibleprice counterpart (inflation targeting). 
Keywords:  Welfare cost of business cycles; Macroeconomic priorities; Equity and bond yields; Optimal monetary policy; Financial Stability 
JEL:  E32 E44 E61 G12 
Date:  2021–08–30 
URL:  http://d.repec.org/n?u=RePEc:fip:fedcwq:93000&r= 
By:  Juan Wang; Gamze Dane; Harry Timmermans 
Abstract:  Car commuters contribute significantly to carbon emissions and seem largely insensitive to dedicated modal shift transportation policy initiatives. Therefore, integrated policies that target multiple life domains may be more effective. In this study, we investigate commuters’ preferences for carsharing facilitating neighborhoods as well as their potential travel behaviors shift if they move to such neighborhoods. This policy, combining real estate, sustainable planning and transportation, aims to reduce neighborhoods parking needs and therefore parking facilities. In compensation, residents are provided convenient access to shared vehicles against lower costs and a better living environment, reflected in more green space or safer children playing areas or larger flats. To examine the potential interest in moving to such neighborhoods, a stated choice experiment is designed that systematically varies attributes of carsharing facilitating neighborhoods to elicit the utility of a carsharing facilitating neighborhood for commuters with a particular sociodemographic profile and commuting behavior. In total, 369 valid responses from commuters who currently live in urban areas in The Netherlands were gathered for the analysis. To derive the utility of carsharing facilitating neighborhoods of a particular profile, a mixed logit model is estimated. Results indicate that the utility of a carsharing facilitating neighborhood primarily depends on carsharing cost, housing costs and housing size. The utility varies with sociodemographic characteristics, such as living city, educational level, monthly income, work status and commuting behavior, measured in terms of private car ownership, carsharing subscription, commuting mode and commuting time. Regarding shifts in travel mode, 25.5% of the respondents stated that they would reduce private car ownership if they would live in a carsharing facilitating neighborhood. 32.8% of the respondents stated that they would use shared vehicles in such neighborhoods for travelling to the office, and 18.7% stated they would use them to access transit. These results can help real estate developers and policy makers understanding how to develop appealing carsharing facilitating neighbourhoods for targeted commuters groups. 
Keywords:  Carsharing facilitating neighborhoods; Commuting; mixed logit model; Stated Choice Experiment 
JEL:  R3 
Date:  2021–01–01 
URL:  http://d.repec.org/n?u=RePEc:arz:wpaper:eres2021_10&r= 
By:  Elmar Zozmann; Mirjam Helena Eerma; Dylan Manning; Gro Lill {\O}kland; Citlali Rodriguez del Angel; Paul E. Seifert; Johanna Winkler; Alfredo Zamora Blaumann; Leonard G\"oke; Mario Kendziorski; Christian von Hirschhausen 
Abstract:  The paper provides energy systemwide estimates of the effects sufficiency measures in different sectors can have on energy supply and system costs. In distinction to energy efficiency, we define sufficiency as behavioral changes to reduce useful energy without significantly reducing utility, for example by adjusting thermostats. By reducing demand, sufficiency measures are a potentially decisive but seldomly considered factor to support the transformation towards a decarbonized energy system. Therefore, this paper addresses the following question: What is the potential of sufficiency measures and what is their impacts on the supply side of a 100% renewable energy system? For this purpose, an extensive literature review is conducted to obtain estimates for the effects of different sufficiency measures on final energy demand in Germany. Afterwards, the impact of these measures on the supply side and system costs is quantified using a bottomup planning model of a renewable energy system. Results indicate that final energy could be reduced by up to 20.5% and as a result cost reduction between 11.3% to 25.6% are conceivable. The greatest potential for sufficiency measures was identified in the heating sector. 
Date:  2021–09 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:2109.00453&r= 
By:  Nordström, Jonas (AgriFood economics centre); Hammarlund, Cecilia (AgriFood economics centre) 
Abstract:  The increased urbanization and human population growth of recent decades have resulted in the loss of urban green spaces. One policy used to prevent the loss of urban green space is ecological compensation. Ecological compensation is the final step in the mitigation hierarchy; compensation measures should thus be a last resort, after all opportunities to implement the earlier steps of the hierarchy have been exhausted. The compensation should balance the ecological damage, aiming for a “no net loss” of biodiversity and ecosystem services. In this study, we develop a simple model that can be used as tool to study the welfare effects of applying ecological compensation when green space is at risk of being exploited, both at an aggregate level for society and for different groups of individuals. Our focus is on urban green space and the value of the ecosystem service – recreation – that urban green space provides. In a case study we show how the model can be used in the planning process to evaluate the welfare effects of compensation measures at various sites within the city. The results from the case study indicate that factors such as population density and proximity to green space have a large impact on aggregate welfare from green space and on net welfare when different compensation sites are compared against each other. 
Keywords:  Urban green space; Ecological compensation; Recreational value; Wellbeing; Utility; Welfare effects; Distributional effects 
JEL:  D60 Q26 Q50 Q57 R52 R58 
Date:  2021–08–20 
URL:  http://d.repec.org/n?u=RePEc:hhs:luagri:2021_003&r= 