nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2021‒11‒22
ten papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Modeling ex-ante risk premia in the oil market By Remzi Uctum; Georges Prat
  2. Regime Switching Optimal Growth Model with Risk Sensitive Preferences By Anindya Goswami; Nimit Rana; Tak Kuen Siu
  3. Costly Trading By Michael Isichenko
  4. Reference Points and the Tradeoff between Risk and Incentives By Dohmen, Thomas; Non, Arjan; Stolp, Tom
  5. Tax evasion, behavioral microsimulation models and flat-rate tax reforms. Analysis for Italy By Andrea Albarea; Michele Bernasconi; Anna Marenzi; Dino Rizzi
  6. The role of risk attitudes and expectations in household borrowing in Estonia By Eva Brandten
  7. Passive or Active? Behavioral changes in different designs of search experiments By Yuta Kittaka; Ryo Mikami; Natsumi Shimada
  8. Rational play in games: A behavioral approach By Giacomo Bonanno
  9. Urban Consumers’ Preferences and Willingness to Pay for Orphan Crop Products: Evidence from a Choice Experiment on Porridge in Kenya By Akaichi, Faical; Ciera, Nichola; Revoredo-Giha, Cesar
  10. Adopting Index Insurance and/or Precautionary Savings: Peer Effects in Complex Decision-Making in Uzbek Experiments By Moritz, Laura; Kuhn, Lena; Bobojonov, Ihtiyor; Glauben, Thomas

  1. By: Remzi Uctum; Georges Prat
    Abstract: Using Consensus Economics survey-based data we show that oil price expectations are not rational, implying that the ex-ante premium is a more relevant concept than the widely popular ex-post premium. We propose for the 3- and 12-month horizons a portfolio choice model with risky oil assets and a risk-free asset. At the maximized expected utility the risk premium is defined as the product of the risk price by the expected oil return volatility. We show that the representative investor can be risk averse or risk seeking depending on the state of nature, implying that the price of risk is positive or negative, respectively. The price of risk and expected volatility being unobservable magnitudes, a state-space model, where the risk prices are represented as stochastic unobservable components and where expected volatilities depend on historical squared returns, is estimated using Kalman filtering. We find evidence of significant disparities of risk prices according to horizons: higher amplitudes and risk seeking behaviour are associated with short horizons and lower fluctuations and risk aversion attitude characterize longer horizons. We show that macroeconomic, financial and oil market-related factors drive risk prices whose signs are consistent with the predictions of prospect theory. An upward sloped term structure of oil risk premia prevails in average over the period.
    Keywords: oil market, oil price expectations, ex-ante risk premium
    JEL: D81 G11 Q43
    Date: 2021
  2. By: Anindya Goswami; Nimit Rana; Tak Kuen Siu
    Abstract: We consider a risk-sensitive optimization of consumption-utility on infinite time horizon where the one-period investment gain depends on an underlying economic state whose evolution over time is assumed to be described by a discrete-time, finite-state, Markov chain. We suppose that the production function also depends on a sequence of i.i.d. random shocks. For the sake of generality, the utility and the production functions are allowed to be unbounded from above. Under the Markov regime-switching model, it is shown that the value function of optimization problem satisfies an optimality equation and that the optimality equation has a unique solution in a particular class of functions. Furthermore, we show that an optimal policy exists in the class of stationary policies. We also derive the Euler equation of optimal consumption. Furthermore, the existence of the unique joint stationary distribution of the optimal growth process and the underlying regime process is examined. Finally, we present a numerical solution by considering a regime switching extension of Cobb-Douglas production function with power utility.
    Date: 2021–10
  3. By: Michael Isichenko
    Abstract: We revisit optimal execution of an active portfolio in the presence of slippage (aka linear, proportional, or absolute-value) costs. Market efficiency implies a close balance between active alphas and trading costs, so even small changes to trading optimization can make a big difference. It has been observed for some time that optimal trading involves a pattern of a no-trade zone with width $\Delta$ increasing with slippage cost parameter $c$. In a setting of a reasonably stable (non-stochastic) forecast of future returns and a quadratic risk aversion, it is shown that $\Delta\sim c^{1/2}$, which differs from the $\Delta\sim c^{1/3}$ scaling reported for stochastic settings. Analysis of optimal trading employs maximization of a utility including projected alpha-based profits, slippage costs, and risk aversion and borrows from a physical analogy of forced motion in the presence of friction.
    Date: 2021–10
  4. By: Dohmen, Thomas (University of Bonn and IZA); Non, Arjan (Erasmus University Rotterdam); Stolp, Tom (SEO Amsterdam)
    Abstract: We conduct laboratory experiments to investigate basic predictions of principal-agent theory about the choice of piece rate contracts in the presence of output risk, and provide novel insights that reference dependent preferences affect the tradeoff between risk and incentives. Subjects in our experiments choose their compensation for performing a real-effort task from a menu of linear piece rate and fixed payment combinations. As classical principal-agent models predict, more risk averse individuals choose lower piece rates. However, in contrast to those predictions, we find that low-productivity risk averse workers choose higher piece rates when the riskiness of the environment increases. We hypothesize that reference points affect piece rate choice in risky environments, such that individuals whose expected earnings would exceed (fall below) the reference point in a risk-free environment behave risk averse (seeking) in risky environments. In a second experiment, we exogenously manipulate reference points and confirm this hypothesis.
    Keywords: incentive, piece-rate, risk, reference point, laboratory experiment
    JEL: D81 D91 M52
    Date: 2021–11
  5. By: Andrea Albarea (Department of Economics, University Of Venice CÃ Foscari); Michele Bernasconi (Department of Economics, University Of Venice CÃ Foscari); Anna Marenzi (Department of Economics, University Of Venice CÃ Foscari); Dino Rizzi (Department of Economics, University Of Venice CÃ Foscari)
    Abstract: It is sometimes argued that a flat-rate tax reform can reduce tax noncompliance. The argument is, however, inconsistent with the so-called Yitzhaki’ s puzzle of the classical expected utility (EU) model. The latter predicts an increase, rather than a reduction, in tax evasion following a cut in the tax rates resulting from a flat-rate reform. We study the impact of a flat-rate tax in a microsimulation tax-benefit model of Italy which allows us to analyse various hypotheses of tax evasion behavior. In addition to the EU model, we analyse expected utility with rank dependent probabilities (EURDP) and the model of reference dependent (RD) preference, the most favourable to overturn Yitzhaki’ s puzzle. Our simulations show that a flat-rate tax would barely reduce overall evasion in Italy in all models considered. Redistributive effects are in all cases large.
    Keywords: Fiscal reforms, tax evasion, reference dependent preferences
    JEL: H20 H26 H30
    Date: 2021
  6. By: Eva Brandten
    Abstract: This study investigates the relations between risk attitudes and expectations and different aspects of borrowing by households in Estonia. The central research question is whether risk aversion and optimism provide additional information beyond the main economic and sociodemographic characteristics in explaining borrowing behaviour. The paper uses microdata from the Estonian Household Finance and Consumption Survey (HFCS) to estimate probit and Heckman models. My analysis shows that risk-tolerant households apply for loans more often than risk-averse households do and that their loans are larger. For mortgage loans, risk aversion is related to the probability of having a loan, whereas for non-mortgage loans, risk aversion is related to the size of the outstanding liabilities. The variables describing the household’s expectations for its future financial situation are on their own related to the decision to apply for a loan, but they do not contain any relevant additional information beyond the main economic and sociodemographic characteristics of the household
    Keywords: household debt, mortgage loans, non-mortgage loans, borrowing decisions, income and price expectations, risk attitudes, Household Finance and Consumption Survey
    JEL: G51 D14
    Date: 2021–11–10
  7. By: Yuta Kittaka; Ryo Mikami; Natsumi Shimada
    Abstract: While search experiments are available in several designs, accumulating experimental evidence suggests that individual search behavior depends on design details. This paper reports the first classification and comparison of several search experiment designs widely accepted in search studies. These designs can be categorized as passive, quasi-active, and active. We found individual- and aggregate-level significant differences in the results across designs, despite identical models. In the passive design, subjects tended to be more reluctant to search than in the active design, and risk-averse subjects quickly terminated their search. Our results highlight the importance and potentials of designing search environments in practice.
    Date: 2021–11
  8. By: Giacomo Bonanno (Department of Economics, University of California Davis)
    Abstract: We argue in favor of a departure from the standard equilibrium approach in game theory in favor of the less ambitious goal of describing only the actual behavior of rational players. We investigate the notion of rationality in behavioral models of extensive-form games (allowing for imperfect information), where a state is described in terms of a play of the game instead of a strategy profile. The players' beliefs are specified only at reached decision histories and are modeled as pre-choice beliefs, allowing us to carry out the analysis without the need for (objective or subjective) counterfactuals. The analysis is close in spirit to the literature on self-confirming equilibrium, but it does not rely on the notion of strategy. We also provide a characterization of rational play that is compatible with pure-strategy Nash equilibrium.
    Keywords: Rationality, extensive-form game, self-confirming equilibrium, Nash equilibrium, behavioral model
    JEL: C7
    Date: 2021–11–17
  9. By: Akaichi, Faical; Ciera, Nichola; Revoredo-Giha, Cesar
    Keywords: Consumer/Household Economics
    Date: 2021–08
  10. By: Moritz, Laura; Kuhn, Lena; Bobojonov, Ihtiyor; Glauben, Thomas
    Keywords: Risk and Uncertainty
    Date: 2021–08

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