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on Utility Models and Prospect Theory |
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Issue of 2022‒01‒31
sixteen papers chosen by |
| By: | Amélie Fievet (UP1 - Université Paris 1 Panthéon-Sorbonne) |
| Abstract: | This contribution aims to highlight a neglected aspect of Samuelson's famous 1937 paper "A Note on Measurement of Utility". Although the 1937 paper is usually regarded as the foundation of discounted utility theory, and rightly so, it is primarily concerned with utility measurement and deals only indirectly with decision over timeintertemporal issues appearing as a by-product of the realisation of a unique utility measure. But the treatment of discounted utility in turn influenced Samuelson's understanding of cardinality. Cardinality appears here as the result of a cognitive ability that manifests when agents face a decision experiment over time in which they are compelled to cardinalize their utility functions. The result is the weak plausibility of cardinality in a more general context, such that, contrary to the usual views, we may say that Samuelson's ordinalist approach was already in the making in 1937. |
| Keywords: | Paul Samuelson,discounted utility,measure of utility |
| Date: | 2021 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-03453458&r= |
| By: | Tomoyuki Nakajima (Faculty of Economics, The University of Tokyo) |
| Date: | 2021–12 |
| URL: | http://d.repec.org/n?u=RePEc:tky:fseres:2021cf1182&r= |
| By: | Marcos Escobar-Anel; Matt Davison; Yichen Zhu |
| Abstract: | This paper challenges the use of stocks in portfolio construction, instead we demonstrate that Asian derivatives, straddles, or baskets could be more convenient substitutes. Our results are obtained under the assumptions of the Black--Scholes--Merton setting, uncovering a hidden benefit of derivatives that complements their well-known gains for hedging, risk management, and to increase utility in market incompleteness. The new insights are also transferable to more advanced stochastic settings. The analysis relies on the infinite number of optimal choices of derivatives for a maximized expected utility (EUT) agent; we propose risk exposure minimization as an additional optimization criterion inspired by regulations. Working with two assets, for simplicity, we demonstrate that only two derivatives are needed to maximize utility while minimizing risky exposure. In a comparison among one-asset options, e.g. American, European, Asian, Calls and Puts, we demonstrate that the deepest out-of-the-money Asian products available are the best choices to minimize exposure. We also explore optimal selections among straddles, which are better practical choices than out-of-the-money Calls and Puts due to liquidity and rebalancing needs. The optimality of multi-asset derivatives is also considered, establishing that a basket option could be a better choice than one-asset Asian call/put in many realistic situations. |
| Date: | 2022–01 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2201.03717&r= |
| By: | Belot, Michele; Kircher, Philipp (Université catholique de Louvain, LIDAM/CORE, Belgium); Muller, Paul |
| Abstract: | We propose a simple method for eliciting individual time preferences without estimating utility functions even in settings where background consumption changes over time. It relies on eliciting preferences for receiving high stakes lottery tickets at different points in time. In a standard intertemporal choice model high rewards decouple lottery choices from variation in background consumption. We validate our elicitation method experimentally on a student sample split into two groups: one asked in December when their current budget is reduced by extraordinary expenditures for Christmas gifts; the other asked in February when no such extra constraints exist. We illustrate an application of our method with unemployed job seekers which naturally have income/consumption variation. |
| Keywords: | Time preferences ; experimental elicitation ; job search ; hyperbolic discounting |
| JEL: | D90 J64 |
| Date: | 2021–12–01 |
| URL: | http://d.repec.org/n?u=RePEc:cor:louvco:2021035&r= |
| By: | Dehez, Pierre (Université catholique de Louvain, LIDAM/CORE, Belgium) |
| Abstract: | 1-convex games have been introduced by Theo Driessen in his 1985 PhD dissertation. They form an interesting class of games for at least one reason: the core of a 1-convex n-player game is a regular simplex of dimension n – 1 or a single point. As a consequence, its nucleolus is the center of gravity of the core. We recall and extend the results obtained by Driessen and provide examples and applications. |
| Keywords: | Transferable utility games ; core ; nucleolus ; Shapley value |
| JEL: | C71 |
| Date: | 2021–11–01 |
| URL: | http://d.repec.org/n?u=RePEc:cor:louvco:2021016&r= |
| By: | Vincent Meisner; Jonas von Wangenheim |
| Abstract: | Evidence suggests that participants in direct student-proposing deferred-acceptance mechanisms (DA) play dominated strategies. To explain the data, we introduce expectation-based loss aversion into a school-choice setting and characterize choice-acclimating personal equilibria in DA. We find that non-truthful preference submissions can be strictly optimal if and only if they are top-choice monotone. In equilibrium, DA may implement allocations with justified envy. Specifically, it discriminates against students who are more loss averse or less confident than their peers, and amplifies already existing discrimination. To level the playing field, we propose sequential mechanisms as alternatives that are robust to these biases. |
| Keywords: | market design, matching, school choice, reference-dependent preferences, loss aversion, deferred acceptance |
| JEL: | C78 D47 D78 D81 D82 D91 |
| Date: | 2021 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_9479&r= |
| By: | Martin M. Andreasen; Giovanni Caggiano; Efrem Castelnuovo; Giovanni Pellegrino |
| Abstract: | This paper uses a nonlinear vector autoregression and a non-recursive identification strategy to show that an equal-sized uncertainty shock generates a larger contraction in real activity when growth is low (as in recessions) than when growth is high (as in expansions). An estimated New Keynesian model with recursive preferences and approximated to third order around its risky steady state replicates these state-dependent responses. The key mechanism behind this result is that firms display a stronger upward nominal pricing bias in recessions than in expansions, because recessions imply higher inflation volatility and higher marginal utility of consumption than expansions. |
| Keywords: | New Keynesian Model, Nonlinear SVAR, Non-recursive identification, State-dependent uncertainty shock, Risky steady state |
| Date: | 2021–09 |
| URL: | http://d.repec.org/n?u=RePEc:een:camaaa:2021-83&r= |
| By: | Benjamin Enke; Thomas W. Graeber |
| Abstract: | This paper studies the relevance of cognitive uncertainty – subjective uncertainty over one’s utility-maximizing action – for understanding and predicting intertemporal choice. The main idea is that when people are cognitively noisy, such as when a decision is complex, they implicitly treat different time delays to some degree alike. By experimentally measuring and manipulating cognitive uncertainty, we document three economic implications of this idea. First, cognitive uncertainty explains various core empirical regularities, such as why people often appear very impatient, why per-period impatience is smaller over long than over short horizons, why discounting is often hyperbolic even when the present is not involved, and why choices frequently violate transitivity. Second, impatience is context-dependent: discounting is substantially more hyperbolic when the decision environment is more complex. Third, cognitive uncertainty matters for choice architecture: people who are nervous about making mistakes are twice as likely to follow expert advice to be more patient. |
| Keywords: | cognitive uncertainty, intertemporal choice, complexity |
| Date: | 2021 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_9472&r= |
| By: | Issouf Abdou (Université des Comores); Philibert Andriamanantena (Université de Fianarantsoa); Mamy Raoul Ravelomanana; Rivo Rakotozafy (Université de Fianarantsoa) |
| Abstract: | This article, which is part of the general framework of mathematics applied to economics, is a decision-making model in total ignorance. Such an environment is characterized by the absence of a law of distribution of the states of nature allowing having good forecasts or anticipations. Based primarily on the integral of Choquet, this model allows aggregating the different states of nature in order to make a better decision. This integral of Choquet imposes itself with respect to the complexity of the environment and also by its relevance of aggregation of the interactive or conflicting criteria. The present model is a combination of the Schmeidler model and the Brice Mayag algorithm for the determination of Choquet 2-additive capacity. It fits into the framework of subjective models and provides an appropriate response to the Ellsberg paradox. |
| Abstract: | Cet article qui s'inscrit dans le cadre général des mathématiques appliquées à l'économie est un modèle de prise de décision dans l'ignorance totale. Un tel environnement est caractérisé par l'absence d'une loi de distribution des états de la nature permettant d'avoir des bonnes prévisions ou anticipations. Se basant principalement sur l'intégrale de Choquet, ce modèle permet d'agréger les différents états de la nature afin de prendre une meilleure décision. Cette intégrale de Choquet s'impose par rapport à la complexité de l'environnement et aussi par son caractère pertinent d'agrégation des critères interactifs ou conflictuels. Le présent modèle est une combinaison du modèle de Schmeidler et de l'algorithme de Brice Mayag pour la détermination de la capacité 2-additive de Choquet. Il s'inscrit dans le cadre des modèles subjectifs et apporte une réponse appropriée au paradoxe d'Ellsberg. |
| Keywords: | Choquet Integral,Utility,Subjective Preferences,Intégrale de Choquet,Utilité,Préférences Subjectives,Incertitude,Mesure floue,Uncertainty,Fuzzy measure |
| Date: | 2021–12–17 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-02344256&r= |
| By: | Anna Bogomolnaia (HSE St Petersburg - Higher School of Economics - St Petersburg, University of Glasgow, CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Hervé Moulin (University of Glasgow); Fedor Sandomirskiy (HSE St Petersburg - Higher School of Economics - St Petersburg) |
| Abstract: | Ann likes oranges much more than apples; Bob likes apples much more than oranges. Tomorrow they will receive one fruit that will be an orange or an apple with equal probability. Giving one half to each agent is fair for each realization of the fruit. However, agreeing that whatever fruit appears will go to the agent who likes it more gives a higher expected utility to each agent and is fair in the average sense: in expectation, each agent prefers the allocation to the equal division of the fruit; that is, the agent gets a fair share. We turn this familiar observation into an economic design problem: upon drawing a random object (the fruit), we learn the realized utility of each agent and can compare it to the mean of the agent's distribution of utilities; no other statistical information about the distribution is available. We fully characterize the division rules using only this sparse information in the most efficient possible way while giving everyone a fair share. Although the probability distribution of individual utilities is arbitrary and mostly unknown to the manager, these rules perform in the same range as the best rule when the manager has full access to this distribution. This paper was accepted by Ilia Tsetlin, behavioral economics and decision analysis. |
| Date: | 2021–03–23 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-03507995&r= |
| By: | Fynn Kemper; Philipp Christoph Wichardt |
| Abstract: | This paper proposes a simple framework to model contextual influences on procedural decision making. In terms of utility, we differentiate between monetary payoffs and contextual psychological ones, e.g. deriving from the subjects’ normative frame of reference. Monetary payoffs are treated as common knowledge while psychological payoffs are treated as partly unforeseeable. Regarding behaviour, we assume that players act optimal given their local perception of the game. As perceptions may be incorrect, we do not consider common equilibrium conditions but instead require strategies to be procedurally justifiable. As we will argue, various common inconsistencies considered in behavioural economics can be understood as procedurally justifiable behaviour. With the present framework, we add an abstract tool to the discussion which allows to consider also the behavioural implications of players foreseeing the corresponding behavioural effects - which is often not considered in the respective original models. |
| Keywords: | behavioural inconsistencies, context effects, limited foresight, procedural decision making, utility |
| JEL: | C70 D01 D91 |
| Date: | 2021 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_9459&r= |
| By: | Takao Asano (Okayama University); Yusuke Osaki (Waseda University) |
| Abstract: | This paper considers precautionary saving against the correlation between two risky attributes (wealth and health) and investigates how the correlation affects optimal savings under multivariate preferences. The signs of higher-order cross derivatives play a key role in determining the direction of precautionary saving against such correlation. Mixed correlation averse (seeking) individuals increase (decrease) savings in response to increases in correlation. Furthermore, we introduce ambiguity to the correlation and investigate how ambiguity affects the amount of optimal savings. The analyses enable us to deepen our understanding of saving behavior under multivariate preferences in the presence of correlation. |
| Keywords: | Mixed correlation aversion (seekingness), Multivariate preferences, Smooth ambiguity model, Stochastic dominance |
| Date: | 2022–01 |
| URL: | http://d.repec.org/n?u=RePEc:kyo:wpaper:1071&r= |
| By: | Bernhard Kasberger; Kyle Woodward |
| Abstract: | We study multi-unit auctions in which bidders have limited knowledge of opponent strategies and values. We characterize optimal prior-free bids; these bids minimize the maximal loss in expected utility resulting from uncertainty surrounding opponent behavior. Optimal bids are simply computable despite bidders having multi-dimensional private information, and in certain cases admit closed-form solutions. In the pay-as-bid auction the minimax-loss bid is unique; in the uniform-price auction the minimax-loss bid is unique if the bidder is allowed to determine the quantities for which they bid, as in many practical applications. Payments to the seller may be higher in either auction format, but minimax-loss bids are never uniformly higher in the pay-as-bid auction. |
| Date: | 2021–12 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2112.11320&r= |
| By: | René van den Brink (VU - Vrije Universiteit Amsterdam [Amsterdam], Tinbergen Institute - Tinbergen Institute); Agnieszka Rusinowska (CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, 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) |
| Date: | 2021–10–17 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-03513560&r= |
| By: | Jourquin, Bart (Université catholique de Louvain, LIDAM/CORE, Belgium) |
| Abstract: | Modal choice models for strategic freight transportation studies covering large inter-regional or international areas generally rely on basic explanatory variables such as transportation costs and transit times. Using origin-destination matrixes, it is also possible to compute an accessibility measure that can further be used as an additional explanatory variable. This paper shows that the inclusion of an accessibility measure in the utility functions used for a logit model significantly improves its predictive power. Moreover, when the refined model is used to compute cost and transit time elasticities, the obtained (absolute) values are somewhat lower. The use of an accessibility measure in the modal choice model has thus a double advantage for policymakers: it improves the predictive power of the freight transport model, giving more accurate traffics on the modal networks, and it avoids overestimations of own and cross-elasticities. |
| Keywords: | Freight transport model ; Modal choice ; Accessibility ; Elasticity |
| Date: | 2021–12–21 |
| URL: | http://d.repec.org/n?u=RePEc:cor:louvco:2021031&r= |
| By: | Matthew Kovach; Gerelt Tserenjigmid |
| Abstract: | We provide the first behavioral characterization of nested logit, a foundational and widely applied discrete choice model, through the introduction of a non-parametric version of nested logit that we call Nested Stochastic Choice (NSC). NSC is characterized by a single axiom that weakens Independence of Irrelevant Alternatives based on revealed similarity to allow for the similarity effect. Nested logit is characterized by an additional menu-independence axiom. Our axiomatic characterization leads to a practical, data-driven algorithm that identifies the true nest structure from choice data. We also discuss limitations of generalizing nested logit by studying the testable implications of cross-nested logit. |
| Date: | 2021–12 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2112.07155&r= |