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on Utility Models and Prospect Theory |
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Issue of 2022‒07‒18
fourteen papers chosen by |
| By: | Appelbaum, Elie |
| Abstract: | This paper provides a simple framework for obtaining asset demand using indirect utility functions. Assuming expected utility maximization, we show that assets are held according to their mean returns' proportional marginal utility. We also show that an asset's equilibrium equity premium is given by the ratio of the indirect utility function's mean and standard deviation elasticities. Furthermore, we show that we can extend these results to a non-expected utility framework. |
| Keywords: | Moments, Indirect Utility Function, Asset Demand, Duality. |
| JEL: | D14 D80 D81 G11 |
| Date: | 2021–11 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:113085&r= |
| By: | Emerson Melo (Indiana University, Department of Economics) |
| Abstract: | In this paper we study a Rational Inattention model in environments where the decision maker faces uncertainty about the true prior distribution over states. The decision maker seeks to select a stochastic choice rule over a finite set of alternatives that is robust to prior ambiguity. Following the robust stochastic optimization literature, we fully characterize the distributional robustness of the Rational Inattention model in terms of a tractable concave program. Exploiting this structure we establish necessary and sufficient conditions to construct robust consideration sets that account for the fact that the prior distribution is unknown. Finally, we quantify the impact of prior uncertainty, by introducing the notion of Worst-Case Sensitivity, which is defined as the worst-case rate of decrease in the expected utility of a robust decision maker when the degree of prior uncertainty vanishes. We show that this quantity is proportional to the standard deviation associated to the decision maker’s expected utility. |
| Keywords: | Rational Inattention, prior uncertainty, misspecified models, Robust Optimization, o-divergences, Shannon Entropy, Risk Measures. |
| Date: | 2022–07 |
| URL: | http://d.repec.org/n?u=RePEc:inu:caeprp:2022011&r= |
| By: | Elminejad, Ali; Havranek, Tomas; Irsova, Zuzana |
| Abstract: | We collect 1,021 estimates from 92 studies that use the consumption Euler equation to measure relative risk aversion and that disentangle it from intertemporal substitution. We show that calibrations of risk aversion are typically larger than estimates thereof. Moreover, reported estimates are typically larger than the underlying risk aversion because of publication bias. After correction for the bias, the literature suggests a mean risk aversion of 1 in economics and 2--7 in finance contexts. The reported estimates are systematically driven by the characteristics of data (frequency, dimension, country, stockholding) and utility (functional form, treatment of durables). To obtain these results we use nonlinear techniques to correct for publication bias and Bayesian model averaging techniques to account for model uncertainty. |
| Keywords: | Euler equation,risk aversion,Epstein-Zin preferences,meta-analysis,publication bias,Bayesian model averaging |
| JEL: | C83 D81 D90 |
| Date: | 2022 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:esprep:260586&r= |
| By: | Nail Kashaev (University of Western Ontario); Victor H. Aguiar (University of Western Ontario) |
| Abstract: | We generalize the stochastic revealed preference methodology of McFadden and Richter (1990) for finite choice sets to settings with limited consideration. Our approach is nonparametric and requires partial choice set variation. We impose a monotonicity condition on attention first proposed by Cattaneo et al. (2020) and a stability condition on the marginal distribution of preferences. Our framework is amenable to statistical testing. These new restrictions extend widely known parametric models of consideration with heterogeneous preferences. |
| Keywords: | Random Utility, Random Consideration Sets |
| JEL: | C50 C51 C52 C91 |
| Date: | 2022 |
| URL: | http://d.repec.org/n?u=RePEc:uwo:uwowop:20223&r= |
| By: | Soroush Ebadian; Anson Kahng; Nisarg Shah; Dominik Peters |
| Abstract: | A voting rule decides on a probability distribution over a set of $m$ alternatives, based on rankings of those alternatives provided by agents. We assume that agents have cardinal utility functions over the alternatives, but voting rules have access to only the rankings induced by these utilities. We evaluate how well voting rules do on measures of social welfare and of proportional fairness, computed based on the hidden utility functions. In particular, we study the distortion of voting rules, which is a worst-case measure. It is an approximation ratio comparing the utilitarian social welfare of the optimum outcome to the welfare of the outcome selected by the voting rule, in the worst case over possible input profiles and utility functions that are consistent with the input. The literature has studied distortion with unit-sum utility functions, and left a small asymptotic gap in the best possible distortion. Using tools from the theory of fair multi-winner elections, we propose the first voting rule which achieves the optimal distortion $\Theta(\sqrt{m})$ for unit-sum utilities. Our voting rule also achieves optimum $\Theta(\sqrt{m})$ distortion for unit-range and approval utilities. We then take a similar worst-case approach to a quantitative measure of the fairness of a voting rule, called proportional fairness. Informally, it measures whether the influence of cohesive groups of agents on the voting outcome is proportional to the group size. We show that there is a voting rule which, without knowledge of the utilities, can achieve an $O(\log m)$-approximation to proportional fairness, the best possible approximation. As a consequence of its proportional fairness, we show that this voting rule achieves $O(\log m)$ distortion with respect to Nash welfare, and provides an $O(\log m)$-approximation to the core, making it interesting for applications in participatory budgeting. |
| Date: | 2022–05 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2205.15760&r= |
| By: | Jean-Pierre H. Dubé; Joonhwi Joo; Kyeongbae Kim |
| Abstract: | We establish the Hurwicz-Uzawa integrability of the broad class of discrete-choice additive random-utility models of individual consumer behavior with perfect substitutes preferences and divisible goods. We derive the corresponding indirect uility function and then establish a representative consumer formulation for this entire class of models. The representative consumer is always normative, facilitating aggregate welfare analysis. These findings should be of interest to the literatures in macro, trade, industrial organization, labor and ideal price index measurement that use representative consumer models, such as CES and its variants. Our results generalize such representative consumer formulations to the broad, empirically-relevant class of models of behavior that are routinely used in the discrete-choice analysis of micro data, including specifications that do not suffer from the IIA property and that allow for heterogeneous consumer preferences and incomes. When products are indivisible, we show that Hurwicz-Uzawa integrability fails; although some model variants might satisfy a stronger version of quasi-linear integrability. |
| JEL: | C43 D01 D11 D60 E1 L00 M3 |
| Date: | 2022–06 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:30130&r= |
| By: | Gong, Doudou (RS: GSBE other - not theme-related research, Quantitative Economics); Dietzenbacher, Bas (RS: GSBE other - not theme-related research, QE Math. Economics & Game Theory); Peters, Hans (RS: FSE DKE Mathematics Centre Maastricht, QE Math. Economics & Game Theory, RS: GSBE other - not theme-related research) |
| Abstract: | This paper introduces and studies a random arrival rule for bankruptcy problems with nontransferable utility. This bankruptcy rule generalizes the random arrival rule for bankruptcy problems with transferable utility which assigns the unique efficient allocation proportional to the sum of marginal vectors. We provide two axiomatic characterizations based on symmetry and monotonicity, respectively. |
| JEL: | C79 D63 D74 |
| Date: | 2022–06–20 |
| URL: | http://d.repec.org/n?u=RePEc:unm:umagsb:2022006&r= |
| By: | Meissner, Luise; Musshoff, Oliver |
| Abstract: | Farmland market regulation and the respective political instruments are very present in the current discussion, especially since the market faces big price increases. In the European Union, several instruments exist. The evaluation and discussion of those instruments is complex and shaped by subjective arguments. Not only are their utility for the society questioned, but also their accuracy and efficiency. Within those points, different concerned parties might have a different focus and different requirements to the regulation instruments. In this article, we intend to enrich and structure the discussion about farmland market regulation. We present an analytical framework for arguments and parties within farmland market regulation. As an example, the German land transaction law is broken down by process, parties and arguments. The framework allows to weight arguments individually. It implicates two results: First, considers conflicting interests in a clear form. Second, a linear utility curve can be calculated which determines the minimum share of pre-sales right executions to achieve a positive aggregated utility. Hence, the framework is able to analyze the utility of the German farmland transaction law from different perspectives. |
| Keywords: | Agricultural and Food Policy, Land Economics/Use |
| Date: | 2022–04 |
| URL: | http://d.repec.org/n?u=RePEc:ags:aesc22:321157&r= |
| By: | Claudia Kelsall (CEE-M - Centre d'Economie de l'Environnement - Montpellier - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement - Institut Agro Montpellier - Institut Agro - Institut national d'enseignement supérieur pour l'agriculture, l'alimentation et l'environnement, iDiv - German Centre for Integrative Biodiversity Research); Martin F Quaas (iDiv - German Centre for Integrative Biodiversity Research); Nicolas Quérou (CEE-M - Centre d'Economie de l'Environnement - Montpellier - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement - Institut Agro Montpellier - Institut Agro - Institut national d'enseignement supérieur pour l'agriculture, l'alimentation et l'environnement) |
| Abstract: | We study optimal harvesting of a renewable resource with stochastic dynamics. To focus on the effect of risk aversion, we consider a resource user who is indifferent with respect to intertemporal variability. We find that a constant escapement strategy is optimal, i.e. the stock after harvesting is constant. Under common specifications of risk aversion, increasing risk and risk aversion increase current resource use, the reason being a substitution effect, i.e. the resource user substitutes assets away from the risky resource stock. We apply the model to the case of the Eastern Baltic cod fishery and, in contrast to the previous literature, find a strong effect of risk and risk aversion on optimal harvesting. |
| Keywords: | Resource Economics,Investment under Uncertainty,Risk Aversion,Prudence,Precautionary Savings |
| Date: | 2022–06–16 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpceem:hal-03696726&r= |
| By: | Elena L. Del Mercato (Centre d'Economie de la Sorbonne, Paris School of Economics); Van Quy Nguyen (Centre d'Economie de la Sorbonne) |
| Abstract: | We consider a pure exchange economy with consumption externalities in preferences. Using the notion of competitive equilibrium à la Nash, we point out that a simple condition for restoring the Second Welfare Theorem is that the set of Pareto optima is included in the set of internal Pareto optima. We provide the Social Redistribution assumption to ensure such inclusion. This assumption is weaker than other relevant assumptions that have been studied in the literature. We also introduce new conditions in a differential setting, called (Strong) Directional Social Redistribution. Our assumptions entail interesting results on the decentralized implementation of Pareto optima, that relate the competitive supporting price and the social shadow price. Finally, we show that, for Bergson-Samuelson utility functions, Strong Directional Social Redistribution is ensured by a specific property of the Jacobian matrix, which has a natural interpretation in terms of externalities |
| Keywords: | Consumption externalities; competitive equilibrium à la Nash; decentralization; social redistribution |
| JEL: | D11 D50 D62 |
| Date: | 2021–07 |
| URL: | http://d.repec.org/n?u=RePEc:mse:cesdoc:21029r&r= |
| By: | Alex Botsis; Christoph Gortz; Plutarchos Sakellaris |
| Abstract: | Using a novel dataset that combines firms' qualitative survey-based sales forecasts with their quantitative balance-sheet data on realized sales, we document that only major forecast errors (those in the two tails of the distribution) are predictable and display autocorrelation. This result is a particular violation of the Full Information Rational Expectations hypothesis that requires explanation. In contrast, minor forecast errors are neither predictable nor autocorrelated. To arrive at this finding, we develop a novel methodology to quantify qualitative survey data on forecasts. It is generally applicable when quantitative information, e.g. from firm balance sheets, is available on the realization of the forecasted variable. To explain our empirical result, we provide a model of rational inattention. When operating in market environments where information processing is more costly, firms optimally limit their degree of attention to information. This results in larger absolute forecast errors that become predictable and autocorrelated. |
| Keywords: | expectations, firm data, forecast errors, panel threshold models, rational inattention, survey data |
| JEL: | C53 C83 D22 D84 E32 |
| Date: | 2021–10 |
| URL: | http://d.repec.org/n?u=RePEc:nsr:escoed:escoe-dp-2021-14&r= |
| By: | David Ronayne (ESMT European School of Management and Technology GmbH); Roberto Veneziani (Queen Mary University of London); William R. Zame (University of California at Los Angeles) |
| Abstract: | Anscombe & Aumann (1963) offer a definition of subjective probability in terms of comparisons with objective probabilities. That definition - which has provided the basis for much of the succeeding work on subjective probability - presumes that the subjective probability of an event is independent of the prize consequences of that event, a property we term Prize Independence. We design experiments to test Prize Independence and find that a large fraction of our subjects violate it; thus, they do not have subjective probabilities. These findings raise questions about the empirical relevance of much of the literature on subjective probability. |
| Keywords: | subjective probability, choice under uncertainty, online experiments |
| JEL: | D01 D81 D84 |
| Date: | 2022–06–21 |
| URL: | http://d.repec.org/n?u=RePEc:esm:wpaper:esmt-22-03&r= |
| By: | Andrea Amelio (University of Bonn) |
| Abstract: | Overconfidence is one of the most ubiquitous cognitive bias. There is copious evidence of overconfidence being relevant in a diverse set of economic domains. In this paper, we relate the recent concept of cognitive uncertainty with overconfidence. Cognitive uncertainty represents a decision maker's uncertainty about her action optimality. We present a simple model of overconfidence based on the concept of cognitive uncertainty. The model relates the concepts theoretically and generates testable predictions. We propose an experimental paradigm to cleanly identify such theoretical relationships. In particular, we focus on overplacement and we find that, as predicted, cognitive uncertainty is inversely related to overplacement. Exogenously manipulating cognitive uncertainty through compound choices, we are able to show a causal relationship with overplacement. Evidence on these relationships allows to link overplacement with other behavioral anomalies explained through cognitive uncertainty. |
| Keywords: | Cognitive Uncertainty, Overconfidence, Overplacement, Cognitive Noise, Experiments |
| JEL: | D91 C91 D83 |
| Date: | 2022–06 |
| URL: | http://d.repec.org/n?u=RePEc:ajk:ajkdps:173&r= |
| By: | Hobler, Stephan |
| Abstract: | Standard rational inattention models suppose that agents process noisy signals about otherwise fully revealing data. I show that introducing imperfect data quality yields new insights in settings in which volatility is time-varying. I impose a two-layered signal structure in which agents learn imperfectly about noisy sources. Treating data as only partially revealing of the true fundamental amplifies impulse responses to a second moment shock and, if data quality is sufficiently poor, can change the qualitative direction of the response. I apply my findings to the price-setting problem of firms and find that higher data quality enhances the transmission of monetary policy and reduces macroeconomic volatility. I also show how the empirically documented procyclicality of data quality has non-trivial implications for the Phillips curve. |
| Keywords: | monetary policy; Phillips curve; rational inattention; Elsevier deal |
| JEL: | D80 E31 E32 E42 E52 |
| Date: | 2022–05–01 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:114913&r= |