nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2022‒09‒12
eleven papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Investigation of the Convex Time Budget Experiment by Parameter Recovery Simulation By Yuta Shimodaira; Kohei Shiozawa; Keigo Inukai
  2. The Limit of the Marginal Distribution Model in Consumer Choice By Yanqiu Ruan; Xiaobo Li; Karthyek Murthy; Karthik Natarajan
  3. Submodular financial markets with frictions By Alain Chateauneuf; Bernard Cornet
  4. Debt Aversion: Theory and Measurement By Thomas Meissner; David Albrecht
  5. Decision-making under Imperfect Information with Bayesian Learning or Heuristic Rules By Carina Burs; Thomas Gries
  6. Decision Choice under Pareto Optimal Criteria By Chatterjee, Sidharta
  7. Noisy Foresight By Anujit Chakraborty; Chad W. Kendall
  8. Time Pressure Preferences By Thomas Buser; Roel van Veldhuizen; Yang Zhong
  9. For Better or Worse? Subjective Expectations and Cost-Benefit Trade-Offs in Health Behavior: An Application to Lockdown Compliance in the United Kingdom By Conti, G.;; Giustinelli, P.;
  10. Avoiding unanticipated power outages: households’ willingness to pay in India By Bigerna, Simona; Choudhary, Piyush; Kumar Jain, Nikunj; Micheli, Silvia; Polinori, Paolo
  11. Deep Hedging: Continuous Reinforcement Learning for Hedging of General Portfolios across Multiple Risk Aversions By Phillip Murray; Ben Wood; Hans Buehler; Magnus Wiese; Mikko S. Pakkanen

  1. By: Yuta Shimodaira; Kohei Shiozawa; Keigo Inukai
    Abstract: The convex time budget (CTB) method is a widely used experimental method for eliciting an individual’s time preference. Researchers adopting the CTB experiment usually assume quasi-hyperbolic discounting utility as a behavioural model and estimate the parameters of the utility function. However, few studies using the CTB method have examined parameter recovery. We conduct simulations and find that the estimation error of the present bias parameter is so large that its effect is difficult to detect. The large error is due to the improper combination of the experimental method and the utility model, and it is not a problem we can deal with after the data collection. This paper suggests the importance of running parameter recovery simulations to audit estimation errors in the experimental design.
    Date: 2022–08
  2. By: Yanqiu Ruan; Xiaobo Li; Karthyek Murthy; Karthik Natarajan
    Abstract: Given data on choices made by consumers for different assortments, a key challenge is to develop parsimonious models that describe and predict consumer choice behavior. One such choice model is the marginal distribution model which requires only the specification of the marginal distributions of the random utilities of the alternatives to explain choice data. In this paper, we develop an exact characterisation of the set of choice probabilities which are representable by the marginal distribution model consistently across any collection of assortments. Allowing for the possibility of alternatives to be grouped based on the marginal distribution of their utilities, we show (a) verifying consistency of choice probability data with this model is possible in polynomial time and (b) finding the closest fit reduces to solving a mixed integer convex program. Our results show that the marginal distribution model provides much better representational power as compared to multinomial logit and much better computational performance as compared to the random utility model.
    Date: 2022–08
  3. By: Alain Chateauneuf (IPAG Business School, CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement); Bernard Cornet (KU - University of Kansas [Lawrence], CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement)
    Abstract: This paper studies arbitrage-free financial markets with bid-ask spreads whose super-hedging prices are submodular. The submodular assumption on the super-hedging price, or the supermodularity usually assumed on utility functions, is the formal expression of perfect complementarity, which dates back to Fisher, Pareto, and Edgeworth, according to Samuelson (J Econ Lit 12:1255–1289, 1974). Our main contribution provides several characterizations of financial markets with frictions that are submodular as a consequence of a more general study of submodular pricing rules. First, a market is submodular if and only if its super-hedging price is a Choquet integral and if and only if its set of risk-neutral probabilities is representable as the core of a submodular non-additive probability that is uniquely defined, called risk-neutral capacity. Second, a market is representable by its risk neutral capacity if and only if it is equivalent to a market, only composed of bid-ask event securities.
    Keywords: Submodularity,financial markets,Frictions,Bid-ask,Arbitrage,Multi-prior model,Super-hedging price,Super-replication,Risk measure,Pricing rules,Choquet integral,Event securities
    Date: 2022
  4. By: Thomas Meissner; David Albrecht
    Abstract: Debt aversion can have severe adverse effects on financial decision-making. We propose a model of debt aversion, and design an experiment involving real debt and saving contracts, to elicit and jointly estimate debt aversion with preferences over time, risk and losses. Structural estimations reveal that the vast majority of participants (89\%) are debt averse, and that this has a strong impact on choice. We estimate the ``debt-premium'' - the compensation a debt averse person would require to accept getting into debt - to be around 16\% of the principal for our average participant.
    Date: 2022–07
  5. By: Carina Burs (Paderborn University); Thomas Gries (Paderborn University)
    Abstract: Information is one of the most important ingredients for decision-making. While the neoclassical assumption of perfect information is surely an important conceptual benchmark for discussing efficient allocations, it is obviously far from describing a rational choice under real conditions. In reality, optimal choices should be considered choices under imperfect information. Thus, decision-makers' information problem can be solved by two strategies. Either they collect an optimal set of information to make an optimal allocation choice under this imperfect information set or they can apply heuristic reasoning. In this paper, we suggest a formal model framework for the example of a simple consumer decision for the allocation of differentiated goods to explore information acquisition strategies in such a simple standard choice situation. Using the model variation under perfect information as a benchmark, we answer the following questions. First and most importantly, under imperfect information, can a heuristic rule substitute information acquisition as an optimal choice? Second, what is the role of risk aversion in the information acquisition process? Finally, we explore the differences to the benchmark, both ex ante the first purchase decision and ex post when repeated purchases and consumption allows for experiences with the choices made.
    Keywords: information economics; imperfect information; Bayesian learning; risk; heuristics; differentiated products
    JEL: D8 D83 D90 D18
    Date: 2022–08
  6. By: Chatterjee, Sidharta
    Abstract: According to the axiomatic foundations of social choice theory, not all decisions benefit everyone. Often, decisions that do not have any implied benefit for the decision maker are made in the (best) interests of others. When a decision is made concerning welfare of others, some individuals—including the decision maker, may be on the receiving end. For, it is impossible to make social decisions by taking into account individual preferences that satisfy all and everyone. This is on account of a great variety in individual choices and preferences ubiquitous among different individuals. Tastes vary among different people—so does individual preferences, and that’s natural. Conflict of interests arises due to subtle variances in individual preferences. In this paper, we discuss about the decision choice that seldom works for every conceivable set of individual preferences. Following Arrovian precepts, it is impossible to satisfy one and all, for there remains a great diversity in individual preferences that result in the problem of choice. Hence, in this research, we develop a taste-based theory of social choice that attempts to address the problem of choice by helping individuals choose the best and the most effective and optimal option among a given set of alternatives that’s assumed to be rational.
    Keywords: Choice, decision making, rational choice, social choice theory, Social welfare, taste-based theory of choice, welfare economic functions.
    JEL: I3 I31
    Date: 2022–08–19
  7. By: Anujit Chakraborty; Chad W. Kendall
    Abstract: Rational agents must perform backwards induction by thinking contingently about future states and actions, but failures of backwards induction and contingent reasoning are ubiquitous. How do boundedly-rational agents make decisions when they fail to correctly forecast actions in the future? We construct an individual decision-making experiment to collect a rich dataset in which subjects must reason only about their own future actions. We demonstrate substantial mistakes relative to the rational benchmark, and use the rich dataset to estimate several possible models of boundedly-rational foresight. We find that a model in which subjects expect to make more mistakes when the payoff consequences of their future actions are more similar best explains behavior.
    JEL: D03 D90
    Date: 2022–08
  8. By: Thomas Buser (University of Amsterdam); Roel van Veldhuizen (Lund University); Yang Zhong (University of Amsterdam)
    Abstract: Many professional and educational settings require individuals to be willing and able to perform under time pressure. We use a lab experiment to elicit preferences for working under time pressure in an incentivized way by eliciting the minimum additional payment participants require to complete a cognitive task under various levels of time pressure versus completing it without pressure. We make three main contributions. First, we document that participants are averse to working under time pressure on aggregate. Second, we show that there is substantial heterogeneity in the degree of time pressure aversion across individuals and that these individual preferences can be partially captured by simple survey questions. Third, we include these questions in a survey of bachelor students and show that time pressure preferences correlate with future career plans. Our results indicate that individual differences in time pressure aversion could be an influential factor in determining labor market outcomes.
    JEL: J24 D9 C91
    Date: 2022–08–22
  9. By: Conti, G.;; Giustinelli, P.;
    Abstract: Health behaviors are actions individuals take that affect their health. Most health behaviors can have both positive and negative consequences for the individual, generating trade-offs in choice. During the acute phases of the COVID-19 pandemic, social distancing and the more extreme self-isolation and shielding were the main actions through which people could (were required to) protect themselves and others from infection and its health-harming consequences. Distancing and isolation, however, are not without costs or risks for individuals’ wellbeing. Because the costs and benefits of alternative actions are ex ante uncertain, individual choices depend on decision makers’ expectations over choice consequences and on how they resolve the trade-offs between expected costs and benefits. Using rich data on subjective expectations collected during the first UK lockdown, we first document people’s perceived costs (risks) and benefits (returns) of alternative compliance behaviors along with their compliance plans. We then develop and estimate a simple model of compliance behavior with uncertain costs and benefits, which we use to quantify the utility trade-offs underlying compliance, decompose group differences in compliance into components attributable to variation in expectations vis-`a-vis preferences, and compute the compensation required for people to be isolated. In a short follow-up, we implement a randomized sensitization intervention reviewing the timeline of the “Cummings affair†. Labour supporters react to the treatment’s negative prompt by lowering their subjective probability of never leaving home (the government’s recommendation) and increasing that of discretionary compliance.
    JEL: C25 C83 D84 I12
    Date: 2022–07
  10. By: Bigerna, Simona; Choudhary, Piyush; Kumar Jain, Nikunj; Micheli, Silvia; Polinori, Paolo
    Abstract: Reliable electricity is a key factor in improving the living conditions of households and sustainable development of the country. Power outages restrict economic and social welfare of developing countries. This study used contingent valuation survey to elicit the factors affecting Indian household’s willingness to pay to avoid unanticipated power outages. The survey was outlined to ensure that a household gives preferences considering multiple aspects of the outages. The households were asked to state their willingness to pay for five different types of outages. Empirical data from 1043 Indian households were analyzed using double hurdle approach. The econometric results indicate that the households’ willingness to pay to avoid power outage strictly depend on the length of outages ranging, on average, from 30.2 INR (2 hours) to INR. 245.6 (12 hours). Further income and environmental attitude of respondents positively influence higher WTP to avoid power outages. Our findings provide useful insights for policy makers and utility companies to design more reliable and customer centric energy generation and distribution models.
    Keywords: Power outages; contingent valuation; willingness to pay; residential electricity
    JEL: C24 C93 D12 Q41
    Date: 2022–08–11
  11. By: Phillip Murray; Ben Wood; Hans Buehler; Magnus Wiese; Mikko S. Pakkanen
    Abstract: We present a method for finding optimal hedging policies for arbitrary initial portfolios and market states. We develop a novel actor-critic algorithm for solving general risk-averse stochastic control problems and use it to learn hedging strategies across multiple risk aversion levels simultaneously. We demonstrate the effectiveness of the approach with a numerical example in a stochastic volatility environment.
    Date: 2022–07

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