nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2022‒10‒03
ten papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Constrained portfolios in incomplete markets: a dynamic programming approach to Heston's model By Marcos Escobar-Anel; Yevhen Havrylenko; Rudi Zagst
  2. Precautionary Saving Behaviour under Ambiguity By Suen, Richard M. H.
  3. Product Lotteries and Loss Aversion By Schäfers, Sebastian
  4. A Rationalization of the Weak Axiom of Revealed Preference By Victor H. Aguiar; Per Hjertstrand; Roberto Serrano
  5. Prolonged Learning and Hasty Stopping: The Wald Problem With Ambiguity By Sarah Auster; Yeon-Koo Che; Konrad Mierendorff
  6. Relational Contracts: Public versus Private Savings By Francesc Dilmé; Daniel Garrett
  7. Wealth Shocks and Portfolio Choice By Dimitris Christelis; Dimitris Georgarakos; Tullio Jappelli; Geoff Kenny
  8. An analysis of objective inflation expectations and inflation risk premia By Sara Cecchetti; Adriana Grasso; Marcello Pericoli
  9. A Dynamic Theory of Random Price Discounts By Francesc Dilmé; Daniel Garrett
  10. Infinite population utilitarian criteria By Geir B Asheim; Kohei Kamaga; Stéphane Zuber

  1. By: Marcos Escobar-Anel; Yevhen Havrylenko; Rudi Zagst
    Abstract: We solve an expected utility-maximization problem with terminal-wealth constraints via dynamic programming in a setting of incomplete markets due to stochastic volatility. We demonstrate that the value function in the constrained problem can be represented as an expected modified utility of a vega-neutral financial derivative on the optimal unconstrained wealth. The optimal wealth and the optimal investment strategy in the constrained problem follow similarly. The case of a power utility and a Value-at-Risk constraint is treated theoretically in details. In numerical studies, we substantiate the impact of risk aversion levels, and investment horizons on the optimal investment strategy. We find a 20% relative difference between constrained and unconstrained allocations for average parameters in a low risk-aversion, short-horizon setting.
    Date: 2022–08
  2. By: Suen, Richard M. H.
    Abstract: This paper analyses a two-period model in which a consumer faces a future income risk but is uncertain about its probability distribution. We derive three sets of sufficient conditions under which a consumer with generalised recursive smooth ambiguity (GRSA) preferences will save more under ambiguity than in a deterministic environment. Our results show how precautionary saving is jointly determined by attitudes toward atemporal risk, ambiguity and intertemporal substitution. We also find a close connection between risk prudence under non-expected utility and precautionary saving under GRSA preferences.
    Keywords: Precautionary Saving; Risk Aversion; Intertemporal Substitution; Smooth Ambiguity Preferences.
    JEL: D81 E21
    Date: 2022–08–02
  3. By: Schäfers, Sebastian (University of Basel)
    Abstract: Product lotteries are a sales strategy where companies hide features of differentiated products from consumers until the purchase is complete. I identify loss aversion as an important factor explaining the existence of vertical product lotteries. I consider a profit-maximizing monopolist serving loss-averse consumers with rational expectations about the lottery. I find that the optimal strategy consists of offering a premium product with high and deterministic quality and a lottery with stochastic and lower expected quality. When consumers are reasonably loss averse, I show that the profit increase from adding a quality lottery exceeds 10% compared to the case without a lottery.
    Keywords: Product lotteries, Probabilistic selling, Reference-dependent preferences, Loss aversion
    JEL: D42 D81 D91 L12
    Date: 2022–08–22
  4. By: Victor H. Aguiar (University of Western Ontario); Per Hjertstrand (Research Institute of Industrial Economics, Sweden); Roberto Serrano (Brown University)
    Abstract: Samuelson’s (1938) weak (generalized) axiom of revealed preference– WGARP–is a minimal and appealing consistency condition of choice. We offer a rationalization of WGARP in general settings. Our main result is an exact analog of the celebrated Afriat’s theorem, but for WGARP. Its ordinal rationalization is in terms of an asymmetric and locally nonsatiated preference function. Its cardinal rationalization uses a coalitional multi-utility (CMU) maxmin representation with a coherency restriction on the coalition structure. Effectively, the CMU representation aggregates piecemeal preferences within the decision maker (multiple rationales without preference reversals that allow for transitivity violations). Basic consumer theory and welfare analysis are also developed. Extensions to the weak axiom of revealed preference–WARP–and choices obeying the law of demand are included.
    Keywords: abstract consumer choice; weak axiom of revealed preference; Afriat’s theorem; asymmetric preference function; coalitional multi-utility rationalization; welfare analysis
    JEL: C60 D10
    Date: 2022
  5. By: Sarah Auster; Yeon-Koo Che; Konrad Mierendorff
    Abstract: This paper studies sequential information acquisition by an ambiguity-averse decision maker (DM), who decides how long to collect information before taking an irreversible action. The agent optimizes against the worst-case belief and updates prior by prior. We show that the consideration of ambiguity gives rise to rich dynamics: compared to the Bayesian DM, the DM here tends to experiment excessively when facing modest uncertainty and, to counteract it, may stop experimenting prematurely when facing high uncertainty. In the latter case, the DM’s stopping rule is non-monotonic in beliefs and features randomized stopping.
    Keywords: Wald Problem, Ambiguity Aversion
    JEL: C61 D81 D83 D91
    Date: 2022–09
  6. By: Francesc Dilmé (University of Bonn); Daniel Garrett (University of Essex)
    Abstract: Work on relational employment agreements often predicts low payments or termination for poor performance. The possibility of saving can, however, limit the e˙ectiveness of mone-tary incentives in motivating an employee with diminishing marginal utility for consump-tion. We study the role of savings and their observability in optimal relational contracts. We focus on the case where players are not too patient, and hence the constant first-best e˙ort cannot be implemented. If savings are hidden, the relationship eventually deterio-rates over time. In particular, both payments and e˙ort decline. On the other hand, if savings are public, consumption is initially high, so the agent’s savings fall over time, and e˙ort and payments to the agent increase. The findings thus suggest how tacit agreements on consumption can forestall the deterioration of dynamic relationships in which the agent can save.
    Keywords: relational contracts, consumption smoothing preferences, private savings
    JEL: C73 J30
    Date: 2022–08
  7. By: Dimitris Christelis (University of Glasgow, CSEF, CFS, CEPR and Netspar); Dimitris Georgarakos (European Central Bank and CFS); Tullio Jappelli (Università di Napoli Federico II, CSEF, CFS, CEPR and Netspar); Geoff Kenny (European Central Bank)
    Abstract: We use new euro area representative data from the Consumer Expectations Survey (CES) to elicit household-specific propensities to invest and consume out of positive wealth shocks. Using a randomized assignment of hypothetical lottery gains ranging from 5,000 to 50,000 euros and a realistic menu of consumption, saving and asset choices, we estimate the causal effect of wealth shocks on risky asset ownership and conditional asset shares. Wealth shocks have a positive effect on stockholding (about a 10 percentage points increase for the largest wealth shock). The majority of households in the sample do not participate in the stock market, even after a large increase in wealth. The conditional asset share invested in stocks does not depend on the size of wealth shocks, with the small exception of very high values of the latter, for which the conditional risky asset share slightly increases. This result is consistent with the notion that preferences are characterized by constant relative risk aversion for the vast majority of risky asset investors.
    Keywords: Household finance; Stock market participation; Risk aversion; Consumer Expectations Survey.
    JEL: D14 G11 G51
    Date: 2022–09–13
  8. By: Sara Cecchetti (Bank of Italy); Adriana Grasso (European Central Bank); Marcello Pericoli (Bank of Italy)
    Abstract: We study euro-area risk-adjusted expected inflation and the inflation risk premium at different maturities, leveraging inflation swaps, inflation options and survey-based forecasts. We introduce a model that features time-varying long-term average inflation and time-varying inflation volatility and we anchor market-based risk-adjusted measures of expected inflation to survey-based inflation forecasts. The results show that medium-term risk-adjusted expected inflation was close to the ECB's aim from 2010 to mid-2014, has since fallen to a low in March 2020 and has risen significantly since the second half of 2021. The medium-term inflation risk premium was positive until 2014 and turned negative since 2015 despite a sharp rise at the end of 2021. The risk-adjusted probabilities of exceeding the ECB's inflation aim and of seeing deflation over the medium term have been low on average.
    Keywords: inflation density, inflation risk premium, objective probability
    JEL: C22 C58 G12 E31 E44
    Date: 2022–07
  9. By: Francesc Dilmé (University of Bonn); Daniel Garrett (Toulouse School of Economics)
    Abstract: A seller with commitment power sets prices over time. Risk-averse buyers arrive to the market and decide when to purchase. We obtain that the optimal price path is a “regular” price, with occasional episodes of sequential discounts that occur at random times. The optimal price path has the property that the price a buyer ends up paying is independent of his arrival and purchase times, and only depends on his valuation. Our theory accommodates empirical findings on the timing of discounts.
    Keywords: dynamic pricing, sales, random mechanisms
    JEL: D82
  10. By: Geir B Asheim (UiO - University of Oslo); Kohei Kamaga (Sophia University [Tokyo]); Stéphane Zuber (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, CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)
    Keywords: utilitarianism,intergenerational equity,population ethics
    Date: 2022

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