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on Utility Models and Prospect Theory |
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Issue of 2022‒10‒10
seventeen papers chosen by |
| By: | Hammitt, James K. |
| Abstract: | Downside risk aversion (downside RA) and decreasing absolute risk aversion (DARA) are different concepts that describe preferences for which the harm from bearing risk is lessened by an increase in wealth. This note presents some intuitive explanations of the difference between the two concepts using simple lotteries and graphical analysis. All risk-averse utility functions exhibit downside risk aversion, except those that exhibit sufficiently strong increasing absolute risk aversion (IARA). In a sense, downside RA is to be expected: adding downside risk to a baseline lottery is analogous to increasing risk while adding upside risk is analogous to decreasing risk. The difference between the two concepts can be attributed to the use of different measures of the harm from risk bearing: downside RA measures harm using the utility premium and DARA measures harm using the risk premium. The two premia can change at different rates and even in different directions as wealth increases. |
| Keywords: | risk aversion; prudence; risk apportionment; utility premium |
| Date: | 2022–09–14 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:127311&r= |
| By: | Ali Zeytoon-Nejad |
| Abstract: | The present paper introduces a theoretical framework through which the degree of risk aversion with respect to uncertain prices can be measured through the context of the indirect utility function (IUF) using a lab experiment. First, the paper introduces the main elements of the duality theory (DT) in economics. Next, it proposes the context of IUFs as a suitable framework for measuring price risk aversion through varying prices as opposed to varying payoffs, which has been common practice in the mainstream of experimental economics. Indeed, the DT in modern microeconomics indicates that the direct utility function (DUF) and the IUF are dual to each other, implicitly suggesting that the degree of risk aversion (or risk seeking) that a given rational subject exhibits in the context of the DUF must be equivalent to the degree of risk aversion (or risk seeking) elicited through the context of the IUF. This paper tests the accuracy of this theoretical prediction through a lab experiment using a series of relevant statistical tests. This study uses the multiple price list (MPL) method, which has been one of the most popular sets of elicitation procedures in experimental economics to study risk preferences in the experimental laboratory using non-interactive settings. The key findings of this study indicate that price risk aversion (PrRA) is statistically significantly greater than payoff risk aversion (PaRA). Additionally, it is shown that the risk preferences elicited under the expected utility theory (EUT) are somewhat subject to context. Other findings imply that the risk premium (RP), as a measure of willingness to pay for insuring an uncertain situation, is statistically significantly greater for stochastic prices compared to that for stochastic payoffs. These results are robust across different MPL designs and various statistical tests that are utilized. |
| Date: | 2022–09 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2209.02653&r= |
| By: | Emmanuelle GABILLON |
| Abstract: | Regret is a negative and counterfactual emotion that occurs when a decision maker believes her past decision, if changed, would achieve a better outcome. Regret is intrinsically related to the comparison of the chosen alternative outcome with the foregone alternative outcomes. The result of this comparison is influenced by the decision maker’s information about the foregone alternative outcomes (feedback structure). In this paper, we use Gabillon (2020)’s model, which generalizes regret theory to any feedback structure. We show that a regretful decision maker exhibits information aversion. The anticipation of learning about the payoffs of the foregone alternatives decreases her expected utility. We use the concept of statistical sufficiency in order to classify the feedback structures according to their informational content. We show that the less informative the feedback structure is, the higher the utility of a regretful decision maker. Regret, Emotion, Information |
| JEL: | D03 D81 D82 |
| Date: | 2022 |
| URL: | http://d.repec.org/n?u=RePEc:grt:bdxewp:2022-12&r= |
| By: | Marcelo Brutti Righi; Fernanda Maria M\"uller; Marlon Ruoso Moresco |
| Abstract: | We propose a risk measurement approach for a risk-averse stochastic problem. We provide results that guarantee that our problem has a solution. We characterize and explore the properties of the argmin as a risk measure and the minimum as a deviation measure. We provide a connection between linear regression models and our framework. Based on this conception, we consider conditional risk and provide a connection between the minimum deviation portfolio and linear regression. Moreover, we also link the optimal replication hedging to our framework. An empirical illustration is carried out to demonstrate the practical utility of our proposal. |
| Date: | 2022–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2208.14809&r= |
| By: | Brown, Alexander L. (Texas A&M University); Imai, Taisuke (LMU Munich); Vieider, Ferdinand M. (Ghent University); Camerer, Colin F. (California Institute of Technology) |
| Abstract: | Loss aversion is one of the most widely used concepts in behavioral economics. We conduct a large-scale interdisciplinary meta-analysis, to systematically accumulate knowledge from numerous empirical estimates of the loss aversion coefficient reported during the past couple of decades. We examine 607 empirical estimates of loss aversion from 150 articles in economics, psychology, neuroscience, and several other disciplines. Our analysis indicates that the mean loss aversion coefficient is between 1.8 and 2.1. We also document how reported estimates vary depending on the observable characteristics of the study design. |
| Keywords: | loss aversion; prospect theory; meta-analysis; |
| JEL: | D81 D90 C90 C11 |
| Date: | 2021–01–26 |
| URL: | http://d.repec.org/n?u=RePEc:rco:dpaper:275&r= |
| By: | Ahrens, Steffen (FU Berlin); Bosch-Rosa, Ciril (TU Berlin); Meissner, Thomas (Maastricht University) |
| Abstract: | We replicate Meissner (2016) where debt aversion was reported for the first time in an intertemporal consumption and saving problem. While Meissner (2016) uses a German sample, our subjects are US undergraduate students. All of the main findings from the original study replicate with similar effect sizes. Additionally, we extend the original analysis by correlating a new individual index of debt aversion on individual characteristics such as gender, cognitive ability, and risk aversion. The findings suggest that gender and risk aversion are not correlated with debt aversion. However, cognitive ability is positively correlated with debt aversion. Overall, this paper confirms the importance of debt aversion in intertemporal consumption problems and validates the approach of Meissner (2016). |
| Keywords: | debt aversion; replication; experiment; |
| JEL: | C91 D84 G11 G41 |
| Date: | 2022–01–20 |
| URL: | http://d.repec.org/n?u=RePEc:rco:dpaper:312&r= |
| By: | Kelsey Jack; Kathryn McDermott; Anja Sautmann |
| Abstract: | Multiple price lists are a convenient tool to elicit willingness to pay (WTP) in surveys and experiments, but choice patterns such as “multiple switching” and “never switching” indicate high error rates. Existing measurement approaches often do not provide accurate standard errors and cannot correct for bias due to framing and order effects. We propose to combine a randomization approach with a random-effects latent utility model to detect bias and account for error. Data from a choice experiment in South Africa shows that significant order effects exist which, if uncorrected, would lead to distorted conclusions about subjects’ preferences. We provide templates to create a multiple price list survey instrument in SurveyCTO and analyze the resulting data using our proposed methods. |
| JEL: | C91 C93 D46 O12 Q51 |
| Date: | 2022–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:30433&r= |
| By: | Horst, Ulrich (HU Berlin); Xia, Xiaonyu (HU Berlin); Zhou, Chao (National University of Singapore) |
| Abstract: | We study an optimal liquidation problem under the ambiguity with respect to price impact parameters. Our main results show that the value function and the optimal trading strategy can be characterized by the solution to a semi-linear PDE with superlinear gradient, monotone generator and singular terminal value. We also establish an asymptotic analysis of the robust model for small amounts of uncertainty and analyze the effect of robustness on optimal trading strategies and liquidation costs. In particular, in our model ambiguity aversion is observationally equivalent to increased risk aversion. This suggests that ambiguity aversion increases liquidation rates. |
| Keywords: | stochastic control; uncertainty; portfolio liquidation; singular terminal value; superlinear growth gradient; |
| JEL: | E20 H30 |
| Date: | 2021–01–26 |
| URL: | http://d.repec.org/n?u=RePEc:rco:dpaper:274&r= |
| By: | Mel Win Khaw; Ziang Li; Michael Woodford |
| Abstract: | In an experiment that elicits subjects' willingness to pay (WTP) for the outcome of a lottery, we confirm the fourfold pattern of risk attitudes described by Kahneman and Tversky. In addition, we document a systematic effect of stake sizes on the magnitude and sign of the relative risk premium, holding fixed both the probability that a lottery pays off and the sign of its payoff (gain vs. loss). We further show that in our data, there is a log-linear relationship between the monetary payoff of the lottery and WTP, conditional on the probability of the payoff and its sign. We account quantitatively for this relationship, and the way in which it varies with both the probability and sign of the lottery payoff, in a model in which all departures from risk-neutral bidding are attributed to an optimal adaptation of bidding behavior to the presence of cognitive noise. Moreover, the cognitive noise required by our hypothesis is consistent with patterns of bias and variability in judgments about numerical magnitudes and probabilities that have been observed in other contexts. |
| JEL: | C91 D03 D81 D87 |
| Date: | 2022–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:30417&r= |
| By: | Andrew Koh; Sivakorn Sanguanmoo |
| Abstract: | Consider a Bayesian decision maker (DM) who, at each time period, chooses to either continue paying attention to information about a state upon which her utility depends, or stop and take action based on her best available information. We show that any distribution of stopping times$\unicode{x2013}$the random times at which DM stops paying attention$\unicode{x2013}$achievable through any dynamic information structure can be replicated by simple structures which give the DM full information at random times, and the null message otherwise. We use this to characterize the distributions of stopping times which can be achieved through information. All distributions on the FOSD frontier can be implemented by simple structures which, conditional on not giving full information, progressively steers the DM's beliefs towards a basin of attraction at which her valuation for full information is maximized. We then introduce a designer whose value function is any increasing function of the DM's stopping time and characterize the designer's optimal structure. These results speak directly to the attention economy. |
| Date: | 2022–09 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2209.05570&r= |
| By: | Mia Lu; Nick Netzer |
| Abstract: | We extend the swaps index of rationality, introduced by Apesteguia and Ballester (2015) for a finite set of alternatives, to the standard consumer choice setting with infinite commodity spaces. Applications include consumer demand from competitive budget sets and the state-space approach to choice under uncertainty. We are primarily interested in Apesteguia and Ballester's result that the swaps index recovers the decision-maker's true preference from choice data for a large class of boundedly rational behavioral models. We show that this result still holds in the consumer choice setting under a suitably defined monotonicity condition. This condition is satisfied for various models of interest but violated for others. |
| Keywords: | Measures of rationality, revealed preference, behavioral welfare economics |
| JEL: | D01 D11 D60 D90 |
| Date: | 2022–08 |
| URL: | http://d.repec.org/n?u=RePEc:zur:econwp:418&r= |
| By: | Anh D. M. Nguyen; Jean-Marc Fournier; Takuma Hisanaga |
| Abstract: | This paper assesses Japan’s fiscal stance in the past and the future with a stochastic structural model called the Buffer-Stock Model of the Government. Our retrospective analysis suggests that the fiscal stance in the 1990s and the early 2000s was overall looser than the model recommendations. As for the future, the model advises the near-term fiscal policy to be supportive with a view to narrowing the output gap and minimizing hysteresis, while recommending a fiscal consolidation over the medium-term at a gradual pace. |
| Keywords: | Fiscal stance; cycle stabilization; government deficit; government debt; baseline model advice; near-term fiscal policy; fiscal policy path; baseline calibration; Japan's fiscal policy; B. sensitivity analysis; Output gap; Fiscal consolidation; Global; utility function; sustainability concern; interest rate-growth differential; debt level; debt buffer |
| Date: | 2022–08–19 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:2022/164&r= |
| By: | Yang Bai |
| Abstract: | Using new annual data of 16 developed countries across bond, equity, and housing markets, I study the return predictability using the payout-price ratios, i.e., coupon price, dividend price, and rent price. None of the 48 country-asset combinations shows consistent in-sample and out-of-sample performance with positive utility gain for the mean-variance investor. Only 3 (4/2) countries show positive economic gains in their equity (housing/bond) markets. The return predictability for the representative agents' risky asset portfolios and wealth portfolios is even weaker, suggesting that timing the investment return of a country using payout-price ratios will not make the investors better off. The predictive regressions based on the VAR analysis by Cochrane (2008, 2011) suggest that 14 (5) countries have predictable payout growth in the equity (housing) markets, ex., the dividend price predicts the dividend growth in the US. The VAR simulation using data from all the countries does not reject the null that the dividend growth is predictable. This paper presents firm evidence against the return predictability based on payout ratios. |
| Date: | 2022–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2209.00121&r= |
| By: | Castro, M.F.;; Guccio, C.;; Romeo, D.; |
| Abstract: | By employing a large sample of both laboratory and field data, we investigate whether attitudes towards risk significantly vary between physicians, medical students and non-medical students. Also, we look for differences in risk propensity between laboratory and artefactual field experimental sessions and control for individuals’ characteristics that may affect risk attitude. Results show significant variation in risk attitude, regardless of the estimation technique employed (linear regression, interval regression and maximum likelihood estimation), suggesting constant relative risk aversion (CRRA) as a supported representation of risk preferences. Finally, data consistently show that physicians are more risk-seeking in the monetary domain than other subject groups. |
| Keywords: | risk aversion; field experiments; laboratory experiment; physicians’ behaviour; |
| JEL: | I1 C81 C93 D81 |
| Date: | 2022–09 |
| URL: | http://d.repec.org/n?u=RePEc:yor:hectdg:22/26&r= |
| By: | Ali Zeytoon-Nejad; Tanzid Hasnain |
| Abstract: | The recent coronavirus outbreak has made governments face an inconvenient tradeoff choice, i.e. the choice between saving lives and saving the economy, forcing them to make immensely consequential decisions among alternative courses of actions without knowing what the ultimate results would be for the society as a whole. This paper attempts to frame the coronavirus tradeoff problem as an economic optimization problem and proposes mathematical optimization methods to make rationally optimal decisions when faced with trade-off situations such as those involved in managing through the recent coronavirus pandemic. The framework introduced and the method proposed in this paper are on the basis of the theory of rational choice at a societal level, which assumes that the government is a rational, benevolent agent that systematically and purposefully takes into account the social marginal costs and social marginal benefits of its actions to its citizens and makes decisions that maximize the society's well-being as a whole. We approach solving this tradeoff problem from a static as well as a dynamic point of view. Finally, we provide several numerical examples clarifying how the proposed framework and methods can be applied in the real-world context. |
| Date: | 2022–09 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2209.02651&r= |
| By: | Cary Deck (Department of Economics, Finance and Legal Studies, University of Alabama and Economic Science Institute, Chapman University); Tae In Jun (Department of Economics, Finance and Legal Studies, University of Alabama); Laura Razzolini (Department of Economics, Finance and Legal Studies, University of Alabama); Tavoy Reid (Department of Economics, Finance and Legal Studies, University of Alabama) |
| Abstract: | The efficient market hypothesis predicts that asset prices reflect all available information. A seminal experiment reported that contingent claim markets could yield market outcomes consistent with information aggregation when traders hold heterogeneous state-contingent values. However, a recent experiment found the rational expectation model outperformed the prior information and maxi-min models in contingent claim markets when traders hold homogeneous values despite the no trade equilibrium in that setting. But that same study failed to replicate the original result calling into question when, if ever, prices reliably reflect the aggregate information of traders with heterogeneous values. In this paper, we show contingent claim markets can robustly yield prices consistent with the efficient market hypothesis when traders hold heterogeneous values in certain circumstances. The key distinction between our environment and that of the previous studies is that we consider trader values that are correlated and not too dissimilar. |
| Keywords: | Information Aggregation, Rational Expectations, Laboratory Experiments |
| JEL: | C9 D8 G1 |
| Date: | 2022 |
| URL: | http://d.repec.org/n?u=RePEc:chu:wpaper:22-13&r= |
| By: | Stich, Lucas (LMU Munich); Spann, Martin (LMU Munich); Schmidt, Klaus M. (LMU Munich) |
| Abstract: | Open access (OA) publishing upends the traditional business model in scientific publishing by requiring authors instead of readers to pay for the publishing-related costs. In this paper, we aim to elicit the willingness to pay (WTP) of authors for open access publishing. We conduct two separate field studies with different methodological approaches in different scientific disciplines (economics and medicine). First, a choice-based conjoint (CBC) analysis measures stated preferences of 243 economists in Germany, Austria, and Switzerland regarding their valuations of open access publishing in the “Top 5” economics journals. Second, a field experiment at four different open access medical journals elicits authors’ self-determined (“Pay-What-You-Want”) payments for open access publications. The results provide a plausible range of authors’ valuations, given that the first study rather provides an upper bound and the second study a lower bound of authors’ willingness to pay for open access publishing. |
| Keywords: | open access; willingness to pay; choice-based conjoint analysis; pay-what-you-want; field experiment; |
| JEL: | D12 M31 L11 L82 |
| Date: | 2021–01–19 |
| URL: | http://d.repec.org/n?u=RePEc:rco:dpaper:271&r= |