nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2023‒01‒30
twelve papers chosen by

  1. Conducting Cost Benefit Analysis in Expected Utility Units Using Revealed Social Preferences By Canning, David
  2. Randomization advice and ambiguity aversion By Christoph Kuzmics; Brian W. Rogers; Xiannong Zhang
  3. Optimal Liquidation with High Risk Aversion in the Almgren--Chriss Model: A Case Study By Leonid Dolinskyi; Yan Dolinsky
  4. Regret theory, Allais' Paradox, and Savage's omelet By Vardan G. Bardakhchyan; Armen E. Allahverdyan
  5. Selective Memory of a Psychological Agent By Jeanne Hagenbach; Frédéric Koessler
  6. Foundations of utilitarianism under risk and variable population By Dean Spears; Stéphane Zuber
  7. The Endowment Effect in the General Population By Dietmar Fehr; Dorothea Kübler
  8. Women's Rights and the Gender Migration Gap By Gutmann, Jerg; Marchal, Léa; Simsek, Betül
  9. Sequential Sampling Beyond Decisions? A Normative Model of Decision Confidence By Rastislav Rehak
  10. Negotiations of Oil and Gas Auxiliary Lease Clauses: Evidence from Pennsylvania’s Marcellus Shale By Max Harleman; Pramod Manohar; Elaine L. Hill
  11. The Status Quo and Belief Polarization of Inattentive Agents: Theory and Experiment By Vladimir Novak; Andrei Matveenko; Silvio Ravaioli
  12. On the solution of games with arbitrary payoffs: An application to an over-the-counter financial market By Iraklis Kollias; John Leventides; Vassilios G. Papavassiliou

  1. By: Canning, David
    Abstract: Assuming individual preferences satisfy the Von Neumann–Morgenstern axioms for expected utility we show how we can measure an individual’s expected utility of any state using their willingness to accept a gamble over two reference points. The utility function captures the diminishing marginal utility of money with income and risk aversion over gambles. This contrasts with the standard money metric valuations that assume linearity of an individual’s welfare in money. Measuring costs and benefits in expected utility units seems more appropriate than money units for applied welfare economics since it reflects individuals’ preferences more accurately, and can be applied to policies that involve risk. In addition, if social preferences satisfy the Von Neumann–Morgenstern axioms and the Pareto principle, social welfare is the weighted sum of these expected utilities. The weights can be calculated directly for the United States from revealed Government preferences on the allocation of mortality risk. The United States Government values lives equally in calculating the welfare losses from mortality risk and this implies an equal weighting of individual utilities if they are measured using willingness to accept a gamble of a probability of death versus the status quo; we call this life metric expected utility. For projects with small effects on expected utility, we show how to convert existing money metric cost benefit studies into life metric expected utility cost benefit analysis using weights based on how the money value of a statistical life varies with income in the United States. Our approach may be particularly appealing for the conduct of cost-benefit studies mandated by regulation in the United States to inform Government policy. It measures costs and benefits in expected utility units that respect individuals’ preferences over risk and sums these utility gains using the Government’s revealed preferences and implied social welfare function.
    Keywords: welfare economics; cost benefit analysis; value of life
    Date: 2023–01–13
  2. By: Christoph Kuzmics (University of Graz, Austria); Brian W. Rogers (Washington University in St. Louis, U.S.A.); Xiannong Zhang (Washington University in St. Louis, U.S.A.)
    Abstract: We design and implement lab experiments to evaluate the normative appeal of behavior arising from models of ambiguity-averse preferences. We report two main empirical findings. First, we demonstrate that behavior reflects an incomplete understanding of the problem, providing evidence that subjects do not act on the basis of preferences alone. Second, additional clarification of the decision making environment pushes subjects’ choices in the direction of ambiguity aversion models, regardless of whether or not the choices are also consistent with subjective expected utility, supporting the position that subjects find such behavior normatively appealing.
    Keywords: Knightian uncertainty; subjective expected utility; ambiguity aversion; lab experiment.
    JEL: C91 D81
    Date: 2023–01
  3. By: Leonid Dolinskyi; Yan Dolinsky
    Abstract: We consider the Bachelier model with linear price impact. Exponential utility indifference prices are studied for vanilla European options in the case where the investor is required to liquidate her position at the maturity date. Our main result is establishing a non-trivial scaling limit for a vanishing price impact which is inversely proportional to the risk aversion. We compute the limit of the corresponding utility indifference prices and find explicitly a family of portfolios which are asymptotically optimal.
    Date: 2023–01
  4. By: Vardan G. Bardakhchyan; Armen E. Allahverdyan
    Abstract: We study a sufficiently general regret criterion for choosing between two probabilistic lotteries. For independent lotteries, the criterion is consistent with stochastic dominance and can be made transitive by a unique choice of the regret function. Together with additional (and intuitively meaningful) super-additivity property, the regret criterion resolves the Allais' paradox including the cases were the paradox disappears, and the choices agree with the expected utility. This superadditivity property is also employed for establishing consistency between regret and stochastic dominance for dependent lotteries. Furthermore, we demonstrate how the regret criterion can be used in Savage's omelet, a classical decision problem in which the lottery outcomes are not fully resolved. The expected utility cannot be used in such situations, as it discards important aspects of lotteries.
    Date: 2023–01
  5. By: Jeanne Hagenbach (ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique); Frédéric Koessler (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, PJSE - Paris Jourdan Sciences Economiques - 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: We consider a single psychological agent whose utility depends on his action, the state of the world, and the belief he holds about that state. The agent is initially informed about the state and decides whether to memorize it, otherwise he has no recall. We model the memorization process by a multi-self game in which the privately-informed first self voluntarily discloses information to the second self, who has identical preferences and acts upon the disclosed information. We show that, for broad categories of psychological utility functions, there exists an equilibrium in which every state is voluntarily memorized. In contrast, if there are exogenous failures in the memorization process, the agent always memorizes states selectively. In this case, we characterize the partially informative equilibria for common classes of psychological utilities.
    Keywords: Multi-self games, Disclosure games, Imperfect recall, Selective memory, Motivated beliefs, Psychological games, Anticipatory utility
    Date: 2022–02
  6. By: Dean Spears (University of Texas at Austin [Austin], IZA - Forschungsinstitut zur Zukunft der Arbeit - Institute of Labor Economics); 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)
    Abstract: Utilitarianism is the most prominent social welfare function in economics. We present three new axiomatic characterizations of utilitarian (that is, additively-separable) social welfare functions in a setting where there is risk over both population size and individuals' welfares. We first show that, given uncontroversial basic axioms, Blackorby et al.'s (1998) Expected Critical-Level Generalized Utilitarianism is equivalent to a new axiom holding that it is better to allocate higher utility-conditional-on-existence to possible people who have a higher probability of existence. The other two characterizations extend and clarify classic axiomatizations of utilitarianism from settings with either social risk or variable-population, considered alone.
    Keywords: Social risk, population ethics, utilitarianism, expected critical-level generalized utilitarianism, prioritarianism
    Date: 2022–12
  7. By: Dietmar Fehr; Dorothea Kübler
    Abstract: We study the endowment effect and expectation-based reference points in the field leveraging the setup of the Socio-Economic Panel. Households receive a small item for taking part in the panel, and we randomly assign respondents either a towel or a notebook, which they can exchange at the end of the interview. We observe a trading rate of 32 percent, consistent with an endowment effect, but no relationship with loss aversion. Manipulating expectations of the exchange opportunity, we find no support for expectation-based reference points. However, trading predicts residential mobility and is related to stock-market participation, i.e., economic decisions that entail parting with existing resources.
    Keywords: exchange asymmetry, reference-dependent preferences, loss aversion, field experiment, SOEP
    JEL: C93 D84 D91
    Date: 2022
  8. By: Gutmann, Jerg; Marchal, Léa; Simsek, Betül
    Abstract: This is the first global study of how institutionally entrenched gender discrimination affects the gender migration gap (GMG) using data on 158 origin and 37 destination countries over the period 1961-2019. We estimate a gravity equation derived from a random utility maximization model of migration that accounts for migrants' gender. Instrumental variable estimates indicate that increasing gender equality in economic or political rights generally deepens the GMG, i.e., it reduces female emigration relative to that of men. In line with our theoretical model, this average effect is driven by higher-income countries. In contrast, increased gender equality in rights reduces the GMG in lower-income countries by facilitating female emigration.
    Keywords: Discrimination, Gender equality, Individual rights, Migration, RUM model
    JEL: F22 J16 J71 K38 O15 P48
    Date: 2023
  9. By: Rastislav Rehak
    Abstract: We study informational dissociations between decisions and decision confidence. We explore the consequences of a dual-system model: the decision system and confidence system have distinct goals, but share access to a source of noisy and costly information about a decision-relevant variable. The decision system aims to maximize utility while the confidence system monitors the decision system and aims to provide good feedback about the correctness of the decision. In line with existing experimental evidence showing the importance of post-decisional information in confidence formation, we allow the confidence system to accumulate information after the decision. We aim to base the post-decisional stage (used in descriptive models of confidence) in the optimal learning theory. However, we find that it is not always optimal to engage in the second stage, even for a given individual in a given decision environment. In particular, there is scope for post-decisional information acquisition only for relatively fast decisions. Hence, a strict distinction between one-stage and two-stage theories of decision confidence may be misleading because both may manifest themselves under one underlying mechanism in a non-trivial manner.
    Keywords: decision; confidence; sequential sampling; optimal stopping;
    JEL: C11 C41 C44 D11 D83 D91
    Date: 2022–11
  10. By: Max Harleman; Pramod Manohar; Elaine L. Hill
    Abstract: Oil and gas lease negotiations provide mineral owners the opportunity to negotiate for both compensation and auxiliary clauses that may protect their health and properties. We use optical character recognition to assemble a novel dataset of compensation and specific clauses in nearly 60, 000 leases signed in the Marcellus Shale Play of Pennsylvania. We leverage the dataset to produce three main findings. First, contrary to the standard utility maximization model, we find a positive relationship between compensation and clauses. Second, we find that as development of the shale play progressed over time, compensation rose and leases became more likely to contain environmentally protective clauses. Third, we find that compensation and the presence of clauses have a weak relationship with the geologic productivity of nearby wells. Together, our findings indicate that oil and gas firms simultaneously make concessions by raising compensation and approving clauses, but these concessions do not depend on geologic productivity. This suggests that some mineral owners, such as those that are high-income or from more socially organized communities, have the skills or resources to negotiate for more favorable leases all-around and point to similar environmental justice concerns identified in other shale plays.
    JEL: D23 Q32 Q33 R11
    Date: 2022–12
  11. By: Vladimir Novak; Andrei Matveenko; Silvio Ravaioli
    Abstract: We show that rational but inattentive agents can become polarized ex-ante. We present how optimal information acquisition, and subsequent belief formation, depend crucially on the agent-specific status quo valuation. Beliefs can systematically - in expectations over all possible signal realizations conditional on the state of the world - update away from the realized truth and even agents with the same initial beliefs might become polarized. We design a laboratory experiment to test the model’s predictions. The results confirm our predictions about the mechanism (rational information acquisition), its effect on beliefs (systematic polarization) and provide general insights into demand for information.
    Keywords: Polarization, Beliefs Updating, Rational Inattention, Status Quo, Experiment
    JEL: C92 D72 D83 D84 D91
    Date: 2023–01
  12. By: Iraklis Kollias; John Leventides; Vassilios G. Papavassiliou (National and Kapodistrian University of Athens, University College Dublin, and UCD Geary Institute for Public Policy, University College Dublin)
    Abstract: This paper defines a variety of game theoretic solution concepts in the language of soft set theory. We begin by defining the Nash equilibrium in pure strategies. We assume that the gains of the players are totally ordered and non-desirable alternatives are absent. Moreover, we introduce the notions of strong and semi-strong utility. These two completely new notions, serve as a mechanism for converting non-ordered gains into totally ordered ones. We define the Nash equilibrium in mixed strategies in a general framework by introducing the notion of an extended game and strategy space. We finally define the Nash solution to cooperative bargaining games within the framework of soft set theory, illustrate a practical application to an over-the-counter (OTC) financial market, and provide a detailed numerical example
    Keywords: Game theory; Soft set theory; Nash equilibrium; Cooperative bargaining games; Over-the-counter financial markets; Financial intermediation
    JEL: C6 C7 G1
    Date: 2022–01–05

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