nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2023‒02‒13
sixteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Randomization advice and ambiguity aversion By Christoph Kuzmics; Brian W. Rogers; Xiannong Zhang
  2. Subjective Expected Utility Through Stochastic Independence By Michel Grabisch; Benjamin Monet; Vassili Vergopoulos
  3. Sensitivity Analysis between Lagrange Multipliers and Consumer Coupon: Utility Maximization Perspective By Mohajan, Devajit; Mohajan, Haradhan
  4. On the notion of measurable utility on a connected and separable topological space: an order isomorphism theorem By Gianmarco Caldini
  5. Can climate shocks make vulnerable subjects more willing to take risks? By Holden, Stein T.; Tilahun, Mesfin
  6. Three layers of uncertainty By Ilke Aydogan; Loïc Berger; Valentina Bosetti; Ning Liu
  7. Regret aversion and information aversion By Emmanuelle Gabillon
  8. Foundations of utilitarianism under risk and variable population By Dean Spears; Stéphane Zuber
  9. Best, worst, and Best&worst choice probabilities for logit and reverse logit models By André de Palma; Karim Kilani
  10. Geometry of set functions in cooperative game theory By Dylan Laplace Mermoud
  11. Acceptable Bilateral Gamma Parameters By Yoshihiro Shirai
  12. Test for Trading Costs Effect in a Portfolio Selection Problem with Recursive Utility By Marine Carrasco; N'Golo Koné
  13. The social cost of carbon with intragenerational inequality and economic uncertainty By van der Ploeg, Frederick; Emmerling, Johannes; Groom, Ben
  14. Robust Bayesian Choice By Stanca Lorenzo
  15. Residential Location and the Male-Female Gap in Labor Market Outcomes - A Lesson from Newcomers to Israel By Moshe Buchinsky; Chemi Gotlibovski; Osnat Lifshitz
  16. Foundations of self-progressive choice theories By Kemal Yildiz

  1. By: Christoph Kuzmics; Brian W. Rogers; Xiannong Zhang
    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.
    Date: 2023–01
  2. By: Michel Grabisch (CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Benjamin Monet; Vassili Vergopoulos
    Abstract: This paper studies decision-making in the face of two stochastically independent sources of uncertainty. It characterizes axiomatically a Subjective Expected Utility representation of preferences where subjective beliefs consist of a product probability measure. The two key axioms in this characterization both involve some behavioral notions of stochastic independence. Our result can be understood as a purely subjective version of the Anscombe and Aumann (1963) theorem that avoids the controversial use of exogenous probabilities by appealing to stochastic independence. We also obtain an extension to Choquet Expected Utility representations.
    Keywords: subjective probability, expected utility, stochastic independence, subjective independence, capacity, Choquet expectation.
    Date: 2023
  3. By: Mohajan, Devajit; Mohajan, Haradhan
    Abstract: Sensitivity analysis is a vital concept in optimization models. From this analysis an economist can predict on the outcome of an economic model by the use of certain range of input variables. Utility maximization policy is essential for the sustainability of the economic organizations. This study takes an attempt to discuss sensitivity analysis between Lagrange multipliers and consumer coupon, where utility maximization is analyzed with detail mathematical analysis. In the study method of Lagrange multipliers is used to investigate the utility function; subject to two constraints: budget constraint, and coupon constraint. Moreover, two Lagrange multipliers are used here with four commodity variables.
    Keywords: Coupon, consumers, Lagrange multipliers, sensitivity analysis, utility maximization
    JEL: C3 C51 C53 C61 C67 L7
    Date: 2022–09–10
  4. By: Gianmarco Caldini
    Abstract: The aim of this article is to define a notion of cardinal utility function called measurable utility and to define it on a connected and separable subset of a weakly ordered topological space. The definition is equivalent to the ones given by Frisch in 1926 and by Shapley in 1975 and postulates axioms on a set of alternatives that allow both to ordinally rank alternatives and to compare their utility differences. After a brief review of the philosophy of utilitarianism and the history of utility theory, the paper introduces the mathematical framework to represent intensity comparisons of utility and proves a list of topological lemmas that will be used in the main result. Finally, the article states and proves a representation theorem for a measurable utility function defined on a connected and separable subset of a weakly ordered topological space equipped with another weak order on its cartesian product. Under some assumptions on the order relations, the main theorem proves existence and uniqueness, up to positive affine transformations, of an order isomorphism with the real line.
    Date: 2022–12
  5. By: Holden, Stein T. (Centre for Land Tenure Studies, Norwegian University of Life Sciences); Tilahun, Mesfin (Centre for Land Tenure Studies, Norwegian University of Life Sciences)
    Abstract: While economists in the past tended to assume that individual preferences, including risk preferences, are stable over time, a recent literature has developed and indicates that risk preferences respond to shocks. This paper utilizes a natural experiment with covariate (drought) and idiosyncratic shocks in combination with an independent field risk experiment. The risk experiment uses a Certainty Equivalent - Multiple Choice List (CE-MCL) approach and is played 1-2 years after the subjects were (to a varying degree) exposed to a covariate drought shock or idiosyncratic shocks. The experimental approach facilitated a comprehensive assessment of shock effects on experimental risk premiums with varying probabilities of good and bad outcomes. The experiment also facilitates the estimation of the utility curvature in an Expected Utility (EU) model, and alternatively, separate estimation of probability weighting and utility curvature in three different Rank Dependent Utility (RDU) models with a two-parameter Prelec probability weighting function. Our study is the first to comprehensively test the theoretical predictions of Gollin and Pratt (1996) versus Quiggin (2003). Gollin and Pratt (1996) build on EU theory and state that an increase in background risk will make subjects more risk averse while Quiggin (2003) states that an increase in background risk can enhance risk-taking in certain types of non-EU models. We find strong evidence that such non-EU preferences dominate in our sample and can explain the surprising result. In our sample of resource-poor young adults living in a risky semiarid rural environment in Sub-Saharan Africa, we find that the covariate drought shock had negative effects on risk premiums and the utility curvature and caused an upward shift in the probability weighting function. To our knowledge, this is the first paper to carry out such a rigorous test of a shock effect on utility curvature and probability weighting.
    Keywords: Covariate shocks; Idiosyncratic shocks; Stability of risk preference parameters; Field experiment; Ethiopia
    JEL: C93 D81
    Date: 2023–01–28
  6. By: Ilke Aydogan (IÉSEG School Of Management [Puteaux]); Loïc Berger (CNRS - Centre National de la Recherche Scientifique, IÉSEG School Of Management [Puteaux], EIEE - European Institute on Economics and the Environment, CMCC - Centro Euro-Mediterraneo per i Cambiamenti Climatici [Bologna]); Valentina Bosetti (Bocconi University [Milan, Italy], EIEE - European Institute on Economics and the Environment, CMCC - Centro Euro-Mediterraneo per i Cambiamenti Climatici [Bologna]); Ning Liu (BUAA - Beihang University)
    Abstract: We explore decision-making under uncertainty using a framework that decom- poses uncertainty into three distinct layers: (1) risk, which entails inherent random- ness within a given probability model; (2) model ambiguity, which entails uncertainty about the probability model to be used; and (3) model misspecification, which en- tails uncertainty about the presence of the correct probability model among the set of models considered. Using a new experimental design, we isolate and measure attitudes towards each layer separately. We conduct our experiment on three different subject pools and document the existence of a behavioral distinction between the three layers. In addition to providing new insights into the underlying processes behind ambiguity aversion, we provide the first empirical evidence of the role of model misspecification in decision-making under uncertainty.
    Keywords: Ambiguity aversion, model uncertainty, model misspecification, non-expected utility, reduction of compound lotteries
    Date: 2023
  7. By: Emmanuelle Gabillon (BSE - Bordeaux Sciences Economiques - UB - Université de Bordeaux - CNRS - Centre National de la Recherche Scientifique)
    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.
    Keywords: Regret, Emotion, Information
    Date: 2022–12–14
  8. 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
  9. By: André de Palma (Université CYU, THEMA - Théorie économique, modélisation et applications - CNRS - Centre National de la Recherche Scientifique - CY - CY Cergy Paris Université); Karim Kilani (LIRSA - Laboratoire interdisciplinaire de recherche en sciences de l'action - CNAM - Conservatoire National des Arts et Métiers [CNAM] - HESAM - HESAM Université - Communauté d'universités et d'établissements Hautes écoles Sorbonne Arts et métiers université)
    Abstract: This paper builds upon the work of Professor Marley, who, since the beginning of his long research career, has proposed rigorous axiomatics in the area of probabilistic choice models. Our study concentrates on models that can be applied to best and worst choice scaling experiments. We focus on those among these models that are based on strong assumptions about the underlying ranking of the alternatives with which the individual is assumed to be endowed when making the choice. Taking advantage of an inclusion-exclusion identity that we showed a few years ago, we propose a variety of best-worst choice probability models that could be implemented in software packages that are flourishing in this field.
    Keywords: Best-worst scaling experiments Logit model Random utility models Reverse logit model, Best-worst scaling experiments, Logit model, Random utility models, Reverse logit model JEL classification
    Date: 2022–12–27
  10. By: Dylan Laplace Mermoud
    Abstract: They are many unexplored links between cooperative transferable utility games and convex, discrete or combinatorial geometry. In this paper, we investigate some of these links, such as the ones between cores of convex games and generalized permutohedra, also named polymatroids or base polyhedra. Another link that we investigate is the one between the resonance hyperplane arrangement and the set of sets of preimputations which are effective for a given coalition. These bridges can give interpretation and intuition to cooperative game theory, as well as bring new results and tools from other fields into the study of cooperative games.
    Date: 2023–01
  11. By: Yoshihiro Shirai
    Abstract: The purpose of this paper is to utilize statistical methodologies to infer from market prices of assets and their derivatives the magnitude of the set of a measure M that defines acceptance sets of risky future cash flows. Specifically, we estimate upper and lower boundaries of the compensation needed for a given bilateral gamma distributed future cash flow to be acceptable. We show that prospects theory provides a natural interpretation of the behaviors implied by such boundaries, which are not compatible with expected utility theory over terminal wealth. Boundaries for bilateral gamma risk neutral scale parameters for given speed parameters are also estimated and tested against market data and, in particular, comparisons are made with known empirical facts about the magnitude of the acceptance set of a common class of risk measures.
    Date: 2023–01
  12. By: Marine Carrasco; N'Golo Koné
    Abstract: This paper addresses a portfolio selection problem with trading costs on stock market. More precisely, we develop a simple GMM-based test procedure to test the significance of rading costs effect in the economy with a áexible form of transaction costs. We also propose a two-step procedure to test overidentifying restrictions in our GMM estimation. In an empirical analysis, we apply our test procedures to the class of anomalies used in Novy-Marx and Velikov (2016). We show that transaction costs have a significant effect on investors behavior for many anomalies. In that case, investors significantly improve the out-of-sample performance of their portfolios by accounting for trading costs. Cet article traite du problème de sélection de portefeuilles avec des coûts de transactions sur le marché des actions. Plus précisément, nous développons une procédure de test basée sur la méthode des moments généralisée pour tester l’effet des coûts de transaction de forme flexible sur l’économie. Nous proposons aussi une approche en deux étapes pour construire un test de suridentification. Dans une analyse économique, nous appliquons nos procédures de test à la classe d’anomalies étudiées par Novy-Marx et Velikov (2016). Nous montrons que les coûts de transaction ont un effet significatif sur le comportement des investisseurs pour beaucoup d’anomalies. Dans ce cas, les investisseurs améliorent de manière importante la performance hors-échantillon de leurs portefeuilles en tenant compte des coûts de transaction.
    Keywords: Portfolio selection, transaction costs, testing overidentifying restrictions, recursive utility, sélection de portefeuilles, coûts de transaction, test de suridentification, utilité récursive
    JEL: C12 G11
    Date: 2023–01–17
  13. By: van der Ploeg, Frederick; Emmerling, Johannes; Groom, Ben
    Abstract: An analytical formula is presented for the Social Cost of Carbon (SCC) taking account of intragenerational income inequality, in addition to intergenerational income inequality, macro-economic uncertainty and rare disasters to economic growth. The social discount rate is adjusted for intra- and intergenerational inequality aversion and risk aversion. If growth reduces intragenerational inequality, the SCC is lower than with inequality-neutral growth, especially if intra- and intergenerational inequality aversion are high. Calibrated to the observed interest rate and risk premium, the SCC in 2020 is $125/tCO2 without considering intragenerational inequality, $81/tCO2 if intragenerational inequality decreases over time, as a continuation of historical trends suggests (based on Shared Socioeconomic Pathway (SSP) 2), and $213/tCO2 if inequality increases (SSP4). Intragenerational inequality has a similar order of effect on the SCC as accounting for rare macroeconomic disasters.
    Keywords: social discount rate; social cost of carbon; intra- and intergenerational inequality aversion; risk aversion; inequality; growth; uncertainty
    JEL: C61 D31 D62 D81 G12 H23 Q54
    Date: 2023–01–10
  14. By: Stanca Lorenzo (Department of Economics, Social Studies, Applied Mathematics and Statistics (ESOMAS) and Collegio Carlo Alberto, University of Torino, Italy;)
    Abstract: A major concern with Bayesian decision making under uncertainty is the use of a single probability measure to quantify all relevant uncertainty. This paper studies prior robustness as a form of continuity of the value of a decision problem. It is shown that this notion of robustness is characterized by a form of stable choice over a sequence of perturbed decision problems, in which the available acts are perturbed in a precise fashion. Subsequently, a choice-based measure of prior robustness is introduced and applied to portfolio choice and climate mitigation.
    Keywords: Risk, Uncertainty, Robustness, Ambiguity, Robust Statistics, Prior Selection.
    JEL: C52 C61 D81
    Date: 2023–01
  15. By: Moshe Buchinsky (UCLA - University of California [Los Angeles] - UC - University of California, NBER - National Bureau of Economic Research [New York] - NBER - The National Bureau of Economic Research, ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique); Chemi Gotlibovski (MTA - The Academic College of Tel Aviv-Yaffo); Osnat Lifshitz (Reichman University [Herzliya])
    Abstract: We estimated two dynamic programing models, one for men and one for women, on a sample of immigrants who arrived in Israel from the Former Soviet Union (FSU) between 1989 and 1995. Following the literature, we assume that the household maximizes its expected utility based only on the husband's human capital. Therefore, the family's residential location decision is based on the husband's labor market opportunities. We study the potential effect of this assumed behavior on the labor market's gender gaps. In the model estimated for men, we endogenize the decisions regarding residential location, employment location, and occupational choices. In contrast, in the model estimated for women the family's residential location is taken as given. Using the estimated parameters from the two models and a number of counterfactual simulations, we are able to decompose the observed gender wage gap into two parts–one based on behavioral differences and the other based on the lower labor market returns for women. The simulations indicate that if women had the same labor market returns and the same preferences as men, their outcomes would have been similar to those of men. Moreover, the simulations show that even without any changes in their labor market conditions, women would have gained in terms of both job quality and wages if the family's residential location was based on their human capital.
    Keywords: Family migration, Gender wage gap, Household Labor Supply, Residential Location
    Date: 2023
  16. By: Kemal Yildiz
    Abstract: Consider a population of agents whose choice behaviors are partially comparable according to given primitive orderings. A choice theory specifies the set of choice functions admissible in the population. A choice theory is self-progressive if any aggregate choice behavior consistent with the theory can uniquely be represented as a probability distribution over admissible choice functions that are comparable to each other. We establish an equivalence between self-progressive choice theories and (i) well-known algebraic structures called lattices; (ii) the maximizers of supermodular functions over choice functions. Keywords: Random choice, heterogeneity, identification, lattice, supermodular optimization, multiple behavioral characteristics.
    Date: 2022–12

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