nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2023‒04‒03
eighteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Random Utility, Repeated Choice, and Consumption Dependence By Christopher Turansick
  2. Microfoundations of Expected Utility and Response Times By Valdes Salvador; Gonzalo ValdesEdwards
  3. Forward Backward SDEs Systems for Utility Maximization in Jump Diffusion Models By Marina Santacroce; Paola Siri; Barbara Trivellato
  4. Measuring Preferences Over Intertemporal Profiles By Chen Sun
  5. Dynamic Utility and related nonlinear SPDE driven by Lévy Noise. By Anis Matoussi; Mohamed Mrad
  6. Against the Odds! The Tradeoff Between Risk and Incentives is Alive and Well By Brice Corgnet; Roberto Hernan-Gonzalez; Yao Thibaut Kpegli; Adam Zylbersztejn
  7. Time-inconsistent contract theory By Camilo Hern\'andez; Dylan Possama\"i
  8. Solving some Stochastic Partial Differential Equations driven by Lévy Noise using two SDEs. * By Mohamed Mrad
  9. Optimal investment with a noisy signal of future stock prices By Peter Bank; Yan Dolinsky
  10. Social herding in mean field games By Deepanshu Vasal
  11. Economic stimulus effects of product innovation under demand stagnation By Daisuke Matsuzaki; Yoshiyasu Ono
  12. Measuring the Attractiveness of Trip Destinations: A Study of the Kansai Region By Keisuke Kondo
  13. Trading ambiguity: a tale of two heterogeneities By Sujoy Mukerji; Han N Ozsoylev; Jean‐marc Tallon
  14. More than a feeling By Dietrich, Stephan; Nichols, Stafford
  15. Neoclassical growth with long-term one-sided commitment contracts By Krueger, Dirk; Uhlig, Harald
  16. Public safety under imperfect taxation By Nicolas Treich; Yuting Yang
  17. More Ambiguous or More Complex? An Investigation of Individual Preferences under Model Uncertainty By Ilke AYDOGAN; Loïc BERGER; Vincent THEROUDE
  18. The disposition effect: experimental evidence that exhibits rationality from professional commodities traders By Guenther, Benno; Lordan, Grace

  1. By: Christopher Turansick
    Abstract: We study the repeated choice interpretation of stochastic choice and the individual interpretation of the random utility model. We consider a myopic agent whose distribution over preferences tomorrow potentially depends on their consumption and preference today. Even when the agent is classically rational in each of their static decisions, there are forms of consumption dependence which are inconsistent with random utility as a model of intertemporal aggregation. We offer two characterizations of Markovian consumption dependence which are consistent with random utility. Further, we characterize the behavioral content of consumption dependence in a two period stochastic choice model.
    Date: 2023–02
  2. By: Valdes Salvador; Gonzalo ValdesEdwards
    Abstract: This paper builds a rule for decisionmaking from the physical behavior of single neurons, the well established neural circuitry of mutual inhibition, and the evolutionary principle of natural selection. No axioms are used in the derivation of this rule. The paper provides a microfoundation to both Economics Choice Theory and Cognitive Psychologys Response Times Theory. The paper finds how classical expected utility should be modified to account for much neuroscientific evidence, and how neuroscientific correlates of choice should be linked to utility. In particular, the model implies the concept of utility is a network property and cannot be calculated as a function of frequencies in one layer of neurons alone; it requires understanding how different layers work together. The resulting rule is simple enough to model markets and games as is customary in the social sciences. Utility maximization and inaction are endogenous to the model, cardinality and independence of irrelevant alternatives, properties present in classical and random utility theories, are only met in limiting situations.
    Date: 2023–02
  3. By: Marina Santacroce; Paola Siri; Barbara Trivellato
    Abstract: We consider the classical problem of maximizing the expected utility of terminal net wealth with a final random liability in a simple jump-diffusion model. In the spirit of Horst et al. (2014) and Santacroce-Trivellato (2014), under suitable conditions the optimal strategy is expressed in implicit form in terms of a forward backward system of equations. Some explicit results are presented for the pure jump model and for exponential utilities.
    Date: 2023–02
  4. By: Chen Sun (HU Berlin)
    Abstract: Growing evidence indicates that utility over time is different from utility under risk. Hence, measuring intertemporal preferences (discounting and utility) exclusively from intertemporal choices is desirable. We develop a simple method for measuring intertemporal preferences. It is parameter-free in both discounting and utility, and allows a wider range of models to be measured than preceding methods. It is easy to implement, clear to subjects, incentive compatible, and does not require more measurements than existing methods if identical assumptions are imposed. In an experiment, we illustrate how the method can be used to test recent models with unconventional assumptions non-parametrically.
    Keywords: measuring time preferences; intertemporal profile; parameter-free;
    JEL: C91 D12 D91
    Date: 2023–02–13
  5. By: Anis Matoussi (LMM - Laboratoire Manceau de Mathématiques - UM - Le Mans Université); Mohamed Mrad (LAGA - Laboratoire Analyse, Géométrie et Applications - UP8 - Université Paris 8 Vincennes-Saint-Denis - UP13 - Université Paris 13 - Institut Galilée - CNRS - Centre National de la Recherche Scientifique)
    Abstract: This work concerns the study of consistent dynamic utilities in a financial market with jumps. We extend the results established in the paper [EKM13] to this framework. The ideas are similar but the difficulties are different due to the presence of the Lévy process. An additional complexity is clearly the interpretation of the terms of jumps in the different problems primal and dual one and relate them to each other. To do, we need an extension of the Itô-Ventzel's formula to jump's frame. By verification, we show that the dynamic utility is solution of a non-linear second order stochastic partial integro-differential equation (SPIDE). The main difficulty is that this SPIDE is forward in time, so there are no results in the literature that ensure the existence of a solution or simply allow us to deduce important properties, in our study, such as concavity or monotonicity. Our approach is based on a complete study of the primal and the dual problems. This allows us, firstly, to establish a connection between the utility-SPIDE and two SDEs satisfied by the optimal processes. Based on this connection and the SDE's theory, stochastic flow technics and characteristic method allow us, secondly, to completely solve the equation; existence, uniqueness, monotony and concavity. * This research benefited from the support of the "Chair Risques Émergents ou atypiques en Assurance", under the aegis of Fondation du Risque, a joint initiative by Le Mans Université, École polytechnique and l'Entreprise MMA and the support of the "Labex MME-DII".
    Keywords: forward utility, stochastic PDE with jumps, Stochastic flows, stochastic characteristics method, performance criteria, horizon-unbiased utility, consistent utility, progressive utility, portfolio optimization, duality
    Date: 2022–02–28
  6. By: Brice Corgnet (Univ Lyon, Emlyon Business School, GATE UMR 5824, F-69130 Ecully, France); Roberto Hernan-Gonzalez (Burgundy School of Business, Dijon, France); Yao Thibaut Kpegli (Univ Lyon, Université Lyon 2, GATE UMR 5824, F-69130 Ecully, France); Adam Zylbersztejn (Univ Lyon, Université Lyon 2, GATE UMR 5824, F-69130 Ecully, France; research fellow at Vistula University Warsaw (AFiBV), Warsaw, Poland)
    Abstract: The risk-incentives tradeoff (RIT) is a fundamental result of principal-agent theory. Yet, empirical evidence has been elusive. This could be due to a lack of robustness of the theory outside of the standard expected utility framework (EUT) or to confounding factors in the empirical tests. First, we theoretically study the existence of RIT under alternative theories: Rank-Dependent Utility (RDU) and Mean-Variance-Skewness (MVS). We show that RIT is remarkably robust under RDU, but not under MVS. Second, we use a novel experimental design that eliminates confounding factors and find evidence for RIT even in the case of risk-seeking agents, which is a distinct prediction of RDU. Our results provide support for the risk-incentives tradeoff and suggest that it applies to a broad range of situations including cases in which agents are risk-seeking (e.g., executive compensation).
    Keywords: Risk-Incentives Tradeoff, Rank-Dependent Utility, Mean-Variance-Skewness, Experiments
    JEL: C92 D23 D86 M54
    Date: 2023
  7. By: Camilo Hern\'andez; Dylan Possama\"i
    Abstract: This paper investigates the moral hazard problem in finite horizon with both continuous and lump-sum payments, involving a time-inconsistent sophisticated agent and a standard utility maximiser principal. Building upon the so-called dynamic programming approach in Cvitani\'c, Possama\"i, and Touzi [18] and the recently available results in Hern\'andez and Possama\"i [43], we present a methodology that covers the previous contracting problem. Our main contribution consists in a characterisation of the moral hazard problem faced by the principal. In particular, it shows that under relatively mild technical conditions on the data of the problem, the supremum of the principal's expected utility over a smaller restricted family of contracts is equal to the supremum over all feasible contracts. Nevertheless, this characterisation yields, as far as we know, a novel class of control problems that involve the control of a forward Volterra equation via Volterra-type controls, and infinite-dimensional stochastic target constraints. Despite the inherent challenges associated to such a problem, we study the solution under three different specifications of utility functions for both the agent and the principal, and draw qualitative implications from the form of the optimal contract. The general case remains the subject of future research.
    Date: 2023–03
  8. By: Mohamed Mrad (LAGA - Laboratoire Analyse, Géométrie et Applications - UP8 - Université Paris 8 Vincennes-Saint-Denis - UP13 - Université Paris 13 - Institut Galilée - CNRS - Centre National de la Recherche Scientifique)
    Abstract: The method of characteristics is a powerful tool to solve some nonlinear second order stochastic PDEs like those satisfied by a consistent dynamic utilities, see [EM13, MM20]. In this situation the solution V (t, z) is theoretically of the formX t V (0, ξ t (z)) whereX and Y are solutions of a system of two SDEs, ξ is the inverse flow ofȲ and V (0, .) is the initial condition. Unfortunately this representation is not explicit except in simple cases whereX andȲ are solutions of linear equations. The objective of this work is to take advantage of this representation to establish a numerical scheme approximating the solution V using Euler approximations X N and ξ N of X and ξ. This allows us to avoid a complicated discretizations in time and space of the SPDE for which it seems really difficult to obtain error estimates. We place ourselves in the framework of SDEs driven by Lévy noise and we establish at first a strong convergence result, in L p-norms, of the compound approximation X N t (Y N t (z)) to the compound variable X t (Y t (z)), in terms of the approximations of X and Y which are solutions of two SDEs with jumps. We then apply this result to Utility-SPDEs of HJB type after inverting monotonic stochastic flows.
    Keywords: Euler scheme, stochastic flow, method of stochastic characteristics, SPDE driven by Lévy noise, Utility-SPDE, Garsia-Rodemich-Rumsey lemma, strong approximation
    Date: 2022–02–01
  9. By: Peter Bank; Yan Dolinsky
    Abstract: We consider an investor who is dynamically informed about the future evolution of one of the independent Brownian motions driving a stock's price fluctuations. With linear temporary price impact the resulting optimal investment problem with exponential utility turns out to be not only well posed, but it even allows for a closed-form solution. We describe this solution and the resulting problem value for this stochastic control problem with partial observation by solving its convex-analytic dual problem.
    Date: 2023–02
  10. By: Deepanshu Vasal
    Abstract: In this paper, we consider a mean field model of social behavior where there are an infinite number of players, each of whom observes a type privately that represents her preference, and publicly observes a mean field state of types and actions of the players in the society. The types (and equivalently preferences) of the players are dynamically evolving. Each player is fully rational and forward-looking and makes a decision in each round t to buy a product. She receives a higher utility if the product she bought is aligned with her current preference and if there is a higher fraction of people who bought that product (thus a game of strategic complementarity). We show that for certain parameters when the weight of strategic complementarity is high, players eventually herd towards one of the actions with probability 1 which is when each player buys a product irrespective of her preference.
    Date: 2023–03
  11. By: Daisuke Matsuzaki; Yoshiyasu Ono
    Abstract: When faced with economic stagnation, innovation, product innovation in particular, is often cited as an effective stimulus because it is thought to encourage household consumption and lead to higher demand. Using a secular stagnation model with wealth preference, we examine the effects of product innovation on employment and consumption. Two types of product innovation are examined: quantity-augmenting-like innovation and addictive innovation. The former works as if a larger quantity were consumed although the actual quantity remains the same. The latter reduces the elasticity of the marginal utility of consumption. We find that the former reduces both consumption and employment whereas the latter expands them.
    Date: 2023–03
  12. By: Keisuke Kondo (Research Institute of Economy, Trade and Industry and Research Institute for Economics and Business Administration, Kobe University, JAPAN)
    Abstract: This study proposes a novel concept of regional attractiveness index based on human mobility flows. Assuming that individuals' mobility choice is based on utility maximization, this study aims to recover the attractiveness of trip destinations by estimating the gravity equation for interregional trip flows. Using data from a Person Trip Survey in the Kansai region of Japan, this study investigates whether different trip purposes (e.g., commuting to office and school, recreational trips, business trips, and returning home) can reveal variations in the attractiveness of trip destinations in a geographical space. This study found that the proposed approach using interregional trip flows can effectively capture the extent to which trip destinations attract people from a region-wide perspective. As real-time human mobility data becomes increasingly available in the age of Big Data, the new index of regional attractiveness is expected to become a key performance indicator for daily monitoring of urban and regional economies.
    Keywords: Regional attractiveness index; Person trip survey; Gravity equation
    JEL: J61 R23 R41
    Date: 2023–03
  13. By: Sujoy Mukerji (QMUL - Queen Mary University of London); Han N Ozsoylev (Özyeğin University); Jean‐marc Tallon
    Abstract: We consider nancial markets with heterogeneously ambiguous assets and heterogeneously ambiguity averse investors. Investors' preferences, a version of the smooth ambiguity model, are a parsimonious extension of the standard mean-variance framework. We consider, in a uni ed setting, portfolio choice, and trade upon arrival of public information, and show, in both cases, there are systematic departures from the predictions of standard theory. These departures are of signi cance as they occur in the direction of empirical regularities that belie the standard theory. In particular, our theory speaks to several puzzling phenomena in a uni ed fashion: the asset allocation puzzle, the observation that earnings announcements are often followed by signi cant trading volume with small price change, and that increases in uncertainty are positively associated with increased trading activity and portfolio rebalancing toward safer assets by individual (retail) investors
    Keywords: Ambiguity, Ambiguity aversion, Earnings announcements, Parameter uncertainty, Portfolio choice, Trading volume, Uncertainty shocks
    Date: 2023
  14. By: Dietrich, Stephan (RS: GSBE MGSoG, Maastricht Graduate School of Governance, RS: UNU-MERIT Theme 2); Nichols, Stafford
    Abstract: Climate impact models are forced to make sweeping assumptions when estimating social and economic welfare damages to countries around the world, because of a lack of data and understanding of local causal mechanisms. In this paper, we estimate the effects of rising temperatures on countries around the world using an experienced utility approach, based on subjective well-being survey data collected in 160 countries for 13 years. We take advantage of 40 years of variation in daily land surface temperature data, to find that one exceptionally hot day significantly lowers well-being. Furthermore, the effect size varies substantially between and within countries. Identifying this high degree of heterogeneity is important because it illustrates the shortcomings of many current models which are geographically coarse. Moreover, we compare the marginal utility of income and non-income effects and find that income accounts for only a small proportion of the damages caused by extreme temperature s. This demonstrates the adverse effect on non-market goods is dramatically higher than previously assumed, which indicates current models are missing a fundamental source of climate-related damages.
    JEL: I31 Q51 Q54 O15
    Date: 2023–02–24
  15. By: Krueger, Dirk; Uhlig, Harald
    Abstract: This paper characterizes the stationary equilibrium of a continuous-time neoclassical production economy with capital accumulation in which households can insure against idiosyncratic income risk through long-term insurance contracts. Insurance companies operating in perfectly competitive markets can commit to future contractual obligations, whereas households cannot. For the case in which household labor productivity takes two values, one of which is zero, and where households have log-utility we provide a complete analytical characterization of the optimal consumption insurance contract, the stationary consumption distribution and the equilibrium aggregate capital stock and interest rate. Under parameter restrictions, there is a unique stationary equilibrium with partial consumption insurance and a stationary consumption distribution that takes a truncated Pareto form. The unique equilibrium interest rate (capital stock) is strictly decreasing (increasing) in income risk. The paper provides an analytically tractable alternative to the standard incomplete markets general equilibrium model developed in Aiyagari (1994) by retaining its physical structure, but substituting the assumed incomplete asset markets structure with one in which limits to consumption insurance emerge endogenously, as in Krueger and Uhlig (2006).
    Keywords: Idiosyncratic Risk, Limited Commitment, Stationary Equilibrium
    JEL: E21 D11 D91 G22
    Date: 2023
  16. By: Nicolas Treich (TSE-R - Toulouse School of Economics - UT1 - Université Toulouse 1 Capitole - Université Fédérale Toulouse Midi-Pyrénées - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement); Yuting Yang (TSE-R - Toulouse School of Economics - UT1 - Université Toulouse 1 Capitole - Université Fédérale Toulouse Midi-Pyrénées - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement)
    Abstract: Standard benefit-cost analysis often ignores distortions caused by taxation and the heterogeneity of taxpayers. In this paper, we theoretically and numerically explore the effect of imperfect taxation on the public provision of mortality risk reductions (or public safety). We show that this effect critically depends on the source of imperfection as well as on the individual utility and survival probability functions. Our simulations based on the calibration of distributional weights and applied to the COVID-19 example suggest that the value per statistical life, and in turn the optimal level of public safety, should be adjusted downwards because of imperfect taxation. However, we also identify circumstances under which this result is reversed, so that imperfect taxation cannot generically justify less public safety.
    Keywords: Public safetyE, Environmental health, Imperfect taxation, Value per statistical life, Distortionary taxation, Wealth inequality, Risk aversion
    Date: 2021–03
  17. By: Ilke AYDOGAN (IESEG School of Management, Univ. Lille, CNRS, UMR 9221 - LEM - Lille Economie Management, F-59000 Lille, France; and iRisk Research Center on Risk and Uncertainty); Loïc BERGER (CNRS, Univ. Lille, IESEG School of Management, UMR 9221 - LEM - Lille Economie Management, F-59000 Lille, France; iRisk Research Center on Risk and Uncertainty; RFF-CMCC European Institute on Economics and the Environment (EIEE), and Centro Euro-Mediterraneo sui Cambiamenti Climatici, Italy); Vincent THEROUDE (Université de Lorraine, Université de Strasbourg, CNRS, BETA, 54000, Nancy, France)
    Abstract: WeThis paper explores the drivers of individual preferences under uncertainty. We propose a characterization of the situations of model uncertainty such as the ones introduced by Ellsberg (1961) by building on the more ambiguous relations of Jewitt and Mukerji (2017) and Izhakian (2020) and on two new more complex relations. Re- considering existing data sets from the recent literature and combining them with new experimental evidence, we show that uncertainty preferences can be driven by considerations regarding both the degree of complexity and ambiguity that a situation entails.
    Keywords: : Ambiguity, model uncertainty, complexity, Ellsberg paradox
    JEL: D81
    Date: 2023–03
  18. By: Guenther, Benno; Lordan, Grace
    Abstract: We conducted a within-subject experiment with 193 professional traders (151 professional commodities traders), to examine how the tendency towards the disposition effect varies across decision-making in mean reverting commodities and non-mean reverting equities contexts. In addition, we consider whether a simple informational intervention that makes the disposition effect salient can alter decision-making. Overall, we find that prior to the intervention the traders exhibit the disposition effect in the direction that aligns with profit maximisation goals suggesting that they are acting rational. For example, when being asked to make decisions on commodities the traders make choices in the direction of the disposition effect, which is rational given that these picks are mean reverting. We also find that the informational intervention is effective in changing the level of the disposition effect observed and also decision-making, regardless of whether traders are considering decisions over mean reverting or non-mean reverting securities. Further, we provide evidence that our simple informational intervention improves trader returns when making decisions on non-mean reverting securities only. In contrast, it has negative impacts when utilised for commodities. Our study highlights the power of simple interventions to make disproportionately large changes to decision-making regardless of whether they are in our best interests, and their beneficial role only when the context is right.
    Keywords: disposition effect; prospect theory; commodities; behavioural finance; trading decision-making; Frontiers deal
    JEL: G11
    Date: 2023–02–23

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