nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2023‒08‒14
fourteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Robust Time-inconsistent Linear-Quadratic Stochastic Controls: A Stochastic Differential Game Approach By Bingyan Han; Chi Seng Pun; Hoi Ying Wong
  2. Can the Seesaw Model Depict the Certainty Effect? By Marek Jenöffy
  3. Experimental Evidence on the Relationship Between Perceived Ambiguity and Likelihood Insensitivity By Luca Henkel
  4. 10$ a ton of carbon ? The Stern-Nordhaus Controversy : Methodological and Ethical Issues By Mathieu Guigourez
  5. An extension of the consumption-based CAPM model By Dionne, Georges; Li, Jingyuan; Okou, Cédric
  6. Modeling evidential cooperation in large worlds By Johannes Treutlein
  7. The Economics of Wellbeing and Psychology: An Historical and Methodological Viewpoint By Drakopoulos, Stavros A.
  8. The Marginal Revolution in the light of Foucault's typology of epistemes By Clémence Thebaut
  9. Ethics and technique in welfare economics: How welfarism evolves in the making By Antoinette Baujard
  10. Economic stimulus effects of product innovation under demand stagnation By Daisuke Matsuzaki; Yoshiyasu Ono
  11. Information Aggregation Under Ambiguity: Theory and Experimental Evidence By Spyros Galanis; Christos A. Ioannou; Stelios Kotronis
  12. The paradox of the contented female worker in Colombia By María Esperanza Cuenca Coral.; Adolfo C. Fernández Puente.; Juan Ricardo Perilla-Jiménez.
  13. Can Leviathan City Governments Use Tax Policy to Attract the Creative Class? By Batabyal, Amitrajeet; Beladi, Hamid
  14. Human-centered Information Security and Privacy: Investigating How and Why Social and Emotional Factors Affect the Protection of Information Assets By Franz, Anjuli

  1. By: Bingyan Han; Chi Seng Pun; Hoi Ying Wong
    Abstract: This paper studies robust time-inconsistent (TIC) linear-quadratic stochastic control problems, formulated by stochastic differential games. By a spike variation approach, we derive sufficient conditions for achieving the Nash equilibrium, which corresponds to a time-consistent (TC) robust policy, under mild technical assumptions. To illustrate our framework, we consider two scenarios of robust mean-variance analysis, namely with state- and control-dependent ambiguity aversion. We find numerically that with time inconsistency haunting the dynamic optimal controls, the ambiguity aversion enhances the effective risk aversion faster than the linear, implying that the ambiguity in the TIC cases is more impactful than that under the TC counterparts, e.g., expected utility maximization problems.
    Date: 2023–06
  2. By: Marek Jenöffy (Büro am Carlsplatz)
    Abstract: The Signal-Preference Model (Seesaw Model) has provided an algorithm for modeling endogenous preferences using the insight of ancient rhetoric and the empirical results of communications research. It predicts how preferences form or can be altered. This paper examines how the Seesaw Model performs in the framework of economic decision theory. The results of the Seesaw Model are compared with Expected Utility Theory, Bayes, and Prospect Theory. I use empirical data gained with students of Humboldt University of Berlin as well as data from Kahneman and Tversky. Surprisingly this model of endogenous preferences does well in solving the certainty effect paradox and the reflection effect paradox. It may be considered that the Seesaw Model produces better results in predicting human decisions than traditional Expected Utility Theory or Prospect Theory. Additionally, the model can not only measure existing preferences but can also predict under which circumstances preferences can be altered.
    Keywords: Information, Uncertainty, Preferences, Communication, Preference Formation
    Date: 2023–06–21
  3. By: Luca Henkel
    Abstract: Observed individual behavior in the presence of ambiguity shows insufficient responsiveness to changes in subjective likelihoods. Despite being integral to theoretical models and relevant in many domains, evidence on the causes and determining factors of such likelihood insensitive behavior is scarce. This paper investigates the role of beliefs in the form of ambiguity perception – the extent to which a decision-maker has difficulties assigning a single probability to each possible event – as a potential determinant. Using an experiment, I elicit measures of ambiguity perception and likelihood insensitivity and exogenously vary the level of perceived ambiguity. The results provide strong support for a perception-based explanation of likelihood insensitivity. The two measures are highly correlated at the individual level, and exogenously increasing ambiguity perception increases insensitivity, suggesting a causal relationship. In contrast, ambiguity perception is unrelated to ambiguity aversion – the extent to which a decision-maker dislikes the presence of ambiguity.
    Keywords: Ambiguity, decision-making under uncertainty, likelihood insensitivity, multiple prior models
    JEL: D81 D83 D91 C91
    Date: 2023–07
  4. By: Mathieu Guigourez (CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)
    Abstract: The Stern-Nordhaus controversy has been emblematic of the economic and ethical debate around the formulation of a discount rate and a carbon price. The aim of this article is to study this controversy in order to shed light on the epistemological and ethical postulates implicitly accepted by the two economists in their work, and more broadly in the integrated models concluding to a social cost of carbon. These implicitly accepted postulates are 1) the comprehension of economic rationality solely as the maximization of expected utility, and 2) a consequentialist point of view. The latter compartmentalize the scope of the ethical debate into cleavages over the formulation of an optimal discount rate. This article aims to broaden the ethical debate around these integrated models by questioning the implicit normativity of how economic rationality is at play in these models and proposes a new way of conceiving individual responsibility in regard to climate change.
    Keywords: Integrated Assessment Models, Economic Rationality, Discount Rate, Social Cost of Carbon, Individual Responsibility, Philosophy of Economics, Expected utility
    Date: 2023–05
  5. By: Dionne, Georges (HEC Montreal, Canada Research Chair in Risk Management); Li, Jingyuan (Lingnan University); Okou, Cédric (HEC Montreal, Finance Department)
    Abstract: We extend the Consumption-based CAPM (C-CAPM) model to representative agents with different risk attitudes. We first use the concept of expectation dependence and show that for a risk averse representative agent, it is the first-degree expectation dependence (FED) rather than the covariance that determines C-CAPM’s riskiness. We extend the assumption of risk aversion to prudence and propose the measure of second-degree expectation dependence (SED) to obtain the values of asset price and equity premium. These theoretical results are linked to the equity premium puzzle. Using the same dataset as in Campbell (2003), the estimated measures of relative risk aversion from FED and SED approximations are much lower than those obtained in the original study and correspond to the theoretical values often discussed in the literature. The theoretical model is then generalized to higher-degree risk changes and higher-order risk averse representative agents.
    Keywords: Consumption-based CAPM; Risk premium; Equity premium puzzle; Expectation dependence; Ross risk aversion
    JEL: D51 D80 G12
    Date: 2023–07–17
  6. By: Johannes Treutlein
    Abstract: Evidential cooperation in large worlds (ECL) refers to the idea that humans and other agents can benefit by cooperating with similar agents with differing values in causally disconnected parts of a large universe. Cooperating provides agents with evidence that other similar agents are likely to cooperate too, resulting in gains from trade for all. This could be a crucial consideration for altruists. I develop a game-theoretic model of ECL as an incomplete information bargaining problem. The model incorporates uncertainty about others' value systems and empirical situations, and addresses the problem of selecting a compromise outcome. Using the model, I investigate issues with ECL and outline open technical and philosophical questions. I show that all cooperators must maximize the same weighted sum of utility functions to reach a Pareto optimal outcome. However, I argue against selecting a compromise outcome implicitly by normalizing utility functions. I review bargaining theory and argue that the Nash bargaining solution could be a relevant Schelling point. I introduce dependency equilibria (Spohn 2007), an equilibrium concept suitable for ECL, and generalize a folk theorem showing that the Nash bargaining solution is a dependency equilibrium. I discuss gains from trade given uncertain beliefs about other agents and analyze how these gains decrease in several toy examples as the belief in another agent decreases. Finally, I discuss open issues in my model. First, the Nash bargaining solution is sometimes not coalitionally stable, meaning that a subset of cooperators can unilaterally improve payoffs by deviating from the compromise. I investigate conditions under which stable payoff vectors exist. Second, I discuss how to model agents' default actions without ECL.
    Date: 2023–07
  7. By: Drakopoulos, Stavros A.
    Abstract: Job satisfaction and life satisfaction research (economics of wellbeing) is an established and booming research field. However, until the late 1970s, the study of the impact of economic variables on subjective wellbeing was considered to be outside the domain of economics. The main reason was the methodological hostility of orthodox economists towards incorporating "subjective" and "psychological" variables. The legacy of economics as a positive social science that dealt with observed or revealed behavior only, was a major obstacle for economists to study subjective wellbeing. The main exception was the pioneering work of Richard Easterlin in 1974, who attempted to account for the discrepancy between income increases and overall life satisfaction. Opening up the communication of economists with psychologists in happiness research, Easterlin relied on references from psychology and especially from social psychology in order to construct his arguments. Influenced by Easterlin, references to theoretical and empirical work in psychology became more apparent when happiness economics attracted more interest by the end of the 20th century. After showing its rich historical past of interaction with psychology, the paper argues that this stance is contrary to the established mainstream tradition and methodology. Further, it demonstrates that leading figures of happiness economics adopt a conscious methodological position towards interacting with psychology, and this puts them at odds with the mainstream economics methodological approach. It is also argued that the economics of happiness attitude towards psychology is linked to other important differences of methodological nature. The paper identifies three major points of diversion: utility cardinality and comparability, empirical methodology, and the specification of agents’ utility function and the ensuing policy implications.
    Keywords: Economics and Psychology; Economics of Wellbeing; Economic Methodology; History of Economic Thought
    JEL: B20 B40 I30
    Date: 2023–07
  8. By: Clémence Thebaut (NET - Neuroépidémiologie Tropicale - CHU Limoges - Institut d'Epidémiologie Neurologique et de Neurologie Tropicale - INSERM - Institut National de la Santé et de la Recherche Médicale - GEIST - Institut Génomique, Environnement, Immunité, Santé, Thérapeutique - UNILIM - Université de Limoges, LEDa - Laboratoire d'Economie de Dauphine - IRD - Institut de Recherche pour le Développement - Université Paris Dauphine-PSL - PSL - Université Paris sciences et lettres - CNRS - Centre National de la Recherche Scientifique, PSL - Université Paris sciences et lettres, UNILIM - Université de Limoges)
    Abstract: Objective: We seek here to draw on the methods and tools put forward by Michel Foucault in The Order of the Things (1966) to shed light on history of welfare economics. More specifically we consider that the rejection of interpersonal comparisons that foreshadowed the marginalist revolution and the transition to ordinal measures of utility during the 19th century can be explained by the shift from the classical episteme to a modern episteme which is described by Foucault. Method: To explore this hypothesis, we drawn on the method of archaeological knowledge, proposed by Foucault (1966, 1969). We started by building a corpus using an incremental research strategy (the "snowball" method), starting from first bibliographic reference on history of welfare economics Baujard (2013, 2014). Then, we study the various statements within a corpus, in order to identify regularities and turning points both in semantics and concepts, so as to compare discourse "styles". Unlike other approaches in social sciences, the method of knowledge archaeology consists in analysing scientific discourses in themselves, outside the social, economic and political context that led them to emerge. Results: Using this methodology, we first examine to what extent the early utilitarianism is typical of the classical episteme as described by Foucault, which entails (i) the use of a mechanistic framework, (ii) the use of mathematics and more generally (iii) an effort to classify different entities. Second we examined how the rejection of interpersonal comparisons in the marginalist literature and the transition to ordinal utilities could be typical of the modern episteme, through the development of positivist stand and transcendental function of the notion of utility.
    Abstract: Cet article s'inscrit dans le cadre d'un projet de recherche visant à mobiliser les méthodes et outils proposés par Michel Foucault pour apporter un éclairage sur un ensemble de discussions que soulève l'évaluation économique en santé. Nous nous intéressons ici à l'ancrage épistémologique des méthodes de révélation des préférences individuelles issues de l'économie du bien-être, qui sont aujourd'hui utilisées pour valoriser les bénéfices en santé, en nous appuyant sur la typologie des épistémès de Foucault dans les Mots et les choses. Plus précisément, nous envisageons que le rejet des comparaisons interpersonnelles, que préfigure la révolution marginaliste et la transition vers une mesure ordinale des utilités, s'explique par le passage d'une épistémè classique à une épistémè moderne. La question du caractère cardinal ou ordinal de la mesure de l'utilité reste centrale pour l'évaluation économique en santé. En effet, les méthodes d'évaluation des bénéfices en santé, notamment au moyen des QALY, se rapprochent d'une mesure cardinale, contrairement au paradigme de la nouvelle économie du bien-être dans lequel elle est censée s'inscrire.
    Keywords: JEL Classification: B12, D61, D63, I10 Welfare economics, Health economic evaluation, Epistemology, Foucault
    Date: 2023–06–24
  9. By: Antoinette Baujard (GATE Lyon Saint-Étienne - Groupe d'Analyse et de Théorie Economique Lyon - Saint-Etienne - ENS de Lyon - École normale supérieure de Lyon - UL2 - Université Lumière - Lyon 2 - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon - UJM - Université Jean Monnet - Saint-Étienne - CNRS - Centre National de la Recherche Scientifique)
    Abstract: Under welfarism, assertions such as "this social state is better than an alternative" or "this policy should be enacted" are based on the assumption that social welfare ultimately depends only on the well-being of individuals. A normative analysis of welfarism seeks to provide a transparent description of the basis upon which welfarism makes its value judgements, which is equivalent to an investigation into its choice of a preferred notion of well-being. Such an investigation, this paper claims, can take two forms, which we should distinguish: the ethical analysis of welfarism is concerned with the appeal to a given ethical theory of well-being; and the technical analysis of welfarism concerns the specific measure of individual utility that in practice is used to measure social welfare. Reviewing a series of claims which bear on how these two versions of welfarism are articulated (the standard, proxy, evidential and tension claims), the paper explores the differences between the ethical and technical approaches in the normative interpretation of welfarist assertions.
    Abstract: Dans le cadre d'étude welfariste, des affirmations telles que "cet état social est meilleur que tel autre état social" ou "cette politique devrait être promulguée" reposent sur l'hypothèse que le bien-être social ne dépend que du bien-être des individus et de rien d'autre. Une analyse normative du welfarisme vise à fournir une description transparente des jugements de valeur impliqués dans ces évaluations et ces recommandations, ce qui revient à s'interroger en particulier sur la notion du bien-être qui a été retenue. Cette enquête normative peut prendre deux formes et cet article défend l'idée qu'il convient de les distinguer : l'analyse éthique du welfarisme concerne le recours à une théorie éthique donnée du bien-être ; et l'analyse technique du welfarisme concerne la mesure de l'utilité individuelle qui est utilisée en pratique pour mesurer ce bien-être social. L'article passe en revue successivement quatre points de vue type portant sur l'articulation de ces deux versions du welfarisme : le point de vue standard, de l'approximation, de la preuve et de la tension. En étudiant l'interprétation normative des affirmations welfaristes, il explore les différences qui émergent entre les approches éthique et technique.
    Keywords: Welfare Economics, Welfarism, Ethics, Practice, Ethical welfarism, Technical welfarism, Demarcation, Neutrality, Non-Neutrality, Axiological transparency, Value judgements
    Date: 2022
  10. By: Daisuke Matsuzaki; Yoshiyasu Ono
    Abstract: When confronting economic stagnation, innovation (product innovation in particular) is often cited as an effective stimulus because it is assumed 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. This study examines three types of product innovation, including quantity-augmenting-like innovation, addictive innovation, and variety expansion. The first works as if a larger quantity were consumed although the actual quantity remains the same, the second reduces the elasticity of the marginal utility of consumption, and the third increases the variety of consumption commodities. We find that the first and third reduce both consumption and employment, whereas the second expands them. It suggests that policy makers should carefully choose the type of product innovation to promote as an economic stimulus: addictive innovation stimulates business activity whereas quantity-augmenting-like innovation and variety expansion worsen stagnation.
    Date: 2023–03
  11. By: Spyros Galanis (Durham University); Christos A. Ioannou (Universite Paris 1 Pantheon - Sorbonne, Paris, France); Stelios Kotronis (Durham University)
    Abstract: We study information aggregation in a dynamic trading model. We show theoretically that separable securities, introduced by Ostrovsky (2012) in the context of Expected Utility, no longer aggregate information if some traders have imprecise beliefs and are ambiguity averse. Moreover, these securities are prone to manipulation as the degree of information aggregation can be influenced by the initial price set by the uninformed market maker. These observations are also confirmed in our laboratory experiment using prediction markets. We define a new class of strongly separable securities, which are robust to the above considerations, and show that they characterize information aggregation in both strategic and non-strategic environments. We derive several testable predictions, which we are able to confirm in the laboratory. Finally, we show theoretically that strongly separable securities are both sufficient and necessary for information aggregation but, strikingly, there does not exist a security that is strongly separable for all information structures
    Date: 2023–05
  12. By: María Esperanza Cuenca Coral.; Adolfo C. Fernández Puente.; Juan Ricardo Perilla-Jiménez.
    Abstract: Using data from the Colombian Great Integrated Household Survey 2021, we explore whether the paradox of the contented female worker, prominent in the specialized literature, arises in the Colombian labor market. Controlling for self - selection bias that are typical in job market discrimination settings, we find supporting evidence of the paradox. We also find supporting evidence to the hypothesis of gender differences in utility functions and adaptive expectations of female workers to their more severe working conditions. Our research implies the need for public policy initiatives focused on both workers well-being and gender equality. Keywords: Gender Economics, Labor Discrimination, Labor Market Equality, Working Conditions, JEL: J16, J710, J810.
    Date: 2023–07–24
  13. By: Batabyal, Amitrajeet; Beladi, Hamid
    Abstract: We focus on an aggregate economy of two nearby cities A and B and study whether it is possible for the leviathan governments in these two cities to use taxes τ^A and τ^B to attract members of the so-called creative class. The creative class population is fixed and members locate either in city A or B depending on the utility from such location. In this setting, we accomplish five tasks. First, given the two taxes, we determine the value of a metric ζ that describes how the creative class population partitions into cities A and B. Second, for a given partition of the creative class population, we state the budget constraints confronting the governments in cities A and B. Third, we state and solve the decision problems of the two governments when they act as independent leviathans and maximize tax revenue. Fourth, we ascertain the efficient taxes that maximize the sum of tax revenues in the aggregate economy. Finally, we discuss the implications of our analysis for tax policy.
    Keywords: Creative Class, Leviathan City Government, Tax Policy, Tax Revenue
    JEL: H20 R11 R50
    Date: 2023–01–09
  14. By: Franz, Anjuli
    Abstract: Information systems (IS) are becoming increasingly integrated into the fabric of our everyday lives, for example, through cloud-based collaboration platforms, smart wearables, and social media. As a result, nearly every aspect of personal, social, and professional life relies on the constant exchange of information between users and online service providers. However, as users and organizations entrust more and more of their personal and sensitive information to IS, the challenges of ensuring information security and privacy become increasingly pressing, particularly given the rise of cybercrime and microtargeting capabilities. While the protection of information assets is a shared responsibility between technology providers, legislation, organizations, and individuals, previous research has emphasized the pivotal role of the user as the last line of defense. Whereas prior works on human-centered information security and privacy have primarily studied the human aspect from a cognitive perspective, it is important to acknowledge that security and privacy phenomena are deeply embedded within users’ social, emotional, and technological environment. Therefore, individual decision-making and organizational phenomena related to security and privacy need to be examined through a socio-emotional lens. As such, this thesis sets out to investigate how and why socio-emotional factors influence information security and privacy, while simultaneously providing a deeper understanding of how these insights can be utilized to design effective security and privacy-enhancing tools and interventions. This thesis includes five studies that have been published in peer-reviewed IS outlets. The first strand of this thesis investigates individual decision-making related to information security and privacy. Daily information disclosure decisions, such as providing login credentials to a phishing website or giving apps access to one’s address book, crucially affect information security and privacy. In an effort to support users in their decision-making, research and practice have begun to develop tools and interventions that promote secure and privacy-aware behavior. However, our knowledge on the design and effectiveness of such tools and interventions is scattered across a diverse research landscape. Therefore, the first study of this thesis (article A) sets out to systematize this knowledge. Through a literature review, the study presents a taxonomy of user-oriented information security interventions and highlights crucial shortcomings of current approaches, such as a lack of tools and interventions that provide users with long-term guidance and an imbalance regarding cyber attack vectors. Importantly, the study confirms that prior works in this field tend to limit their scope to a cognitive processing perspective, neglecting the influence of social and emotional factors. The second study (article B) examines how users make decisions on disclosing their peers’ personal information, a phenomenon referred to as privacy interdependence. Previous research has shown that users tend to have a limited understanding of the social ramifications of their decisions to share information, that is, the impact of their disclosure decisions on others’ privacy. The study is based on a theoretical framework that suggests that for a user, recognizing and respecting others’ privacy rights is heavily influenced by the perceived salience of others within their own socio-technical environment. The study introduces an intervention aimed at increasing the salience of others’ personal data during the decision-making process, resulting in a significant decrease of interdependent privacy infringements. These findings indicate that current interfaces do not allow users to make informed decisions about their peers’ privacy – a problem that is highly relevant for policymakers and regulators. Shifting the focus towards an organizational context of individual security decision-making, the third study (article C) investigates employees’ underlying motives for reporting cyber threats. With the aim to maximize employees’ adoption of reporting tools, the study examines the effect of two tool design features on users’ utilitarian and hedonic motivation to report information security incidents. The findings suggest that reporting tools that elicit a sense of warm glow, that is, a boost of self-esteem and personal satisfaction after performing an altruistic act, result in higher tool adoption compared to those that address solely users’ utilitarian motivation. This unlocks a new perspective on organizational information security as a whole and showcases new ways in which organizations can engage users in promoting information security. The second strand of this thesis focuses on the context of organizational information security. Beyond individual decision-making, organizations face the challenge of maintaining an information security culture, including, for example, employees’ awareness of security risks, top management commitment, and interdepartmental collaboration with regard to security issues. The fourth study (article D) presents a measurement instrument to assess employees’ security awareness. Complementary to the predominant method of self-reported surveys, the study introduces an index based on employees’ susceptibility to simulated social engineering attacks. As such, it presents a novel way to measure security awareness that closes the intention-behavior gap and enables information security officers to nonintrusively monitor human vulnerabilities in real-time. Furthermore, the findings indicate that security education, training and awareness (SETA) programs not only increase employees’ awareness of information security risks, but also improve their actual security behavior. Finally, the fifth study (article E) investigates the influence of external socio-emotional disruption on information security culture. Against the backdrop of the COVID-19 pandemic, the longitudinal study reveals novel inhibitors and facilitators of information security culture that emerged in the face of global socially and emotionally disruptive change over the course of 2020. Specifically, the study demonstrates that such disruptive events can influence information security culture negatively, or – counterintuitively – positively, depending on prerequisites such as digital maturity and economic stability. Overall, this thesis highlights the importance of considering socio-emotional factors in protecting information assets by providing a more comprehensive understanding of why and how such factors affect human behavior related to information security and privacy. By doing so, this thesis answers calls for research that urge scholars to consider security and privacy issues in a larger social and emotional context. The studies in this thesis contribute to IS research on information security and privacy by (1) uncovering social and emotional motives as hitherto largely neglected drivers of users decision-making, (2) demonstrating how tools and interventions can leverage these motives to improve users’ protection of information assets, and (3) revealing the importance of external socio-emotional factors as a thus far under-investigated influence on organizational information security. In practice, this thesis offers actionable recommendations for designers building tools and interventions to support decision-making with regard to information security and privacy. Likewise, it provides important insights to information security officers on how to build a strong and resilient information security culture, and guides policymakers in accounting for socially embedded privacy phenomena.
    Date: 2023

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