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on Utility Models and Prospect Theory |
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Issue of 2023‒12‒11
eight papers chosen by |
| By: | Marcos Escobar-Anel; Yevhen Havrylenko; Rudi Zagst |
| Abstract: | Hedge fund managers with the first-loss scheme charge a management fee, a performance fee and guarantee to cover a certain amount of investors' potential losses. We study how parties can choose a mutually preferred first-loss scheme in a hedge fund with the manager's first-loss deposit and investors' assets segregated. For that, we solve the manager's non-concave utility maximization problem, calculate Pareto optimal first-loss schemes and maximize a decision criterion on this set. The traditional 2% management and 20% performance fees are found to be not Pareto optimal, neither are common first-loss fee arrangements. The preferred first-loss coverage guarantee is increasing as the investor's risk-aversion or the interest rate increases. It decreases as the manager's risk-aversion or the market price of risk increases. The more risk averse the investor or the higher the interest rate, the larger is the preferred performance fee. The preferred fee schemes significantly decrease the fund's volatility. |
| Date: | 2023–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2310.19023&r=upt |
| By: | Gustafsson, Johan E. (University of Texas at Austin); Spears, Dean (University of Texas at Austin); Zuber, Stéphane (Paris School of Economics) |
| Abstract: | The expectation of a sum of utilities is a core criterion for evaluating policies and social welfare under variable population and social risk. Our contribution is to show that a previously unrecognized combination of weak assumptions yields general versions of this criterion, both in fixed-population and in variable-population settings. We show that two dimensions of weak dominance (over risk and individuals) characterize a social welfare function with two dimensions of additive separability. So social expected utility emerges merely from social statewise dominance (given other axioms). Moreover, additive utilitarianism, in the variable- population setting, arises from a new, weak form of individual stochastic dominance with two attractive properties: It only applies to lives certain to exist (so it does not compare life against non-existence), and it avoids prominent egalitarian objections to utilitarianism by only applying if certain correlations are preserved. Our result provides a foundation for evaluating climate change, growth, and depopulation. |
| Keywords: | social risk, variable population, utilitarianism |
| JEL: | D63 D81 |
| Date: | 2023–10 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp16561&r=upt |
| By: | Joshua Lanier; Jeremy Large; John Quah |
| Abstract: | We present a discrete choice, random utility model and a new estimation technique for analyzing consumer demand for large numbers of products. We allow the consumer to purchase multiple units of any product and to purchase multiple products at once (think of a consumer selecting a bundle of goods in a supermarket). In our model each product has an associated unobservable vector of attributes from which the consumer derives utility. Our model allows for heterogeneous utility functions across consumers, complex patterns of substitution and complementarity across products, and nonlinear price effects. The dimension of the attribute space is, by assumption, much smaller than the number of products, which effectively reduces the size of the consumption space and simplifies estimation. Nonetheless, because the number of bundles available is massive, a new estimation technique, which is based on the practice of negative sampling in machine learning, is needed to sidestep an intractable likelihood function. We prove consistency of our estimator, validate the consistency result through simulation exercises, and estimate our model using supermarket scanner data. |
| Date: | 2022–06–27 |
| URL: | http://d.repec.org/n?u=RePEc:oxf:wpaper:998&r=upt |
| By: | Brian Jabarian; Simon Lazarus |
| Abstract: | We conduct an incentivized experiment on a nationally representative US sample (N=708) to test whether people prefer to avoid ambiguity even when it means choosing dominated options. In contrast to the literature, we find that 55% of subjects prefer a risky act to an ambiguous act that always provides a larger probability of winning. Our experimental design shows that such a preference is not mainly due to a lack of understanding. We conclude that subjects avoid ambiguity per se rather than avoiding ambiguity because it may yield a worse outcome. Such behavior cannot be reconciled with existing models of ambiguity aversion in a straightforward manner. |
| Keywords: | uncertainty, complexity, ambiguity, decision-making |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10745&r=upt |
| By: | Savchuk, Vladimir |
| Abstract: | This presentation provides an overview of the various approaches and theories related to decision-making when faced with uncertainty. The paper's main focus is on the decision-making process itself, including how all its various components should be combined and how they should be reflected in decision rules. While the theme is not new, significant progress has been made in the past century in terms of developing decision-making techniques and measuring and managing uncertainty, largely due to the advancements in probability theory and fuzzy set theory. The goal of this paper is to develop a Value Chain for the Decision-Making process, achieved through the integration of the main components of the decision-making system under uncertainty, namely: (i) concepts of uncertainty, (ii) ways of thinking under uncertainty, (iii) creating models, and (iv) techniques of decision-making. These issues are considered in their dialectical relationship. The presentation will not delve into the specifics of each part of the system but rather aims to explain its essence and practical applicability. Both data-driven decision-making and non-quantitative approaches to making decisions are explored in the presentation. |
| Keywords: | Uncertainty, Risk, Probability, Fuzzy sets, Metaphor, Narrative, Decision Theory, Expected Utility Theory, Prospect Theory, Possibility Theory, Real Options. |
| JEL: | M21 |
| Date: | 2022–11 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:119083&r=upt |
| By: | Ernst ⓡ Fehr; Thomas ⓡ Epper; Julien ⓡ Senn; Ernst Fehr |
| Abstract: | Parsimony is a desirable feature of economic models but almost all human behaviors are characterized by vast individual variation that appears to defy parsimony. How much parsimony do we need to give up to capture the fundamental aspects of a population’s distributional preferences and to maintain high predictive ability? Using a Bayesian nonparametric clustering method that makes the trade-off between parsimony and descriptive accuracy explicit, we show that three preference types—an inequality averse, an altruistic and a predominantly selfish type—capture the essence of behavioral heterogeneity. These types independently emerge in four different data sets and are strikingly stable over time. They predict out-of-sample behaviour equally well as a model that permits all individuals to differ and substantially better than a representative agent model and a state-of-the-art machine learning algorithm. Thus, a parsimonious model with three stable types captures key characteristics of distributional preferences and has excellent predictive power. |
| Keywords: | distributional preferences, altruism, inequality aversion, preference heterogeneity, stability, out-of-sample prediction, parsimony, Bayesian nonparametrics |
| JEL: | D31 D63 C49 C90 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10727&r=upt |
| By: | Giuseppe Attanasi (UNIROMA - Università degli Studi di Roma "La Sapienza" = Sapienza University [Rome]); Claire Rimbaud (Leopold Franzens Universität Innsbruck - University of Innsbruck); Marie Claire Villeval (GATE Lyon Saint-Étienne - Groupe d'Analyse et de Théorie Economique Lyon - Saint-Etienne - UL2 - Université Lumière - Lyon 2 - UJM - Université Jean Monnet - Saint-Étienne - CNRS - Centre National de la Recherche Scientifique) |
| Abstract: | We investigate whether a player's guilt aversion is modulated by the co-players' vulnerability. To this goal, we introduce new variations of a three-player Trust game in which we manipulate payoff vulnerability and endowment vulnerability. The former is the traditional vulnerability which arises when a player's material payoff depends on another player's action (e.g., recipient's payoff in a Dictator game). The latter arises when a player's initial endowment is entrusted to another player (e.g., trustor's endowment in a Trust game). Treatments vary whether trustees can condition their decision on the belief of a co-player who is payoff-vulnerable and/or endowment-vulnerable, or not vulnerable at all, and the decision rights of the vulnerable player. We find that trustees' guilt aversion is insensitive to both the dimension of the co-player's vulnerability and to the decision rights of the co-player. Guilt is activated even absent vulnerability of the co-player whose beliefs are disappointed. It is triggered by the willingness to respond to the co-player's beliefs on his strategy, regardless of whether this strategy concerns this player or a third player's vulnerability, that is, indirect vulnerability. |
| Keywords: | Guilt Aversion, Vulnerability, Psychological Game Theory, Trust Game, Dictator Game, Experiment |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-03620418&r=upt |
| By: | Li, defu; Bental, Benjamin |
| Abstract: | The neoclassical Euler equation provides the necessary conditions for households to maximize lifetime utility by allocating income between consumption and investment, and is the core equation for solving the steady-state of the neoclassical growth model. The existing textbooks (Barro and Sala-i-Martin, 2004, ch6.3; Acemoglu, 2009, ch13.2, ch15.6; Aghion and Howitt, 2009, ch3.2.2) ignore the premise of this equation and directly apply it to solve the steady state of other growth models, which not only leads to incorrect results but also limits the ability of growth models to analyze the steady-state technological progress direction. This note first points out and rigorously verifies the errors in existing textbooks; Then, by replacing the capital accumulation function with exogenous growth rate with the generalized capital accumulation function considering adjustment costs of investment in the Acemoglu (2009, ch15.6) model, the note put forward the generalized Euler equation and steady-state equilibrium including capital-augmenting technological progress, which reveals the necessary conditions for the neoclassical Euler equation and Uzawa’s (1961) steady-state theorem; Finally, it is pointed out that the possible reasons for the misuse of the neoclassical Euler equation in existing textbooks maybe confuse the rental price of capital and the interest rate of investment. |
| Keywords: | Neoclassical Euler equation, Uzawa’s steady-state theorem, Growth model, the direction of technical change，the rental price of capital, the interest rate of investment |
| JEL: | E13 O30 O40 O41 |
| Date: | 2023–11–06 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:119048&r=upt |