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on Utility Models and Prospect Theory |
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Issue of 2024‒05‒06
eleven papers chosen by |
| By: | Lorenzo Bastianello; Vassili Vergopoulos |
| Abstract: | By embedding uncertainty into time, we obtain a conjoint axiomatic characterization of both Exponential Discounting and Subjective Expected Utility that accommodates arbitrary state and outcome spaces. In doing so, we provide a novel and simple time-interpretation of subjective probability. The subjective probability of an event is calibrated using time discounting. |
| Date: | 2024–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2403.15319&r=upt |
| By: | Daniele Caliari; Henrik Petri |
| Abstract: | We show that the set of aggregate choices of a population of rational decision-makers - random utility models (RUMs) - can be represented by a population of irrational ones if, and only if, their preferences are sufficiently uncorrelated. We call this representation: Irrational RUM. We then show that almost all RUMs can be represented by a population in which at least some decision-makers are irrational and that under specific conditions their irrational behavior is unconstrained. |
| Date: | 2024–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2403.10208&r=upt |
| By: | Jean-Pierre Drugeon (Paris School of Economics and Centre National de la Recherche Scientifique); Thai Ha-Hui (Université Paris-Saclay, Univ Evry, EPEE) |
| Abstract: | This paper provides a framework for understanding preferences over utility streams across different time periods. We analyze preferences for the close future, for the distant future, and a synthesis of both, establishing a representation involving weights over time periods. Examining scenarios where two utility streams cannot be robustly compared to each other, we introduce notions in which one has more "potential" to be preferred over another, which lead to MaxMin, MaxMax, and α-MaxMin representations. Finally, we consider temporal bias in the form of violations of stationarity. For close future preferences, we obtain a generalization of quasi-hyperbolic discounting. For distant future preferences, we obtain Banach limits and discuss the relationship with exponential discounting. |
| Keywords: | Axiomatisation, Myopia, Multiple Discounts, α-MaxMin Citeria, Temporal Biases, Banach Limits, Infinite Dimensional Topologies |
| JEL: | D11 D15 D90 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:eve:wpaper:23-08&r=upt |
| By: | Bahman Angoshtari; Shida Duan |
| Abstract: | Predictable forward performance processes (PFPPs) are stochastic optimal control frameworks for an agent who controls a randomly evolving system but can only prescribe the system dynamics for a short period ahead. This is a common scenario in which a controlling agent frequently re-calibrates her model. We introduce a new class of PFPPs based on rank-dependent utility, generalizing existing models that are based on expected utility theory (EUT). We establish existence of rank-dependent PFPPs under a conditionally complete market and exogenous probability distortion functions which are updated periodically. We show that their construction reduces to solving an integral equation that generalizes the integral equation obtained under EUT in previous studies. We then propose a new approach for solving the integral equation via theory of Volterra equations. We illustrate our result in the special case of conditionally complete Black-Scholes model. |
| Date: | 2024–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2403.16228&r=upt |
| By: | Daniel Krähmer |
| Abstract: | The paper studies the canonical hold-up problem with one-sided investment by the buyer and full ex post bargaining power by the seller. The buyer can covertly choose any distribution of valuations at a cost and privately observes her valuation. The main result shows that in contrast to the well-understood case with linear costs, if investment costs are strictly convex in the buyer’s valuation distribution, the buyer’s equilibrium utility is strictly positive and to- tal welfare is strictly higher than in the benchmark when valuations are public information, thus alleviating the hold-up problem. In fact, when costs are mean-based or display decreas- ing risk, the hold-up problem may disappear completely. Moreover, the buyer’s equilibrium utility and total welfare might be non-monotone in costs. The paper utilizes an equilibrium characterization in terms of the Gateaux derivative of the cost function. |
| Keywords: | Information Design, Hold-Up Problem, Unobservable Information |
| JEL: | C61 D42 D82 |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:bon:boncrc:crctr224_2024_523&r=upt |
| By: | Cosmin Ilut; Rosen Valchev |
| Abstract: | We develop a novel framework of bounded rationality under cognitive frictions that studies learning over optimal behavior through both deliberative reasoning and accumulated experiences. Using both types of information, agents engage in Bayesian non-parametric estimation of the unknown action value function. Reasoning signals are produced internally through mental deliberation, subject to a cognitive cost. Experience signals are the observed utility outcomes at previous actions. Agents' subjective estimation uncertainty, which evolves through information accumulation, modulates the two modes of learning in a state- and history-dependent way. We discuss how the model draws on and bridges conceptual, methodological and empirical insights from both economics and the cognitive sciences literature on reinforcement learning. |
| Date: | 2024–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2403.18185&r=upt |
| By: | Preker, Jurek (Center for Mathematical Economics, Bielefeld University); Karos, Dominik (Center for Mathematical Economics, Bielefeld University) |
| Abstract: | Before choosing her action to match the state of the world, an agent observes a stream of messages generated by some unknown binary signal. The agent can either learn the underlying signal for free and update her belief accordingly or ignore the observed message and keep her prior belief. After each period the stream stops with positive probability and the final choice is made. We show that a Markovian agent with Gilboa-Schmeidler preferences learns and updates after confirming messages, but she ignores contradicting messages if her belief is sufficiently strong. Her threshold solely depends on the least precise signal. The agent has strictly higher anticipatory utility than an agent who uses every message to update. However, the latter has a higher chance to choose the correct outcome in the end. In a population of strategic agents, who only differ in their initial beliefs, polarization is inevitable. |
| Keywords: | Dynamic Decision Problem, Ambiguity, Gilboa-Schmeidler Preferences, Confirmation Bias, Polarization |
| Date: | 2024–04–09 |
| URL: | http://d.repec.org/n?u=RePEc:bie:wpaper:689&r=upt |
| By: | Daniel Krähmer; Roland Strausz |
| Abstract: | We study unidirectional incentive compatibility which incentivizes an agent to report truthfully when she can misrepresent private information in one direction only. In the canonical setting with continuous, one-dimensional private information, and quasi-linear utility, unidirectional incentive compatibility imposes no restrictions on the allocation rule and holds if and only if the change of the agent’s information rent function respects a lower bound that is based on the allocation rule’s monotone envelope. In monopolistic screening models with strong interdependent values or with countervailing incentives, optimal contracts differ from optimal bidirectionally incentive compatible contracts, possibly displaying non-monotone allocations. |
| Keywords: | Screening, Verifiability, Implementability, Optimal Contracting |
| JEL: | D82 |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:bon:boncrc:crctr224_2024_524&r=upt |
| By: | Mika Akesaka; Ryo Mikami; Yoshiyasu Ono |
| Abstract: | This study theoretically considers household behavior with wealth preference and empirically investigates the validity of insatiable wealth preference using a nationally representative survey. With wealth preference, the marginal rate of substitution of asset holdings for consumption depends on the nominal interest rates of assets at each point in time. We focus on this property and find that the marginal utility of holding financial assets remains strictly positive as asset holdings increase and has a strictly positive lower bound, implying the insatiability of wealth preference. This property plays a crucial role in creating secular demand stagnation and expanding asset price bubbles. |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:dpr:wpaper:1241&r=upt |
| By: | Tomohiro Hirano; Alexis Akira Toda |
| Abstract: | This paper provides a detailed analysis of the local determinacy of monetary and non-monetary steady states in Tirole (1985)'s classical two-period overlapping generations model with capital and production. We show that the sufficient condition for local determinacy in endowment economies provided by Scheinkman (1980) does not generalize to models with production: there are robust examples with arbitrary utility functions in which the non-monetary steady state is locally determinate or indeterminate. In contrast, the monetary steady state is locally determinate under fairly weak conditions. |
| Date: | 2024–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2403.13222&r=upt |
| By: | Nocciola, Luca; Zamora-Pérez, Alejandro |
| Abstract: | We shed light on the demand for a central bank digital currency (CBDC) as a means of payment, based on survey payment data. We provide a quantitative framework to assess transactional demand for CBDC at the point of sale, accommodating a wide range of design choices. We develop a structural model of payment means adoption and usage and estimate CBDC demand based on individuals’ preferences for payment method attributes. We disentangle the friction potentially associated to CBDC adoption, assessing two of its potential drivers: information frictions and gradual diffusion of digital payment methods. We find that modelling adoption is key to understanding CBDC demand. Finally, we show that optimal CBDC design, information campaigns, and network effects can substantially boost demand. JEL Classification: E41, E42, E47 |
| Keywords: | CBDC, money demand, payments, Random utility, structural model |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20242926&r=upt |