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on Utility Models and Prospect Theory |
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Issue of 2024‒05‒20
ten papers chosen by |
| By: | Joshua Lanier; Matthew Polisson; John K. -H. Quah |
| Abstract: | The standard criterion of rationality in economics is the maximization of a utility function that is stable across multiple observations of an agent's choice behavior. In this paper, we discuss two notions of the money pump that characterize two corresponding notions of utility-maximization. We explain the senses in which the amount of money that can be pumped from a consumer is a useful measure of the consumer's departure from utility-maximization. |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2404.04843&r=upt |
| By: | Baccarin Stefano (Department of Economics, Social Studies, Applied Mathematics and Statistics, University of Torino, Torino, Italy;) |
| Abstract: | We study a dynamic portfolio optimization problem over a finite horizon with n risky securities and a risk-free asset. The prices of the risky securities are modelled by ordinary exponentials of jump- diffusions. The goal is to maximize the expected discounted utility from both consumption up to the final horizon and terminal wealth. We prove a verification theorem that characterize the value function and the optimal policy by means of a regular solution of a HJB partial integro-differential equation. The verification theorem is used to obtain closed-form expressions for the value function and the optimal policy considering CRRA utility functions U(x) = x^r/r, with r |
| Keywords: | Optimal consumption/investment over a finite horizon, CRRA utility, Dynamic programming, Levy processes with finite activity, Integro-differential PDE |
| JEL: | H7 H70 H77 D7 D72 |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:tur:wpapnw:092&r=upt |
| By: | Claudia Ceci; Alessandra Cretarola |
| Abstract: | We investigate the optimal reinsurance problem in the risk model with jump clustering features introduced in [7]. This modeling framework is inspired by the concept initially proposed in [15], combining Hawkes and Cox processes with shot noise intensity models. Specifically, these processes describe self-exciting and externally excited jumps in the claim arrival intensity, respectively. The insurer aims to maximize the expected exponential utility of terminal wealth for general reinsurance contracts and reinsurance premiums. We discuss two different methodologies: the classical stochastic control approach based on the Hamilton-Jacobi-Bellman (HJB) equation and a backward stochastic differential equation (BSDE) approach. In a Markovian setting, differently from the classical HJB-approach, the BSDE method enables us to solve the problem without imposing any requirements for regularity on the associated value function. We provide a Verification Theorem in terms of a suitable BSDE driven by a two-dimensional marked point process and we prove an existence result relaying on the theory developed in [27] for stochastic Lipschitz generators. After discussing the optimal strategy for general reinsurance contracts and reinsurance premiums, we provide more explicit results in some relevant cases. Finally, we provide comparison results that highlight the heightened risk stemming from the self-exciting component in contrast to the externally-excited counterpart and discuss the monotonicity property of the value function. |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2404.11482&r=upt |
| By: | Cremer, Helmuth; Lozachmeur, Jean-Marie |
| Abstract: | We study the design of nonlinear reimbursement rules for expenses on secondary pre- ventive and on therapeutic care. With some probability individuals are healthy and do not need any therapeutic health care. Otherwise they become ill and their health status (the severity of their disease) is realized and identifies their ex post type. Preventive care is determined ex ante, that is before the health status is determined while curative care is chosen ex post. Insurance benefits depend on preventive and curative care in a possibly nonlinear way, and marginal benefits can be positive or negative. In the first best, achieved when health status is ex post publicly observable, insurance benefits are fiat (lump sum payments) and do not depend on expenditures. When the severity of the disease is not observable, so that there is ex post moral hazard, this solution is not incentive compatible (for more healthy individuals). The optimal insurance then implies benefits that increase with both types of care. This is because health expenditures reduce informational rents and they are upward distorted. This relaxes the incentive constraint because less healthy individuals value care more than healthy individuals. Even though preventive care is chosen ex ante, when there is no asymmetry of in- formation, it does have an impact on the incentive constraint and thus on informational rents. This is due to two concurring effects. First, prevention is more effective for the more severely ill. Second, these individuals also have a lower marginal utility of income so that a given level of expenditure on preventive care has less impact on their utility. |
| Keywords: | ex post moral hazard; health insurance; secondary prevention |
| JEL: | I11 I13 I18 |
| Date: | 2024–04–26 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:129305&r=upt |
| By: | Annika Bacher |
| Abstract: | Single women hold less risky financial portfolios than single men. This paper analyzes the determinants of the “gender investment gap” based on a structural life-cycle framework. The model is able to rationalize the investment gap without introducing gender heterogeneity in preferences (e.g. in risk aversion). Rather, lower income levels and larger household sizes of single women are the main determinants for explaining the gap. Importantly, expectations about future realizations of both variables (that cannot easily be controlled for in regressions) drive most of the investment differences for young households whereas heterogeneity in observable characteristics explains the gap later in life. |
| Keywords: | Household Finance, Life-Cycle, Gender, Portfolio Choice |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:bbq:wpaper:0003&r=upt |
| By: | Sang Hu; Zihan Zhou |
| Abstract: | For optimal stopping problems with time-inconsistent preference, we measure the inherent level of time-inconsistency by taking the time needed to turn the naive strategies into the sophisticated ones. In particular, when in a repeated experiment the naive agent can observe her actual sequence of actions which are inconsistent with what she has planned at the initial time, she then chooses her immediate action based on the observations on her later actual behavior. The procedure is repeated until her actual sequence of actions are consistent with her plan at any time. We show that for the preference value of cumulative prospect theory, in which the time-inconsistency is due to the probability distortion, the higher the degree of probability distortion, the more severe the level of time-inconsistency, and the more time required to turn the naive strategies into the sophisticated ones. |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2404.02498&r=upt |
| By: | Selart, Marcus |
| Abstract: | According to normative decision theory there exists a principle of procedure invariance which states that a decision maker's preference order should remain the same, independently of which response mode is used. For example, the decision maker should express the same preference independently of whether he or she has to judge or decide. Nevertheless, previous research in behavioral decision making has suggested that judgments and choices yield different preference orders in both the risky and the riskless domain. In the latter, the prominence effect has been demonstrated. The main purpose of the present series of experiments was to test cognitive explanations which account for the prominence effect. One of the explanations provided a psychological account based primarily on decision-strategy compatibility. Two other explanations built on information structuring approaches. In the first one, the general idea was that decision makers differentiate between alternatives by value and belief restructuring. In the second approach, violations of invariance were assumed to be attributed to the information structure of the task which in many cases demand problem simplification. A prominence effect was in most experiments found for both choices and preference ratings. This finding spoke against the strategy compatibility explanation. Instead, the different forms of cognitive restructuring provided a better account. However, none of these provided a single explanation. Yet, the structure compatibility explanation appeared to be the more viable one, in particular of the relation between experimental manipulations and response mode outcomes. The predictions of the value-belief restructuring explanation, on the other hand, seemed to be more valid for the prominence effect found in choice than for preference ratings. |
| Date: | 2024–04–12 |
| URL: | http://d.repec.org/n?u=RePEc:osf:socarx:kyvtq&r=upt |
| By: | Nicolas Caramp; Dejanir H. Silva |
| Abstract: | We study the role of asset revaluation in the monetary transmission mechanism. We build an analytical heterogeneous-agents model with two main ingredients: i) rare disasters; ii) heterogeneous beliefs. The model captures time-varying risk premia and precautionary savings in a setting that nests the textbook New Keynesian model. The model generates large movements in asset prices after a monetary shock but these movements can be neutral on real variables. Real effects depend on the redistribution among agents with heterogeneous precautionary motives. In a calibrated exercise, we find that this channel accounts for the majority of the transmission to output. |
| Keywords: | monetary policy, wealth effects, asset prices, aggregate risk, heterogeneity beliefs |
| JEL: | E21 E44 E52 G12 |
| Date: | 2024 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_11049&r=upt |
| By: | Kristoffer Berg; Morten Håvarstein; Magnus E. Stubhaug |
| Abstract: | Surveys and experiments suggest that people hold workers more responsible for income gains stemming from merit, such as education, than circumstances, such as parental education. This paper shows how to design income taxes that account for merits. First, we introduce social welfare functions that accommodate individual preferences and hold workers responsible for their merits. Second, we show how to map social welfare function primitives into empirically measurable statistics and exploit long-run Norwegian income and family relations register data to examine the relationship between merit and income. Third, we simulate optimal income tax implications of our meritocratic social welfare functions. The result is that accounting for merit leads to lower optimal marginal income tax rates than the utilitarian criterion recommends, but the difference is smaller when workers are not held responsible for merits that are explained by circumstances. |
| Keywords: | equality of opportunity, meritocracy, optimal income taxation, welfare criteria |
| JEL: | D31 D63 H21 |
| Date: | 2024 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_11058&r=upt |
| By: | Avichai Snir (Department of Economics, Bar-Ilan University, Israel); Dudi Levy (Department of Economics, Bar-Ilan University, Israel); Dian Wang (Alvarez College of Business, University of Texas at San Antonio, USA); Haipeng (Allan) Chen (Tippie College of Business, University of Iowa, USA); Daniel Levy (Department of Economics, Bar-Ilan University, Israel; Department of Economics, Emory University, USA; ICEA; ISET, TSU; Rimini Centre for Economic Analysis) |
| Abstract: | Many experimental studies report that economics students tend to act more selfishly than students of other disciplines, a finding that received widespread public and professional attention. Two main explanations that the existing literature offers for the differences found in the behavior between economists and non-economists are: (i) the selection effect, and (ii) the indoctrination effect. We offer an alternative, novel explanation: we argue that these differences can be explained by differences in the interpretation of the context. We test this hypothesis by conducting two social dilemma experiments in the US and Israel with participants from both economics and non-economics majors. In the experiments, participants face a tradeoff between profit maximization (market norm) and workers’ welfare (social norm). We use priming to manipulate the cues that the participants receive before they make their decision. We find that when participants receive cues signaling that the decision has an economic context, both economics and non-economics students tend to maximize profits. When the participants receive cues emphasizing social norms, on the other hand, both economics and non-economics students are less likely to maximize profits. We conclude that some of the differences found between the decisions of economics and non-economics students can be explained by contextual cues. |
| Keywords: | Self-Selection, Indoctrination, Self-Interest, Market Norms, Social Norms, Economic Man, Rational Choice, Fairness, Experimental Economics, Laboratory Experiments, Priming, Economists vs. Non-Economists |
| JEL: | A11 A12 A13 A20 B40 C90 C91 D01 D63 D91 P10 |
| Date: | 2024–05 |
| URL: | http://d.repec.org/n?u=RePEc:rim:rimwps:24-06&r=upt |