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on Utility Models and Prospect Theory |
| By: | Miller, Anne |
| Abstract: | Bounded cardinal utility theory (BCUT), built on the seminal work of Van Praag (1968), is based on three axioms. • The leaning-S-shaped utility function reflects the individual’s experiences of fulfilment of a need – deprivation (increasing marginal utility (MU)), subsistence (a point of inflection), sufficiency (diminishing MU), and either satiation at finite consumption with the possibility of surfeit, or satiation at infinite consumption, and with an intensity-of-need parameter. • Bounded cardinal utility, (between 0 and 1), enables interpersonal welfare comparisons to be made and partially solves the non-measurability problem of utility (Van Praag, 1968). • A separability rule states that the utilities of commodities fulfilling the same need are weakly separable (multiplicative) and those of commodities fulfilling two separate needs are strongly separable (additive). Walasek et al (2024) point out that ‘there was never a clear psychological theory about the causes of loss aversion’. BCUT identifies (variable) MU as ‘the psychological value of losses compared to equivalent gains’ associated with endowments of unearned consumption. A leaning-S-shaped utility function represents increasing ‘gain appeal’ when the individual’s endowments are less than subsistence, and the theory predicts that (decreasing) loss aversion occurs only if the individual experiences sufficiency and thus is not deprived of consumption. The steepness parameter, lambda, could be measured by subsistence / intensity-of-need, for choices within one need, or by an individual’s relative-intensities-of-need parameters (ratio of intensities-of-need parameters), for choices involving two needs. This note suggests that BCUT might provide a clearer psychological basis for the analysis of loss aversion than current practice. |
| Keywords: | loss aversion, prospect theory, valuation, leaning-S-shaped utility, diminishing marginal utility |
| JEL: | D11 D81 J22 |
| Date: | 2024–09–11 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:121997 |
| By: | L. Elisa Celis; Amit Kumar; Nisheeth K. Vishnoi; Andrew Xu |
| Abstract: | This paper considers the scenario in which there are multiple institutions, each with a limited capacity for candidates, and candidates, each with preferences over the institutions. A central entity evaluates the utility of each candidate to the institutions, and the goal is to select candidates for each institution in a way that maximizes utility while also considering the candidates' preferences. The paper focuses on the setting in which candidates are divided into multiple groups and the observed utilities of candidates in some groups are biased--systematically lower than their true utilities. The first result is that, in these biased settings, prior algorithms can lead to selections with sub-optimal true utility and significant discrepancies in the fraction of candidates from each group that get their preferred choices. Subsequently, an algorithm is presented along with proof that it produces selections that achieve near-optimal group fairness with respect to preferences while also nearly maximizing the true utility under distributional assumptions. Further, extensive empirical validation of these results in real-world and synthetic settings, in which the distributional assumptions may not hold, are presented. |
| Date: | 2024–09 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2409.04897 |
| By: | Mogens Fosgerau; Nikolaj Nielsen; Mads Paulsen; Thomas Kj{\ae}r Rasmussen; Rui Yao |
| Abstract: | This paper considers substitution patterns in the perturbed utility route choice model. We provide a general result that determines the marginal change in link flows following a marginal change in link costs across the network. We give a general condition on the network structure under which all paths are necessarily substitutes and an example in which some paths are complements. The presence of complementarity contradicts a result in a previous paper in this journal; we point out and correct the error. |
| Date: | 2024–09 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2409.08347 |
| By: | Shalini Mitra; Gareth Liu-Evans |
| Abstract: | This paper investigates the role of an intangible investment technology shock in driving and propagating business cycles. In a dynamic general equilibrium framework with borrowing constrained entrepreneurs, we show that consumption smoothing by entrepreneurs, which is associated with reallocation of physical investment and hours from final goods to intangible investment, is the key mechanism through which aggregate co-movement arises in the model. The reallocation channel is especially strong in the presence of binding financial constraints. We use firm level intangible capital estimates to discipline the model and show that the entrepreneur’s degree of risk aversion, which determines their preference for consumption smoothing given their constant relative risk aversion (CRRA) utility, plays a key role in quantitatively generating the observed joint aggregate business cycle dynamics of output, consumption, investment and hours. For instance, entrepreneurs can display too little or too much risk aversion, in which case aggregate comovement is negated. |
| Keywords: | Intangible investment shock, reallocation, intangible capital, business cycles, aggregate comovement |
| JEL: | E13 E22 E32 O33 |
| Date: | 2024–09–24 |
| URL: | https://d.repec.org/n?u=RePEc:liv:livedp:202414 |
| By: | Shen Li; Yuyang Zhang; Zhaolin Ren; Claire Liang; Na Li; Julie A. Shah |
| Abstract: | Binary human choice feedback is widely used in interactive preference learning for its simplicity, but it provides limited information about preference strength. To overcome this limitation, we leverage human response times, which inversely correlate with preference strength, as complementary information. Our work integrates the EZ-diffusion model, which jointly models human choices and response times, into preference-based linear bandits. We introduce a computationally efficient utility estimator that reformulates the utility estimation problem using both choices and response times as a linear regression problem. Theoretical and empirical comparisons with traditional choice-only estimators reveal that for queries with strong preferences ("easy" queries), choices alone provide limited information, while response times offer valuable complementary information about preference strength. As a result, incorporating response times makes easy queries more useful. We demonstrate this advantage in the fixed-budget best-arm identification problem, with simulations based on three real-world datasets, consistently showing accelerated learning when response times are incorporated. |
| Date: | 2024–09 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2409.05798 |
| By: | Li, Hanwu (Center for Mathematical Economics, Bielefeld University); Riedel, Frank (Center for Mathematical Economics, Bielefeld University) |
| Abstract: | We explore intertemporal preferences that are recursive and account for local intertemporal substitution. First, we establish a rigorous foundation for these preferences and analyze their properties. Next, we examine the associated optimal consumption problem, proving the existence and uniqueness of the optimal consumption plan. We present an infinite-dimensional version of the Kuhn-Tucker theorem, which provides the necessary and sufficient conditions for optimality. Additionally, we investigate quantitative properties and the construction of the optimal consumption plan. Finally, we offer a detailed description of the structure of optimal consumption within a geometric Poisson framework. |
| Keywords: | recursive utility, intertemporal substitution, Hindy-Huang-Kreps preferences, backward stochastic differential equation with jumps, Poisson processes |
| Date: | 2024–09–23 |
| URL: | https://d.repec.org/n?u=RePEc:bie:wpaper:693 |
| By: | Tsoulfidis, Lefteris; Chatzarakis, Nikolaos |
| Abstract: | This paper examines the conditions leading neoclassical economics to its division into microeconomics and macroeconomics, comparing it with the integrated macroscopic-microscopic approach of Classical Political Economy (CPE). Neoclassical economics emerged in the last quarter of the 19th century introducing a subjective theory of value based on individual preferences and optimizing behavior. The division between micro and macroeconomics became visible during the 1930s crisis due to what came to be known as monopolistic competition and macroeconomic revolutions. The stagflation crisis (of late 1960s to early 1980s) prompted the so-called microfounding of macroeconomics and the unified treatment of macroeconomic issues. By contrast, the CPE maintains a unified perspective, analyzing capitalism broadly at a macroscopic level focusing on labor as the primary value creator. Unlike neoclassical theory, CPE prioritizes aggregated variables and social class incomes driven by survival and profit motives rather than subjective preferences. The paper concludes that issues of effective demand, growth, and cycles can be fruitfully addressed within the unified CPE framework, highlighting the theoretical consistency of employing the labor theory of value for evaluating aggregate variables like capital. |
| Keywords: | Microfoundations, Classical Political Economy, Labor Theory of Value, Utility, Marginal Productivity |
| JEL: | B21 B22 B51 D01 E10 E11 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:121951 |
| By: | David Landriault; Bin Li; Hong Li; Yuanyuan Zhang |
| Abstract: | This paper introduces an economic framework to assess optimal longevity risk transfers between institutions, focusing on the interactions between a buyer exposed to long-term longevity risk and a seller offering longevity protection. While most longevity risk transfers have occurred in the reinsurance sector, where global reinsurers provide long-term protections, the capital market for longevity risk transfer has struggled to gain traction, resulting in only a few short-term instruments. We investigate how differences in risk aversion between the two parties affect the equilibrium structure of longevity risk transfer contracts, contrasting `static' contracts that offer long-term protection with `dynamic' contracts that provide short-term, variable coverage. Our analysis shows that static contracts are preferred by more risk-averse buyers, while dynamic contracts are favored by more risk-averse sellers who are reluctant to commit to long-term agreements. When incorporating information asymmetry through ambiguity, we find that ambiguity can cause more risk-averse sellers to stop offering long-term contracts. With the assumption that global reinsurers, acting as sellers in the reinsurance sector and buyers in the capital market, are generally less risk-averse than other participants, our findings provide theoretical explanations for current market dynamics and suggest that short-term instruments offer valuable initial steps toward developing an efficient and active capital market for longevity risk transfer. |
| Date: | 2024–09 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2409.08914 |
| By: | Bašić, Zvonimir (University of Glasgow); Bortolotti, Stefania (University of Bologna); Salicath, Daniel (NAV Norwegian Labour and Welfare Administration); Schmidt, Stefan (Max Planck Institute for Research on Collective Goods); Schneider, Sebastian O. (Max Planck Institute for Research on Collective Goods); Sutter, Matthias (Max Planck Institute for Research on Collective Goods) |
| Abstract: | Incentives are supposed to increase effort, yet individuals react differently to incentives. We examine this heterogeneity by investigating how personal characteristics, preferences, and socio-economic background relate to incentives and performance in a real effort task. We analyze the performance of 1, 933 high-school students under a Fixed, Variable, or Tournament payment. Productivity and beliefs about relative performance, but hardly any personal characteristics, play a decisive role for performance when payment schemes are exogenously imposed. Only when given the choice to select the payment scheme, personality traits, economic preferences and socioeconomic background matter. Algorithmic assignment of payment schemes could improve performance, earnings, and utility, as we show. |
| Keywords: | effort, productivity, incentives, personality traits, preferences, socio-economic background, ability, heterogeneity, sorting, algorithm, lab-in-the-field experiment |
| JEL: | C93 D91 J24 J41 |
| Date: | 2024–09 |
| URL: | https://d.repec.org/n?u=RePEc:iza:izadps:dp17287 |
| By: | Mario Ghossoub; Michael B. Zhu; Wing Fung Chong |
| Abstract: | We study Pareto optimality in a decentralized peer-to-peer risk-sharing market where agents' preferences are represented by robust distortion risk measures that are not necessarily convex. We obtain a characterization of Pareto-optimal allocations of the aggregate risk in the market, and we show that the shape of the allocations depends primarily on each agent's assessment of the tail of the aggregate risk. We quantify the latter via an index of probabilistic risk aversion, and we illustrate our results using concrete examples of popular families of distortion functions. As an application of our results, we revisit the market for flood risk insurance in the United States. We present the decentralized risk sharing arrangement as an alternative to the current centralized market structure, and we characterize the optimal allocations in a numerical study with historical flood data. We conclude with an in-depth discussion of the advantages and disadvantages of a decentralized insurance scheme in this setting. |
| Date: | 2024–09 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2409.05103 |
| By: | Slupphaug, KJell (Statistics Norway (SSB)); Mehmetoglu, Mehmet; Mittner, Matthias (University of Tromsø) |
| Abstract: | The estimation of interaction and quadratic effects in Structural Equation Models (SEMs) is a complex task in psychometrics. Latent product term (LPT) models, initially developed for interaction effects between latent variables, are also used to model quadratic effects. Despite over 30 years of research, no consensus has emerged on the best method for modeling interactions in SEMs, partly due to efforts to simplify existing approaches for broader accessibility. LPT models are categorized into Product Indicator (PI) and Distribution Analytic (DA) approaches. PI methods are conceptually simple but often sacrifice accuracy due to necessary simplifications, making them error-prone and difficult to implement manually. In contrast, DA methods, such as Latent Moderated Structural Equations (LMS) and Quasi Maximum Likelihood (QML), provide more accurate estimates in simulations but are computationally intensive and less accessible due to limited implementations. We introduce modsem, an R package that simplifies the estimation of interaction and quadratic effects in SEMs. modsem supports various methods, including PI, LMS, and QML, and extends them to models with multiple endogenous variables. It integrates seamlessly with the popular lavaan syntax, enhancing accessibility for researchers. We demonstrate modsem’s utility with applications to the Theory of Planned Behaviour and PISA 2006 data, highlighting its effectiveness in estimating complex models. Future work will focus on validating and refining LMS and QML approaches, and exploring alternative methods like Bayesian and Structural After Measurement (SAM) approaches. |
| Date: | 2024–09–02 |
| URL: | https://d.repec.org/n?u=RePEc:osf:osfxxx:h3rpw |