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on Utility Models and Prospect Theory |
| By: | Manuel Nunez (University of Connecticut); Mark Schneider (University of Alabama and Economic Science Institute, Chapman University) |
| Abstract: | Axiomatic non-expected utility models are generally more difficult to falsify than expected utility theory as they are less restrictive (by weakening the independence axiom). Recent work computes the Vapnik-Chervonenkis (VC) dimension of a theory to determine the extent to which the theory is falsifiable. Popular ambiguity theories have VC dimensions that increase exponentially in the number of states or that are infinite, whereas the VC dimension of expected utility theory increases linearly in the number of states. In this paper we axiomatically characterize the class of generalized non-extreme outcome expected utility (NEO-EU) preferences in the Anscombe-Aumann framework and show that their VC dimension increases linearly in the number of states. Our paper shows that this popular class of ambiguity preferences which has been broadly applied provides a counter-example to the conjecture that axiomatic models of ambiguity attitudes are substantially more difficult to falsify than expected utility theory. |
| Keywords: | Generalized NEO-EU; Choice under Ambiguity; Decision Theory |
| JEL: | D81 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:chu:wpaper:24-15 |
| By: | Timothy W. Shields (Argyros College of Business and Economics, Economic Science Institute, Chapman University); James Wilhelm (Argyros College of Business and Economics, Economic Science Institute, Chapman University) |
| Abstract: | A robust finding in managerial accounting research is that participants prefer economically equivalent contracts framed as bonuses to penalties. Another finding is that participants put forth more effort when facing penalty contracts than equivalent bonus contracts. Both results are commonly described as due to loss aversion, an integral portion of Prospect Theory. We test whether loss aversion is correlated with higher effort in an experiment with two parts. In the first part, we elicit individual participants' loss aversion using two measures. In the second part of the experiment, participants choose costly efforts to increase the likelihood of high versus low state-contingent payoffs framed as bonuses or penalties. We find significant differences in the effort chosen between treatments: participants put in significantly more effort when facing penalty contracts. However, we find no evidence that either measure's degree of loss aversion correlates with effort choices as predicted by Prospect Theory. We find that only a quarter of participants are consistent with the Prospect Theory, and for those, we see little evidence of the commonly cited features of loss aversion. While the most cited reason for framing incentives changing participant behavior is loss aversion, our results suggest that this reason is falsified. While the results from prior studies are replicable, the untested underlying mechanism is not loss aversion. |
| Keywords: | contract framing, loss-aversion, bonus, penalty, utility preference, model selection |
| JEL: | C92 D82 D81 M40 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:chu:wpaper:24-14 |
| By: | Nuerxiati Abudurexiti; Erhan Bayraktar; Takaki Hayashi; Hasanjan Sayit |
| Abstract: | Portfolio selection problems that optimize expected utility are usually difficult to solve. If the number of assets in the portfolio is large, such expected utility maximization problems become even harder to solve numerically. Therefore, analytical expressions for optimal portfolios are always preferred. In our work, we study portfolio optimization problems under the expected utility criterion for a wide range of utility functions, assuming return vectors follow hyperbolic distributions. Our main result demonstrates that under this setup, the two-fund monetary separation holds. Specifically, an individual with any utility function from this broad class will always choose to hold the same portfolio of risky assets, only adjusting the mix between this portfolio and a riskless asset based on their initial wealth and the specific utility function used for decision making. We provide explicit expressions for this mutual fund of risky assets. As a result, in our economic model, an individual's optimal portfolio is expressed in closed form as a linear combination of the riskless asset and the mutual fund of risky assets. Additionally, we discuss expected utility maximization problems under exponential utility functions over any domain of the portfolio set. In this part of our work, we show that the optimal portfolio in any given convex domain of the portfolio set either lies on the boundary of the domain or is the unique globally optimal portfolio within the entire domain. |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2410.04459 |
| By: | Esben Scrivers Andersen |
| Abstract: | We derive a system of fixed-point equations for the equilibrium transfers in a class of one-to-one matching models with linear transferable utility. We then show that, when the degree of substitution between alternatives is bounded from above, the derived system of equations constitutes a contraction mapping. As a result, fixed-point iterations are guaranteed to converge to the unique distribution of equilibrium transfers. |
| Date: | 2024–09 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2409.05518 |
| By: | Bowen-Hill, Oscar |
| Abstract: | Decision making is an important and varied part of everyday life. There are many things that contribute to how a decision is made, from personal bias to the way our expectations alter our circumstances these evaluations change from person to person. Subjective expected utility has become a general rationalisation of decision making: the options picked are the ones perceived as most likely to take us closest to, if not achieve, our goals. This investigation challenges this. This investigation was two-fold. Firstly, it combined a framework of established decision- making factors into a Behavioural Utility Profile (BUP) which could be used to predict different individuals’ ages. Created and evaluated by a Machine Learning ‘Random Forest regression’ tool, this profile was found to be effective, indicating that the BUP represented a reliable profile for influences of decision making, and that how this profile is structured changes with age. Finally, with a specially designed Subjective Expected Futility taskset, the investigation reasoned that decision making rationale are changing. Instead of approaching goals with an ‘achieve the best outcome’ methodology, the investigation found that the context in which participants made decisions altered choices to present a shorter-term approach: ‘Seek flexibility. Choose shorter-term’. |
| Date: | 2023–07–06 |
| URL: | https://d.repec.org/n?u=RePEc:osf:osfxxx:v29p7 |
| By: | Jiaqin Wei; Jianming Xia; Qian Zhao |
| Abstract: | We investigate the portfolio selection problem for an agent with rank-dependent utility in an incomplete financial market. For a constant-coefficient market and CRRA utilities, we characterize the deterministic strict equilibrium strategies. In the case of time-invariant probability weighting function, we provide a comprehensive characterization of the deterministic strict equilibrium strategy. The unique non-zero equilibrium, if exists, can be determined by solving an autonomous ODE. In the case of time-variant probability weighting functions, we observe that there may be infinitely many non-zero deterministic strict equilibrium strategies, which are derived from the positive solutions to a nonlinear singular ODE. By specifying the maximal solution to the singular ODE, we are able to identify all the positive solutions. In addition, we address the issue of selecting an optimal strategy from the numerous equilibrium strategies available. |
| Date: | 2024–09 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2409.19259 |
| By: | Christoph Knochenhauer; Alexander Merkel; Yufei Zhang |
| Abstract: | We consider the Merton problem of optimizing expected power utility of terminal wealth in the case of an unobservable Markov-modulated drift. What makes the model special is that the agent is allowed to purchase costly expert opinions of varying quality on the current state of the drift, leading to a mixed stochastic control problem with regular and impulse controls involving random consequences. Using ideas from filtering theory, we first embed the original problem with unobservable drift into a full information problem on a larger state space. The value function of the full information problem is characterized as the unique viscosity solution of the dynamic programming PDE. This characterization is achieved by a new variant of the stochastic Perron's method, which additionally allows us to show that, in between purchases of expert opinions, the problem reduces to an exit time control problem which is known to admit an optimal feedback control. Under the assumption of sufficient regularity of this feedback map, we are able to construct optimal trading and expert opinion strategies. |
| Date: | 2024–09 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2409.11569 |
| By: | Tajika, Tomoya |
| Abstract: | We model a protest against a firm aiming to remove a product that causes negative externalities. Both the firm and consumers are uncertain about the product’s value, but consumers receive noisy signals. Price plays a key role in aggregating information. When prices are high, consumers with both good and bad signals derive almost the same utility from the product being sold, making protests uninformative. By endogenizing the price, we show that as consumer signals improve, protests become less informative, reducing social welfare. This suggests that consumer ignorance may play a role in protest success. |
| Keywords: | Protest, boycotts, information aggregation, ethical voters, monopoly pricing |
| JEL: | D42 D72 D81 D82 |
| Date: | 2024–09–19 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:122143 |
| By: | Christopher K. Allsup; Irene S. Gabashvili |
| Abstract: | This paper introduces a strategic planning tool for master-planned communities designed specifically to quantify residents' subjective preferences about large investments in amenities and infrastructure projects. Drawing on data obtained from brief online surveys, the tool ranks alternative plans by considering the aggregate anticipated utilization of each proposed amenity and cost sensitivity to it (or risk sensitivity for infrastructure plans). In addition, the tool estimates the percentage of households that favor the preferred plan and predicts whether residents would actually be willing to fund the project. The mathematical underpinnings of the tool are borrowed from utility theory, incorporating exponential functions to model diminishing marginal returns on quality, cost, and risk mitigation. |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2410.04676 |
| By: | Koundouri, Phoebe; Pittis, Nikitas; Samartzis, Panagiotis |
| Abstract: | This paper analyzes the root cause of Ellsberg-type choices. This class of problems share the feature that at the time of the decision, t = m, the decision maker (DM) possesses partial information, Im, about the events/propositions of interest F: DM knows the objective probabilities of the sub-class F1, F1 С F only, whereas she is uninformed about the probabilities of the complement F’1 . As a result, DM may slip into the state of "comparative ignorance" (see Heath and Tve rsky 1991 and Fox and Tversky 1995). Under this state, DM is likely to exhibit "ambiguity aversion" (AA) for the events of F’1 relative to those of F1. AA, in turn results in DM having non-coherent beliefs, that is, her prior probability function, PI0m, is not additive. A possible way to mitigate AA is to motivate DM to form her prior in a state of "uniform ignorance". This may be accomplished by inviting DM to bring herself to the hypothetical time t = 0, in the context of which Im was still a contingency, and trace her "counterfactual prior", Pc0, "back then". Under uniform ignorance, DM may adhere to the "Principle of Indiference", thus identifying Pc0 with the uniform distribution. Once Pc0 is elicited, DM can embody the existing information Im into her current, actual set of beliefs Pm by means of Bayesian Conditionalization. In this case, we show that Pm is additive. |
| Keywords: | JEL Classifcation: C44, D81, D83, D89 |
| JEL: | C0 |
| Date: | 2023–02 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:122027 |
| By: | Yang Sun; Wei Zhao; Junjie Zhou |
| Abstract: | We study dynamic network formation from a centralized perspective. In each period, the social planner builds a single link to connect previously unlinked pairs. The social planner is forward-looking, with instantaneous utility monotonic in the aggregate number of walks of various lengths. We show that, forming a nested split graph at each period is optimal, regardless of the discount function. When the social planner is sufficiently myopic, it is optimal to form a quasi-complete graph at each period, which is unique up to permutation. This finding provides a micro-foundation for the quasi-complete graph, as it is formed under a greedy policy. We also investigate the robustness of these findings under non-linear best response functions and weighted networks. |
| Date: | 2024–09 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2409.14136 |
| By: | Brice Corgnet (EM - EMLyon Business School, GATE - Groupe d'analyse et de théorie économique - UL2 - Université Lumière - Lyon 2 - ENS LSH - Ecole Normale Supérieure Lettres et Sciences Humaines - CNRS - Centre National de la Recherche Scientifique); Camille Cornand; Nobuyuki Hanaki |
| Abstract: | We design a novel experiment to assess investors' behavioural and physiological reactions to negative tail events. Investors who observed, without suffering from, tail events decreased their bids whereas investors suffering tail losses increased them. However, the increase in bids after tail losses was not observed for those who exhibited no emotional arousal. This suggests that emotions are key in explaining Prospect Theory prediction of risk seeking in the loss domain. |
| Keywords: | tail events, emotions, risk |
| Date: | 2023–09–28 |
| URL: | https://d.repec.org/n?u=RePEc:hal:journl:hal-04228190 |
| By: | Satoshi Nakano; Kazuhiko Nishimura |
| Abstract: | The welfare of a dynasty that consists of identical Bernoullian utilities subject to Cobb-Douglas production with constant labor is maximized. We blend two discounting schemes to avoid the objective function from exploding to infinity: one is the compound discounting of future utilities and the other is the binary discounting which undiscounts utilities before the planning horizon but fully discounts those that lie beyond. After presenting a general solution to the optimal schedule of consumption, we study the planning solution analytically and also numerically, to discover that the optimal planning horizon is not necessarily an infinity, even under the case of zero compound discounting. Furthermore, we study the inequality of consumptions among generations with respect to the compound discount rates and planning horizons. |
| Date: | 2024–09 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2409.15978 |
| By: | Ban, Kitti; Tóth-Fáber, Eszter; Kóbor, Andrea (Research Centre for Natural Sciences); Lages, Martin (University of Glasgow) |
| Abstract: | Do we preferentially learn from positive rather than negative decision outcomes? Previous studies indicated that such bias characterises learning during simple reward learning tasks. However, no research has yet confirmed whether learning bias is also present during sequential decision making under uncertainty. To fill this gap, we utilised a complex yet ecologically valid paradigm, the Balloon Analogue Risk Task (BART), which measures risk-taking propensity under uncertainty in everyday decision making. Comparing learning from positive and negative outcomes in the BART has been made possible by the Scaled Target Learning model, which characterises both risk-taking propensity and sensitivity to wins and losses. For the first time, we applied this model to a modified BART paradigm with different levels of perceived uncertainty. Crucially, our analyses revealed learning bias during high levels of uncertainty, under which condition bias was negatively tied to task performance. Furthermore, increased sensitivity to wins compared to losses was linked to more risk-seeking behaviour across all conditions, suggesting that learning bias could mediate risky behaviour. Overall, our results contribute to a more accurate characterisation of reward learning behaviour and suggest that learning bias arises when the level of perceived uncertainty surges. |
| Date: | 2024–10–01 |
| URL: | https://d.repec.org/n?u=RePEc:osf:osfxxx:3cvqk |
| By: | Chu, Angus C.; Liao, Chih-Hsing; Peretto, Pietro |
| Abstract: | How does taxation affect growth and inequality? We develop a Schumpeterian model with wealth heterogeneity, which influences the effects of tax policy. Our model features iso-elastic utility on leisure under which the change in consumption dispersion across heterogeneous households may cause a novel positive effect of labor income tax on employment in addition to the usual negative effect, which together yield an overall ambiguous effect. A negative (positive) effect on employment causes a negative (positive) effect on growth and innovation in the short run and also a negative (positive) effect on the real interest rate, which determines asset income. Consequently, labor income tax has an ambiguous effect on gross income inequality but unambiguously increases consumption inequality by reducing disposable wage income. Therefore, its effects on income inequality and consumption inequality are drastically different. We also calibrate the model to examine its quantitative implications. |
| Keywords: | taxation; innovation; inequality; economic growth |
| JEL: | O23 O3 O4 |
| Date: | 2024–09 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:122219 |
| By: | Hodula, Martin; Janků, Jan; Malovaná, Simona; Ngo, Ngoc Anh |
| Abstract: | In our paper, we provide a review of the literature to identify the main transmission channels through which geopolitical risks (GPR) influence m a cro-financial st ab ility. We be gi n by analyzing the existing measures of geopolitical tensions and uncertainty, showing that GPR impacts economic and financial u n certainty e p isodically, w i th s i gnificant bu t tr an sient spikes during major geopolitical events. The review then identifies t he t wo p rincipal c hannels through which GPR affects macro-financial s t ability: t he fi nancial ch an nel, op erating th rough increased uncertainty and heightened risk aversion, leading to shifts in investment portfolio allocations and cross-border capital flows; a nd t he r eal e conomy c hannel, impacting global trade, s upply chains, and commodity markets. Using data from the past two to three decades, we provide graphical analyses that confirm t he fi ndings in the literature, hi ghlighting the episodic nature of the impact of GPR. These insights underscore the need for policymakers and financial i nstitutions t o adopt event-specific a p proaches t o e f fectively m i tigate t h e a d verse e f fects o f g e opolitical r i sks on economic and financial systems. |
| Keywords: | Financial stability, geopolitical risk, global economy, macro-financial impact, uncertainty shocks |
| JEL: | D80 E32 F44 F51 G2 G15 H56 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:bofitp:303508 |
| By: | Chetan Ghate; Pawan Gopalakrishnan; Anuradha Saha |
| Abstract: | India’s savings rate surged from 13% in 1970 to 38% in 2008, declining steadily thereafter to 30% in 2019. Unlike other developing or developed nations, the savings rate in India, and some other countries, shows a hump-shaped trajectory with its peak coinciding with the Great Recession of 2007-2009. We build a neoclassical monetary-growth model to explain the long-run savings pattern in India. We find that the post-2009 decline in inflation is a key factor in explaining the hump shape in the savings rate. The fall in inflation increases future wealth which induces households to increase consumption and lower savings in the future. Consumption smoothing and risk aversion induce households to increase consumption in the initial periods as well. While this smoothes consumption along the transition path, it reduces savings in the initial periods. Thus, household savings are low but rising in the 1990s, peaking along with inflation in 2008 and then declining post-2008. The fit of the model improves considerably when we extend the model to allow for two types of agents: Ricardian and Rule of Thumb. Our model predicts a dynamic association between inflation and household savings that mimics the hump-shaped pattern in savings that India and some other countries have experienced. |
| Keywords: | Indian economic growth, savings rate, non-linear dynamics, monetary-growth models, demographics |
| JEL: | E21 J11 O23 O47 |
| Date: | 2024–09 |
| URL: | https://d.repec.org/n?u=RePEc:een:camaaa:2024-60 |
| By: | Bernoth, Kerstin; Herwartz, Helmut; Trienens, Lasse |
| Abstract: | Using a data-driven identification approach of structural vector autoregressive models, we analyse the factors driving the US dollar exchange rate for a sample of eight advanced countries over the period 1980M1 to 2022M6. We find that the exchange rates are significantly affected not only by US monetary policy, but also by shocks to inflation expectations associated with shifts in fiscal sustainability concerns. In addition, external shocks related to global risk aversion and the convenience yield that investors are willing to give up to hold US dollar assets have a significant impact on the US dollar exchange rate. All three shocks considered make an important contribution to explaining US dollar exchange rate changes, with external shocks being the most impactful on average. Moreover, we find evidence that the monetary policy response to shocks to long-run inflation expectations has changed over time, suggesting shifts in monetary policy reaction functions. |
| JEL: | E52 C32 E43 F31 G15 F41 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:vfsc24:302351 |
| By: | Han, Seoungmin |
| Keywords: | Generative AI, AI Generated Content, AI Disclaimer, Authenticity, Deception, Utilitarian, Hedonic |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:itsb24:302503 |