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on Utility Models and Prospect Theory |
| By: | Hammond, Peter J (University of Warwick) |
| Abstract: | A decision-making agent is usually assumed to be Bayesian rational, or to maximize subjective expected utility, in the context of a completely and correctly specified decision model. Following the discussion in Hammond (2007) of Schumpeter's (1911, 1934) concept of entrepreneurship, and of Shackle's (1953) concept of potential surprise, this paper considers enlivened decision trees whose growth over time cannot be accurately modelled in full detail. An enlivened decision tree involves more severe limitations than model mis-specification, unforeseen contingencies, or unawareness, all of which are typically modelled with reference to a universal state space large enough to encompass any decision model that an agent may consider. We consider three motivating examples based on : (i) Homer's classic tale of Odysseus and the Sirens; (ii) a two-period linear-quadratic model of portfolio choice; (iii) the game of Chess. Though our novel framework transcends standard notions of risk or uncertainty, a form of Bayesian rationality is still possible. Instead of subjective probabilities of different models of a classical finite decision tree, we show that Bayesian rationality and continuity imply subjective expected utility maximization when some terminal nodes have attached real-valued subjective evaluations instead of consequences. Moreover, subjective evaluations lie behind, for example, the kind of Monte Carlo tree search algorithm that has been used by some powerful chess-playing software packages. |
| Keywords: | Prerationality ; consequentialist decision theory ; entrepreneurship ; potential surprise ; enlivened decision trees ; subjective evaluation of continuation ; subtrees ; Monte Carlo tree search. JEL Codes: D81 ; D91 ; D11 ; D63 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:wrk:wcreta:89 |
| By: | Duffy, Sean; Smith, John |
| Abstract: | Standard random utility models can account for stochastic choice. However, a common implication is that the realized utilities are equal with probability zero. This knife-edge aspect implies that indifference is thin because arbitrarily small changes in utility will break indifference. Semiorders can represent preferences where indifference is thick, however, choice is not random. We design an incentivized binary line length judgment experiment to better understand how indifference can be both thick and random. In the 2-choice treatment, subjects select one of the lines. In the 3-choice treatment, subjects select one of the lines or can express indifference, which directs the computer to "flip a coin" to decide. In every trial, there is a longer line and subjects were told this fact. For each of our line pairs, subjects make 5 decisions in the 2-choice treatment and 5 decisions in the 3-choice treatment. In the line pair with the smallest length difference, 49.7% of 2-choice treatment trials are optimal. For this line pair in the 3-choice treatment, only 1 out of 113 subjects selected indifference on all 5 available trials. There are well-known predictions that optimal choices will have shorter response times than suboptimal choices (Fudenberg, Strack, and Strzalecki, 2018) and we find evidence of this in our dataset. However, not much seems to be known about the response times and indifference. In the 3-choice treatment, we find that indifference choices have longer response times than suboptimal choices. We find that indifference choices are associated with risk aversion and a measure of the beliefs of the favorability of the coin flip. We do not find that indifference choices become more likely across trials, however we find the likelihood of selecting the longer line--in both 2-choice and 3-choice treatments--are decreasing across trials. We hope that the results of our experiment can help inform models of choice where indifference is both thick and random. |
| Keywords: | choice theory, judgment, indifference, memory, search |
| JEL: | C91 D03 |
| Date: | 2024–09–20 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:122165 |
| By: | Ashley Davey; Harry Zheng |
| Abstract: | We consider the portfolio optimisation problem where the terminal function is an S-shaped utility applied at the difference between the wealth and a random benchmark process. We develop several numerical methods for solving the problem using deep learning and duality methods. We use deep learning methods to solve the associated Hamilton-Jacobi-Bellman equation for both the primal and dual problems, and the adjoint equation arising from the stochastic maximum principle. We compare the solution of this non-concave problem to that of concavified utility, a random function depending on the benchmark, in both complete and incomplete markets. We give some numerical results for power and log utilities to show the accuracy of the suggested algorithms. |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2410.05524 |
| By: | Jonathan Chapman; Erik Snowberg; Stephanie W. Wang; Colin Camerer |
| Abstract: | We introduce DOSE⸻Dynamically Optimized Sequential Experimentation⸻to elicit preference parameters. DOSE starts with a model of preferences and a prior over the parameters of that model, then dynamically chooses a customized question sequence for each participant according to an experimenter-selected information criterion. After each question, the prior is updated, and the posterior is used to select the next, informationally-optimal, question. Simulations show that DOSE produces parameter estimates that are approximately twice as accurate as those from established elicitation methods. DOSE estimates of individual-level risk and time preferences are also more accurate, more stable over time, and faster to administer in a large representative, incentivized survey of the U.S. population (N = 2; 000). By reducing measurement error, DOSE identifies a stronger relationship between risk aversion and cognitive ability than other elicitation techniques. DOSE thus provides a flexible procedure that facilitates the collection of incentivized preference measures in the field. |
| Keywords: | preference elicitation, risk preferences, time preferences, dynamic experiments, cognitive ability, preference stability |
| JEL: | C81 C90 D03 D81 D90 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:ces:ceswps:_11361 |
| By: | Li, Jiangyan; Fairley, Kim; Fenneman, Achiel |
| Abstract: | The Ellsberg urn is conventionally used in experiments to measure ambiguity attitudes, yet there is no uniformity in the method for producing Ellsberg urns, which complicates the comparability of results across studies. By surveying 69 experimental studies, we distill four different methods of ambiguity production—Ellsberg urns that are produced by (i) the experimenter, (ii) another random participant, (iii) compound risk lotteries, and (iv) compound risk derived from random numbers in nature. In an experiment we then assess participants’ ambiguity attitudes concerning each production method and detect no statistically significant differences among them. However, a notable proportion of preference inconsistency is observed when utilizing compound risk lotteries for ambiguity generation. Generally, our findings suggest interchangeability among the four production methods in future laboratory experiments. Nevertheless, we suggest employing method (i) as it is the most uncomplicated and straightforward production method. |
| Keywords: | Ambiguity, ambiguity aversion, likelihood insensitivity, uncertainty, Ellsberg, experiment |
| JEL: | C90 D80 |
| Date: | 2024–09–06 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:122336 |
| By: | Alexandre Truc (GREDEG - Groupe de Recherche en Droit, Economie et Gestion - UNS - Université Nice Sophia Antipolis (1965 - 2019) - CNRS - Centre National de la Recherche Scientifique - UniCA - Université Côte d'Azur); Dorian Jullien (CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, UP1 UFR02 - Université Paris 1 Panthéon-Sorbonne - École d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne) |
| Abstract: | This paper studies the controversy on Fehr and Schmidt's model of inequity aversion. It borrows insights from disciplines such as philosophy and the sociology of science that have specialized in studying scientific controversies. Our goal is to contribute to the historical and methodological literature on behavioral economics, which happens to have neglected behavioral economists' research on social preferences. Our analysis of the controversy reveals some new insights about the relation of behavioral economics with other sub-fields in economics, as well as with other disciplines. |
| Keywords: | Controversies, Behavioral Economics, Rhetoric, Social Preferences, Norms, Inequity Aversion |
| Date: | 2023 |
| URL: | https://d.repec.org/n?u=RePEc:hal:journl:hal-04719263 |
| By: | Emily E. Cook (Texas A&M University); Ruipu Gao (Tulane University) |
| Abstract: | We illustrate two ways in which the price paid for college tuition ("net tuition") may affect students' major choice: 1) a selection effect in which increased net tuition discourages attendance among students with high non-pecuniary returns to low-wage majors, and 2) a "switching" effect in which all students are more likely to choose a high-wage major when net tuition is high, because the marginal utility of consumption increases with net tuition. Using fixed-effects regressions on data from public colleges from 2000-2019 and an IV strategy based on state-level appropriations budgets, we estimate a \$1, 723 increase in the annual wage associated with college graduates' degree fields per a \$1, 000 increase in net tuition. |
| Keywords: | major choice, net tuition, human capital |
| JEL: | I22 I23 I26 |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:tul:wpaper:2411 |
| By: | Danilo Cavapozzi; Marco Francesconi; Cheti Nicoletti |
| Abstract: | Using UK longitudinal data on dual-earner couples, this paper estimates a model of intrahousehold housework decisions, which combines a randomized experimental framework eliciting counterfactual choices with gender norms differences across ethnicities and cohorts to identify the impacts of individual preferences and gender identity norms. Equal sharing of tasks yields greater utility for both men and women, with women disliking domestic chores as much as men. Although couples would want to use housework arrangements to compensate for differentials in labor market involvement, women end up performing a substantially larger share of housework. This is not due to specialization, rather social norms play a key role. Exposure to more egalitarian gender attitudes significantly increases the probability of choosing an equal share of housework. Were attitudes evened up to the most progressive levels observed in the sample, women doing more housework than their partners would stop to be the norm already among present-day households, except for households with children. |
| Keywords: | intrahousehold allocation of chores, labor supply, vignettes, gender identity norms, gender gaps |
| JEL: | C25 C26 D13 J16 J22 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:ces:ceswps:_11413 |
| By: | Yifan Wu; Ramesh Johari; Vasilis Syrgkanis; Gabriel Y. Weintraub |
| Abstract: | We consider a retailer running a switchback experiment for the price of a single product, with infinite supply. In each period, the seller chooses a price $p$ from a set of predefined prices that consist of a reference price and a few discounted price levels. The goal is to estimate the demand gradient at the reference price point, with the goal of adjusting the reference price to improve revenue after the experiment. In our model, in each period, a unit mass of buyers arrives on the market, with values distributed based on a time-varying process. Crucially, buyers are forward looking with a discounted utility and will choose to not purchase now if they expect to face a discounted price in the near future. We show that forward-looking demand introduces bias in naive estimators of the demand gradient, due to intertemporal interference. Furthermore, we prove that there is no estimator that uses data from price experiments with only two price points that can recover the correct demand gradient, even in the limit of an infinitely long experiment with an infinitesimal price discount. Moreover, we characterize the form of the bias of naive estimators. Finally, we show that with a simple three price level experiment, the seller can remove the bias due to strategic forward-looking behavior and construct an estimator for the demand gradient that asymptotically recovers the truth. |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2410.14904 |
| By: | Couts, Spencer J. (U of Southern California); Goncalves, Andrei S. (Ohio State U); Liu, Yicheng (Ohio State U); Loudis, Johnathan (U of Notre Dame) |
| Abstract: | In this paper, we study the role of subjective risk premia in explaining subjective expected return time variation and disagreement using the long-term Capital Market Assumptions of major asset managers and investment consultants from 1987 to 2022. We find that market risk premia explain most of the expected return time variation, with the rest explained by alphas. The risk premia effect is almost entirely driven by time variation in risk quantities as opposed to risk price. Nevertheless, risk price explains about half of the transitory effect of risk premia on expected returns. Market risk premia also explain most of the expected return disagreement, but in this case alphas have a quantitatively significant effect, and risk price and risk quantities are roughly equally responsible for the risk premia effect. Our results provide benchmark moments that asset pricing models should match to be consistent with institutional investors' beliefs. |
| JEL: | G10 G11 G12 G23 G40 |
| Date: | 2024–08 |
| URL: | https://d.repec.org/n?u=RePEc:ecl:ohidic:2024-17 |