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on Utility Models and Prospect Theory |
| By: | Yuehao Bai; Max Tabord-Meehan |
| Abstract: | This paper studies the sharp testable implications of an additive random utility model with a discrete multi-valued treatment and a discrete multi-valued instrument, in which each value of the instrument only weakly increases the utility of one choice. Borrowing the terminology used in randomized experiments, we call such a setting an encouragement design. We derive inequalities in terms of the conditional choice probabilities that characterize when the distribution of the observed data is consistent with such a model. Through a novel constructive argument, we further show these inequalities are sharp in the sense that any distribution of the observed data that satisfies these inequalities is generated by this additive random utility model. |
| Date: | 2024–11 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2411.09808 |
| By: | Tiantian Mao; Gilles Stupfler; Fan Yang |
| Abstract: | We study a general risk measure called the generalized shortfall risk measure, which was first introduced in Mao and Cai (2018). It is proposed under the rank-dependent expected utility framework, or equivalently induced from the cumulative prospect theory. This risk measure can be flexibly designed to capture the decision maker's behavior toward risks and wealth when measuring risk. In this paper, we derive the first- and second-order asymptotic expansions for the generalized shortfall risk measure. Our asymptotic results can be viewed as unifying theory for, among others, distortion risk measures and utility-based shortfall risk measures. They also provide a blueprint for the estimation of these measures at extreme levels, and we illustrate this principle by constructing and studying a quantile-based estimator in a special case. The accuracy of the asymptotic expansions and of the estimator is assessed on several numerical examples. |
| Date: | 2024–11 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2411.07212 |
| By: | Dmitry Ryvkin; Qin Wu |
| Abstract: | We study the optimal allocation of prizes in rank-order tournaments with loss averse agents. Prize sharing becomes increasingly optimal with loss aversion because more equitable prizes reduce the marginal psychological cost of anticipated losses. Furthermore, loss aversion can boost effort if prizes are sufficiently equitable, but otherwise effort declines with loss aversion. Overall, these results give credence to more equitable allocations of competitive rewards. A win-win scenario is where optimal prizes are equitable even under loss neutrality, in which case the principal benefits from agents' loss aversion. |
| Date: | 2024–11 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2411.01068 |
| By: | Fessler, Pirmin; Rapp, Severin |
| Abstract: | We estimate the relationship between people’s biased perceptions of their rank in the wealth distribution and savings behavior. Using unique wealth survey data from Austria, we uncover a significant bias in self-assessed distributional ranks. Our estimates indicate that individuals who underestimate their wealth rank have a savings rate approximately 50% higher than those who assess their rank accurately. Preferences that feature relative wealth in the utility function can explain this relationship. Our findings inform contemporary macroeconomic models and contribute to understanding the impact of information bubbles on economic decisions. (Stone Center on Socio-Economic Inequality Working Paper) |
| Date: | 2024–11–14 |
| URL: | https://d.repec.org/n?u=RePEc:osf:socarx:3x4jh |
| By: | Debopam Bhattacharya; Ekaterina Oparina; Qianya Xu |
| Abstract: | We analyze demand settings where heterogeneous consumers maximize utility for product attributes subject to a nonlinear budget constraint. We develop nonparametric methods for welfare-analysis of interventions that change the constraint. Two new findings are Roy's identity for smooth, nonlinear budgets, which yields a Partial Differential Equation system, and a Slutsky-like symmetry condition for demand. Under scalar unobserved heterogeneity and single-crossing preferences, the coefficient functions in the PDEs are nonparametrically identified, and under symmetry, lead to path-independent, money-metric welfare. We illustrate our methods with welfare evaluation of a hypothetical change in relationship between property rent and neighborhood school-quality using British microdata. |
| Date: | 2024–11 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2411.01064 |
| By: | Alexander M. Danzer; Helen Zeidler |
| Abstract: | This paper investigates time inconsistencies in food consumption based on a field experiment at a college canteen where participants repeatedly select and consume lunch menus. The design features a convex non-monetary budget in a natural environment and satisfies the consume-on-receipt assumption. Leveraging 3, 666 choices of different food healthiness, we find no time inconsistency at the meal level. Utility weight estimates at the dish level reveal that consumers balance healthiness between food categories. Individuals who exert self-control take up a commitment device as soon as available, while non-committers are present-biased. Dynamic inconsistencies in food and money choices are independent. |
| Keywords: | field experiment, dynamic inconsistency, commitment, food consumption |
| JEL: | D12 D01 C93 D91 I12 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:ces:ceswps:_11454 |
| By: | Matthew Gould (Department of Economics and Finance, Brunel University London, Cleveland Road, Uxbridge, UB8 2TL, UK); Matthew D. Rablen (School of Economics, University of Sheffield, Sheffield S1 4DT, UK) |
| Abstract: | We focus on the preferences of a salient group of highly-experienced individuals who are entrusted with making decisions that affect the lives of millions of their citizens, heads of government. We test for the presence of a fundamental behavioral bias, loss aversion, by examining heads of governments choice of decision rules for international organizations. Loss averse leaders would choose decision rules that oversupply negative (blocking) power at the expense of positive power (to initiate affirmative action), causing potential welfare losses through harmful policy persistence and reform deadlocks. If loss aversion is muted by experience and high-stakes it may not be exhibited in this context. We find evidence of significant loss aversion implied in the Qualified Majority rule of the Treaty of Lisbon, when understood as a Nash bargaining outcome. World leaders may be more loss averse than the populous they represent. |
| Keywords: | Loss aversion, Behavioral biases, Voting, Bargaining, Voting power, EU Council of Ministers |
| JEL: | D03 D81 D72 C78 |
| Date: | 2024–11 |
| URL: | https://d.repec.org/n?u=RePEc:shf:wpaper:2024011 |
| By: | Costa-Font, Joan (London School of Economics); Cowell, Frank A. (London School of Economics) |
| Abstract: | This paper examines a behavioural explanation for the Brexit referendum result, the role of an individual's inequality aversion (IA). We study whether the referendum result was an "unconsidered Leave" partially driven by people's low aversion to inequality. We use a representative sample of the UK population fielded in 2017, and analyse the extent to which lottery-based individual IA estimates predict their Brexit vote. We consider alternative potential drivers of IA in both income and health domains; these include risk aversion, locus of control, alongside socio-economic and demographic characteristics. A greater aversion to income inequality predicts a lower probability of voting for Leave, even when controlling for risk aversion and other drivers of the Brexit vote. This effect is only true among men, for whom an increase in income IA by one standard deviation decreases their likelihood of voting for leaving the EU by 5% on average. Had there been a greater IA, the overall referendum result might have been different. However, the effect of health inequality aversion is not significantly different from zero. |
| Keywords: | Brexit, inequality aversion, income inequality aversion, health inequality aversion, imaginary grandchild, risk aversion, locus of control |
| JEL: | H1 I18 |
| Date: | 2024–11 |
| URL: | https://d.repec.org/n?u=RePEc:iza:izadps:dp17439 |
| By: | Yaacov Kopeliovich; Michael Pokojovy |
| Abstract: | With the recent advancements in machine learning (ML), artificial neural networks (ANN) are starting to play an increasingly important role in quantitative finance. Dynamic portfolio optimization is among many problems that have significantly benefited from a wider adoption of deep learning (DL). While most existing research has primarily focused on how DL can alleviate the curse of dimensionality when solving the Hamilton-Jacobi-Bellman (HJB) equation, some very recent developments propose to forego derivation and solution of HJB in favor of empirical utility maximization over dynamic allocation strategies expressed through ANN. In addition to being simple and transparent, this approach is universally applicable, as it is essentially agnostic about market dynamics. To showcase the method, we apply it to optimal portfolio allocation between a cash account and the S&P 500 index modeled using geometric Brownian motion or the Heston model. In both cases, the results are demonstrated to be on par with those under the theoretical optimal weights assuming isoelastic utility and real-time rebalancing. A set of R codes for a broad class of stochastic volatility models are provided as a supplement. |
| Date: | 2024–11 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2411.09899 |