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on Utility Models and Prospect Theory |
| By: | Mohammed Abdellaoui (GREGHEC - Groupement de Recherche et d'Etudes en Gestion - HEC Paris - Ecole des Hautes Etudes Commerciales - CNRS - Centre National de la Recherche Scientifique); Emmanuel Kemel (GREGHEC - Groupement de Recherche et d'Etudes en Gestion - HEC Paris - Ecole des Hautes Etudes Commerciales - CNRS - Centre National de la Recherche Scientifique); Ferdinand M Vieider; Amma Panin (University of Louvain,) |
| Abstract: | We present a novel method-called risk equivalents-that uses a single measure to elicit discount rates while avoiding concerns about the shape of the utility function. The method is valid under discounted expected utility (DEU), and also under several of its behavioral extensions including more general models that account for a biased perception of time and risk (such as time-or likelihood-insensitivity). We implement the method in a field experiment in India measuring inter-temporal discount rates for money and the consumption of tea.We empirically observe that discount rates elicited by traditional methods are related to utility curvature, whereas discount rates elicited by risk equivalents are not. Risk equivalents also mitigate differences in discount rates measured for money and for tea, suggesting that unaddressed utility curvature may play a role in results that demonstrate good-specific discounting.Risk equivalents are general, fast and tractable, three features that are particularly useful in field studies. |
| Keywords: | time discounting money vs consumption utility confound JEL-classification: D03 D81 D91, time discounting, money vs consumption, utility confound JEL-classification: D03, D81, D91 |
| Date: | 2024–05 |
| URL: | https://d.repec.org/n?u=RePEc:hal:journl:hal-04866738 |
| By: | M\"ucahit Ayg\"un; Roger J. A. Laeven; Mitja Stadje |
| Abstract: | We introduce a model-free preference under ambiguity, as a primitive trait of behavior, which we apply once as well as repeatedly. Its single and double application yield simple, easily interpretable definitions of ambiguity aversion and ambiguity prudence. We derive their implications within canonical models for decision under risk and ambiguity. We establish in particular that our new definition of ambiguity prudence is equivalent to a positive third derivative of: (i) the capacity in the Choquet expected utility model, (ii) the dual conjugate of the divergence function under variational divergence preferences and (iii) the ambiguity attitude function in the smooth ambiguity model. We show that our definition of ambiguity prudent behavior may be naturally linked to an optimal insurance problem under ambiguity. |
| Date: | 2025–01 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2501.13143 |
| By: | Kensei Nakamura; Shohei Yanagita |
| Abstract: | Uncertainty aversion introduced by Gilboa and Schmeidler (1989) has played a central role in decision theory, but at the same time, many incompatible behaviors have been observed in the real world. In this paper, we consider an axiom that postulates only a minimal degree of uncertainty aversion, and examine its implications in the preferences with the basic structure, called the invariant biseparable preferences. We provide three representation theorems for these preferences. Our main result shows that a decision maker with such a preference evaluates each act by considering two "dual" scenarios and then adopting the worse one as its evaluation in a cautious manner. The other two representations share a structure similar to the main result, which clarifies the key implication of weak uncertainty aversion. Furthermore, we offer another foundation for the main representation in the objective/subjective rationality model and characterizations of extensions of the main representation. |
| Date: | 2025–01 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2501.13410 |
| By: | Avner Seror (Aix Marseille Univ, CNRS, AMSE, Marseille, France) |
| Abstract: | As large language models (LLMs) become integrated to decision-making across various sectors, a key question arises: do they exhibit an emergent "moral mind" - a consistent set of moral principles guiding their ethical judgments - and is this reasoning uniform or diverse across models? To investigate this, we presented about forty different models from the main providers with a large array of structured ethical scenarios, creating one of the largest datasets of its kind. Our rationality tests revealed that at least one model from each provider demonstrated behavior consistent with stable moral principles, effectively acting as approximately optimizing a utility function encoding ethical reasoning. We identified these utility functions and observed a notable clustering of models around neutral ethical stances. To investigate variability, we introduced a novel non-parametric permutation approach, revealing that the most rational models shared 59% to 76% of their ethical reasoning patterns. Despite this shared foundation, differences emerged: roughly half displayed greater moral adaptability, bridging diverse perspectives, while the remainder adhered to more rigid ethical structures. |
| Keywords: | Decision Theory, revealed preference, Rationality, artificial intelligence, LLM, PSM. |
| JEL: | D9 C9 C44 |
| Date: | 2024–11 |
| URL: | https://d.repec.org/n?u=RePEc:aim:wpaimx:2433 |
| By: | Thomas Bernhardt |
| Abstract: | In this short note, we address two issues in the literature about modern tontines with bequest and utility maximisation: how to verify optimal controls and the decreasing allocation of funds in the tontine. We want to raise awareness in the actuarial community about the dual approach to solve optimal control problems when working with power utilities. Additionally, we point out that bequest preferences should be time-dependent or otherwise yield unrealistic investment strategies. We base our attempt at modelling bequest preferences on common sense rules like 100% payback upon death at the start that vanishes over time. Our modelling shows that the resulting investment strategy almost linearly adjusts the allocation in the tontine from 0% to 100% over time. |
| Date: | 2025–01 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2501.08972 |
| By: | Georges Prat (EconomiX - EconomiX - UPN - Université Paris Nanterre - CNRS - Centre National de la Recherche Scientifique); Remzi Uctum (EconomiX - EconomiX - UPN - Université Paris Nanterre - CNRS - Centre National de la Recherche Scientifique) |
| Abstract: | This paper contributes to the literature on crude oil risk premiums by providing ex-ante measures of these premiums using survey oil price expectations over an extended period. These ex-ante premiums are uncorrelated with ex-post premiums commonly used in existing studies, whereas they are more relevant as they directly influence investors' decision-making. Utilizing a portfolio choice model, we explain the ex-ante premium as the product of the price of risk and the expected variance, both varying over time and across horizons. We estimate this relationship using a multivariate state-space framework. From our estimated risk prices we find, on average, that investors exhibit risk-seeking behaviour in the short term and risk aversion in the long term. It follows that the term structure of oil risk premiums are prominently upward-sloping. Additionally, consistent with the prospect theory, investors are found to be predominantly risk averse in a context of expected gains and risk-seeking in a context of expected losses. Finally, the dynamics of risk prices are shown to be driven by identifiable economic, financial, and oil market-related factors. |
| Keywords: | Oil price expectations, Ex-ante oil risk premium, Survey data, Prospect theory, D81, G11, Q43 |
| Date: | 2024–12 |
| URL: | https://d.repec.org/n?u=RePEc:hal:journl:hal-04873466 |
| By: | Cédric Gutierrez (Bocconi University [Milan, Italy]); Emmanuel Kemel (GREGH - Groupement de Recherche et d'Etudes en Gestion à HEC - HEC Paris - Ecole des Hautes Etudes Commerciales - CNRS - Centre National de la Recherche Scientifique) |
| Abstract: | The consequences of most economic decisions are uncertain; they are conditional on events with unknown probabilities that decision makers evaluate based on their beliefs. In addition to consequences and beliefs, the context that generates events-the source of uncertainty-can also impact preferences, a pattern called source dependence. Despite its importance, there is currently no definition of source dependence that allows for comparisons across individuals and sources. This paper presents a tractable definition of source dependence by introducing a function that matches the subjective probabilities of events generated by two sources. It also presents methods for estimating such functions from a limited number of observations that are compatible with commonly-used choice-based approaches for separating attitudes from beliefs. As an illustration, we implement these methods on three datasets, including two original experiments, and show that they consistently capture clear, albeit heterogeneous, patterns of source dependence between natural sources. Our approach provides a framework for future research to explore how source dependence varies across individuals and situations. |
| Keywords: | Decision under uncertainty ambiguity aversion sources of uncertainty subjective beliefs source dependence familiarity bias. JEL Classification: D81 DD91 C91, Decision under uncertainty, ambiguity aversion, sources of uncertainty, subjective beliefs, source dependence, familiarity bias. JEL Classification: D81, DD91, C91 |
| Date: | 2024–05–23 |
| URL: | https://d.repec.org/n?u=RePEc:hal:journl:hal-04866878 |
| By: | Jorge Justiniano (University of Bonn); Andreas Kleiner (University of Bonn); Benny Moldovanu (University of Bonn); Martin Rumpf (University of Bonn); Philipp Strack (Yale University) |
| Abstract: | In this paper, we explore a scenario where a sender provides an information policy and a receiver, upon observing a realization of this policy, decides whether to take a particular action, such as making a purchase. The senderÕs objective is to maximize her utility derived from the receiverÕs action, and she achieves this by careful selection of the information policy. Building on the work of Kleiner et al., our focus lies specifically on information policies that are associated with power diagram partitions of the underlying domain. To address this problem, we employ entropy-regularized optimal transport, which enables us to develop an efficient algorithm for finding the optimal solution. We present experimental numerical results that highlight the qualitative properties of the optimal configurations, providing valuable insights into their structure. Furthermore, we extend our numerical investigation to derive optimal information policies for monopolists dealing with multiple products, where the sender discloses information about product qualities. |
| Date: | 2024–12–16 |
| URL: | https://d.repec.org/n?u=RePEc:cwl:cwldpp:2419 |
| By: | Rosella Levaggi; Francesco Menoncin; Andrea Modena |
| Abstract: | Tolerating tax evasion may increase debt less than an equivalent tax cut. In our model, utility-maximizing entrepreneurs earn income from risky production technologies and risk-free bonds. The government uses income taxes and bonds to finance its expenses. Entrepreneurs can evade taxes at the risk of being audited and fined. Aggregate tax evasion and debt-to-GDP are positively related in equilibrium. Nevertheless, reducing effective tax rates by tolerating evasion may generate a lower debt-to-GDP ratio (but also lower growth) than equivalent debt-financed nominal tax cuts. Policies are equivalent with log utility. |
| Keywords: | Dynamic tax evasion; general equilibrium; public debt. |
| JEL: | D5 E6 H2 |
| Date: | 2025–01 |
| URL: | https://d.repec.org/n?u=RePEc:bon:boncrc:crctr224_2025_623 |
| By: | Norihito Sakamoto |
| Abstract: | This paper revisits impossibility results on the tyrannies of aggregation and non-aggregation. I propose two aggregation principles (quantitative aggregation and ratio aggregation) and investigate theoretical implications. As a result, I show that quantitative aggregation and minimal non-aggregation are incompatible while ratio aggregation and minimal non-aggregation are compatible under the assumption of standard axioms in social choice theory. Furthermore, this study provides a new characterization of the leximin rule by using replication invariance and the strong version of non-aggregation. Finally, I propose a class of practical and acceptable social welfare orderings that satisfy the principles of aggregation and non-aggregation, which has various advantages over the standard rank-discounted generalized utilitarianism. |
| Date: | 2025–01 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2501.09979 |
| By: | Jiequn Han (Flatiron Institute); Yucheng Yang (University of Zurich; Swiss Finance Institute); Weinan E (Princeton University) |
| Abstract: | We propose an efficient, reliable, and interpretable global solution method, the Deep learning-based algorithm for Heterogeneous Agent Models (DeepHAM), for solving high dimensional heterogeneous agent models with aggregate shocks. The state distribution is approximately represented by a set of optimal generalized moments. Deep neural networks are used to approximate the value and policy functions, and the objective is optimized over directly simulated paths. In addition to being an accurate global solver, this method has three additional features. First, it is computationally efficient in solving complex heterogeneous agent models, and it does not suffer from the curse of dimensionality. Second, it provides a general and interpretable representation of the distribution over individual states, which is crucial in addressing the classical question of whether and how heterogeneity matters in macroeconomics. Third, it solves the constrained efficiency problem as easily as it solves the competitive equilibrium, which opens up new possibilities for normative studies. As a new application, we study constrained efficiency in heterogeneous agent models with aggregate shocks. We find that in the presence of aggregate risk, a utilitarian planner would raise aggregate capital for redistribution less than in absence of it because poor households do more precautionary savings and thus rely less on labor income. |
| Keywords: | Heterogeneous agent models, aggregate shocks, global solution, deep learning, generalized moments, constrained efficiency |
| Date: | 2025–01 |
| URL: | https://d.repec.org/n?u=RePEc:chf:rpseri:rp2506 |
| By: | Zongxia Liang; Zhaojie Ren; Bin Zou |
| Abstract: | This paper studies an optimal insurance problem for a utility-maximizing buyer of insurance, subject to the seller's endogenous default and background risk. An endogenous default occurs when the buyer's contractual indemnity exceeds the seller's available reserve, which is random due to the background risk. We obtain an analytical solution to the optimal contract for two types of contracts, differentiated by whether their indemnity functions depend on the seller's background risk. The results shed light on the joint effect of the seller's default and background risk on the buyer's insurance demand. |
| Date: | 2025–01 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2501.05672 |