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on Utility Models and Prospect Theory |
| By: | Lukas Janasek (Institute of Economic Studies, Charles University, Prague, Czech Republic) |
| Abstract: | This paper develops a novel gradient-based reinforcement learning algorithm for solving dynamic quantile models with uncertainty. Unlike traditional approaches that rely on expected utility maximization, we focus on agents who evaluate outcomes based on specific quantiles of the utility distribution, capturing intratemporal risk attitudes via a quantile level ? ? (0, 1). We formulate a recursive quantile value function associated with time consistent dynamic quantile preferences in Markov decision process. At each period, the agent aims to maximize the quantile of a distribution composed of instantaneous utility combined with the discounted future value, conditioned on the current state. Next, we adapt the Actor-Critic framework to learn ?-quantile of the distribution and policy maximizing the ?-quantile. We demonstrate the accuracy and robustness of the proposed algorithm using an quantile intertemporal consumption model with known analytical solutions. The results confirm the effectiveness of our algorithm in capturing optimal quantile-based behavior and stability of the algorithm. |
| Keywords: | Dynamic programming, Quantile preferences, Reinforcement learning |
| JEL: | C61 C63 |
| Date: | 2025–07 |
| URL: | https://d.repec.org/n?u=RePEc:fau:wpaper:wp2025_12 |
| By: | Miller, Anne |
| Abstract: | This paper shows that a demand equation derived by adding two bounded leaning-S-shaped utilities includes the inferior-Giffen response. A leaning-S-shaped, bounded cardinal utility, (0 u 1), for a single commodity is identified as a representation of the individual’s experience 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. The separability rule states that utilities of commodities fulfilling the same need are weakly separable (multiplicative) and those of commodities fulfilling two different needs are strongly separable (additive). Functional forms are derived from a utility function created by adding two normal distribution functions with satiation at infinity, the parameters of which have meaningful psychological interpretations. The indifference map, demand and Engels curve diagrams are explored. Concave- and convex-to-the-origin indifference curves, (the former defining ‘dysfunctional poverty’, leading to disequilibrium in the derived functional forms), are separated by a straight-line indifference curve with slope defined by the relative-intensities-of-need. Convex-to-the-origin indifference curves enable optimisation even for deprivation in one need. The boundaries between superior and inferior responses, and between inferior normal and inferior Giffen, are reflected in envelope curves in the derived functional form diagrams. The inferior-Giffen experience occurs when an individual responds to a price increase for an abundant, cheaper good by consuming more of it, enabled by relinquishing some consumption of a more expensive commodity fulfilling a different need, of which s/he is already extremely deprived. |
| Keywords: | Bounded cardinal utility includes increasing marginal utility expressing deprivation; additive separability for different needs; dysfunctional poverty leads to involuntary unemployment and disequilibrium; envelope curves reflect inferior responses; the straight-line indifference curve determines the equilibrium price and survival endowments. |
| JEL: | C21 D11 |
| Date: | 2025–06–28 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:125146 |
| By: | H. Peter Boswijk (University of Amsterdam and Tinbergen Institute); Jeroen Dalderop (University of Notre Dame); Roger J. A. Laeven (University of Amsterdam and Tinbergen Institute); Niels Marijnen (University of Amsterdam and Tinbergen Institute) |
| Abstract: | This paper develops a semiparametric estimation method that jointly identifies the probability weighting and utility functions implicit in option prices. Our econometric method avoids direct specification of the objective conditional return distributions, which are instead obtained by transforming the options’ implied risk-neutral distributions according to the posited rank-dependent utility model. We nonparametrically estimate the probability weighting function using the kernel density of suitable utility-adjusted probability integral transforms. The parameters of the utility function are estimated by maximizing the resulting profile likelihood. We establish the asymptotic properties of our estimation procedure, and demonstrate its good finite sample performance in Monte Carlo simulations. Empirical results based on S&P 500 index option prices and returns over the period 1996–2023 reveal the relevance of probability weighting, in particular at the monthly horizon where the weighting function is inverse-S shaped, which is robust to various specifications of the utility function. |
| Keywords: | Semiparametric inference; Probability weighting function; Profile likelihood; Kernel estimation; Options |
| JEL: | C14 C58 G13 |
| Date: | 2025–03–21 |
| URL: | https://d.repec.org/n?u=RePEc:tin:wpaper:20250022 |
| By: | Estelle CAMPENET; David DESMARCHELIER |
| Abstract: | The literature has highlighted the potential occurrence of a limit cycle through a Hopf bifurcation near the steady state of a competitive Ramsey economy when pollution significantly increases the marginal utility of consumption (compensation effect). This latter condition is necessary but not sufficient. More specifically, pollution inertia must be strong when pollution originates from production but not when it stems from consumption. This paper investigates the reasons for this difference and emphasizes the role of decreasing marginal productivity of capital in explaining it. |
| Keywords: | Ramsey model, Pollution inertia, Hopf bifurcation. |
| JEL: | E32 O44 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:ulp:sbbeta:2025-10 |
| By: | Eickhoff, Katharina; Neuwohner, Meike; Peis, Britta; Rieken, Niklas; Vargas Koch, Laura; Végh, Lázló A. |
| Abstract: | We consider dynamic auctions for finding Walrasian equilibria in markets with indivisible items and strong gross substitutes valuation functions. Each price adjustment step in these auction algorithms requires finding an inclusion-wise minimal maximally overdemanded set or an inclusion-wise minimal maximally underdemanded set at the current prices. Both can be formulated as a submodular function minimization problem. We observe that minimizing this submodular function corresponds to a polymatroid sum problem, and using this viewpoint, we give a fast and simple push-relabel algorithm for finding the required sets. This improves on the previously best running time of Murota, Shioura and Yang (ISAAC 2013). Our algorithm is an adaptation of the push-relabel framework by Frank and Miklós (JJIAM 2012) to the particular setting. We obtain a further improvement for the special case of unit-supplies. We further show the following monotonicity properties of Walrasian prices: both the minimal and maximal Walrasian prices can only increase if supply of goods decreases, or if the demand of buyers increases. This is derived from a fine-grained analysis of market prices. We call packing prices a price vector such that there is a feasible allocation where each buyer obtains a utility maximizing set. Conversely, by covering prices we mean a price vector such that there exists a collection of utility maximizing sets of the buyers that include all available goods. We show that for strong gross substitutes valuations, the component-wise minimal packing prices coincide with the minimal Walrasian prices and the component-wise maximal covering prices coincide with the maximal Walrasian prices. These properties in turn lead to the price monotonicity results. |
| Keywords: | dynamic auctions; walrasian prices; strong gross substitutes; polymatroid sum; push-relabel; monotonicity |
| JEL: | J1 |
| Date: | 2025–04–12 |
| URL: | https://d.repec.org/n?u=RePEc:ehl:lserod:127980 |
| By: | Campbell, John Y.; Martin, Ian W. R. |
| Abstract: | How much consumption is sustainable, if \sustainability" re- quires that welfare should not be expected to decline over time? We impose a sustainability constraint on a standard consump- tion/portfolio choice problem. The constraint does not distort portfolio choice, but it imposes an upper bound on the sustain- able consumption-wealth ratio, which must lie between the riskless interest rate and the expected return on wealth (and if risky capital evolves according to a geometric Brownian motion, it lies exactly halfway between the two). Sustainability requires an upward drift in wealth and consumption to compensate future generations for the increased risk they face. |
| JEL: | D63 D81 E21 H43 Q01 |
| Date: | 2025–06–16 |
| URL: | https://d.repec.org/n?u=RePEc:ehl:lserod:126073 |
| By: | Taco Prins (University of Amsterdam); Frederick van der Ploeg (University of Amsterdam and Tinbergen Institute); Ton S. van den Bremer (University of Amsterdam and Tinbergen Institute) |
| Abstract: | We analyse optimal investment in one of the most important forms of climate adaptation: flood protection. Investments to build and heighten dykes and surge barriers involve considerable adjustment costs, so that their construction locks in the level of flood protection for some time. Investment decisions must take into account both economic and sea level rise uncertainty over a horizon of several decades, where the latter is to a large extent driven by global warming. We put forward a tractable macro-finance DSGE model that includes flood risk. We obtain solutions for optimal flood protection as a function of these uncertainties, costs, and preferences regarding impatience, risk aversion and intertemporal substitution. Sea level rise uncertainty always leads to more flood protection. Economic uncertainty leads to less (more) protection if the elasticity of substitution is greater (less) than one. We illustrate our results with a calibrated case study for the Netherlands. |
| Keywords: | Sea level rise, flood risk, macroeconomic risk, climate adaptation, discounting, risk aversion, intertemporal substitution |
| JEL: | F64 Q51 Q54 |
| Date: | 2025–04–25 |
| URL: | https://d.repec.org/n?u=RePEc:tin:wpaper:20250030 |
| By: | Jiakun Zheng (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique); Ling Zhou (School of Economics, Shanghai University of Finance and Economics) |
| Abstract: | Narrow bracketers who are myopic in specific decisions would fail to consider preexisting risks in investment and neglect hedging opportunities. Growing evidence has demonstrated the relevance of narrow bracketing. We take a step further in empirical investigation and study individual heterogeneity in narrow bracketing. Specifically, we use a lab experiment in investment and hedging that elicits subjects' preferences on rich occasions to uncover the individual degree of narrow bracketing without imposing distributional assumptions. Combining prospect theory and narrow bracketing can explain our findings: Subjects who invest more also insure more, and subjects insure significantly less in the loss domain than in the gain domain. More importantly, we show that the distribution of the individual degree of narrow bracketing is skewed at two extremes, yet with a substantial share of people in the middle who partially suffer from narrow bracketing. Neglecting this aspect, we would overestimate the severity of narrow bracketing and misinterpret its relation with individual characteristics. |
| Keywords: | Hedging, Narrow bracketing, Prospect theory, Subject heterogeneity |
| Date: | 2025–04–10 |
| URL: | https://d.repec.org/n?u=RePEc:hal:journl:hal-05063379 |
| By: | Fadina, Tolulope (Center for Mathematical Economics, Bielefeld University); Schmidt, Thorsten (Center for Mathematical Economics, Bielefeld University) |
| Abstract: | This paper discusses ambiguity in the context of single-name credit risk. We focus on uncertainty on the default intensity but also discuss uncertainty on the recovery in a fractional recovery of the market value. This approach is a first step towards integrating uncertainty in credit risky term structure models and can profit from its simplicity. We derive drift conditions in a Heath-Jarrow-Morton forward rate setting in the case of ambiguous default intensity in combination with zero recovery, and in the case of ambiguous fractional recovery of the market value. |
| Keywords: | Model ambiguity, default time, credit risk, no-arbitrage, reduced- form HJM models, recovery process. |
| Date: | 2025–06–24 |
| URL: | https://d.repec.org/n?u=RePEc:bie:wpaper:710 |
| By: | Gangadharan, Lata (Monash Univ); Rabanal, Jean Paul (University of Stavanger); Riyanto, Eko (Nanyang Technological University;); Rud, Olga (University of Stavanger); Ødegaard, Bernt Arne (University of Stavanger) |
| Abstract: | We examine whether shareholders' responses to risky investment decisions are influenced by the gender of the firm's manager, particularly when these decisions directly affect the fundamental value per share. Our findings indicate that male and female managers make similar investment choices, that shareholder beliefs about the managers' choices are generally accurate, and that market prices do not differ by manager gender. These findings suggest that gender diversity in leadership does not negatively affect shareholder valuation. However, when subjects are explicitly asked to compare the investment of male and female managers, strong gender stereotypes emerge, and most expect male managers to take on more risk. A similar bias is evident in share price comparisons, with male-led firms slightly favored, although the effect is weaker than that observed in the beliefs about investment decisions. This pattern suggests that, while individual judgments may be biased, market mechanisms can partially alleviate such biases. |
| Keywords: | Gender; Risk Aversion; Corporate decisions; Experimental Finance |
| JEL: | C90 D81 G11 G35 G41 G51 |
| Date: | 2025–07–13 |
| URL: | https://d.repec.org/n?u=RePEc:hhs:stavef:2025_002 |
| By: | Frank Schorfheide; Zhiheng You |
| Abstract: | Econometricians invest substantial effort in constructing standard errors that yield valid inference under a hypothetical data-generating process. This paper asks a fundamental question: Are the uncertainty statements reported by applied researchers consistent with empirical frequencies? The short answer is no. Drawing on the forecasting literature, we predict estimates from “new” studies using estimates from corresponding baseline studies. By doing this across a large number of study groups and linking parameters through a hierarchical model, we compare stated probabilities to observed empirical frequencies. Alignment occurs only under limited external validity, namely, that the studies estimate different parameters. |
| JEL: | C11 C18 C21 |
| Date: | 2025–06 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:33962 |
| By: | Zakirov, Bekzod; Useinov, Akhtem |
| Abstract: | In mainstream economics, there is an assumption that individuals are rational actors whose decision-making is based on incentives, regulations and available information. When such an assumption is translated into designing public policies, authorities designing policies consider individual citizens as rational decision-makers. However, human choices are commonly influenced by various biases, emotional responses and social influences. The biases in human decision-making processes make traditional policy tools like tax incentives, mandatory requirements, and public awareness campaigns ineffective. This paper reviews and argues that behavioral insights can strengthen traditional policy instruments by better aligning interventions and human behavior. The countries in Central Asia, including Uzbekistan, can achieve better policy outcomes through evidence-based, behaviorally informed design, complementing assumption-driven approaches. The paper explains the fundamentals of behavioral insights through worldwide examples and provides specific recommendations for implementing BI in policy development with implications for Uzbekistan. |
| Keywords: | behavioral insights; policy design; rationality; nudge; Central Asia; Uzbekistan |
| JEL: | A12 D81 H0 H3 O21 |
| Date: | 2025–06–19 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:125051 |
| By: | Laura Capera Romero (Vrije Universiteit Amsterdam and Tinbergen Institute); Anne Opschoor (Vrije Universiteit Amsterdam and Tinbergen Institute) |
| Abstract: | This paper compares the statistical and economic performance of state-of-the-art highfrequency based multivariate volatility models with a simpler, widely used alternative - the Exponentially Weighted Moving Average (EWMA) filter. Using over two decades of 100 U.S. stock returns (2002–2023), we assess model performance through a Global Minimum Variance portfolio optimization exercise across various forecast horizons. We find that the EWMA model consistently outperforms more complex HF-based volatility models, delivering significant utility gains when including transaction costs, due in part to its lower turnover. Even in the absence of transaction costs, the EWMA filter cannot be beaten in most cases. Our results are robust to various dimensions, including no-short-selling constraints, varying portfolio sizes, and alternative parameter choices, highlighting the continued relevance of the EWMA model in high-frequency-based portfolio allocation. |
| Date: | 2025–06–26 |
| URL: | https://d.repec.org/n?u=RePEc:tin:wpaper:20250041 |