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on Utility Models and Prospect Theory |
| By: | Mestieri, Marti; Norris, Jordan |
| Abstract: | We uncover an equivalence between two opposite behavioral microfoundations for the standard multinomial logit choice model: 1) agents optimize their choice accordingly to the random utility model under Gumbel idiosyncratic shocks; 2) agents randomize over options subject to a minimum utility requirement. Both generate identical multinomial logit choice probabilities, yet have different welfare implications: welfare is strictly lower under randomization, since only optimizing agents select into options with favorable realizations of idiosyncratic shocks. |
| Keywords: | Entropy; Logit |
| JEL: | C25 D61 C60 |
| Date: | 2026–01 |
| URL: | https://d.repec.org/n?u=RePEc:cpr:ceprdp:21030 |
| By: | Bilbiie, Florin; Hanks, Fergal; Lavender, Sean |
| Abstract: | Complementarity between consumption and work is essential for heterogeneous-agent models' ability to generate realistic multiplier effects from aggregate demand shocks, while avoiding puzzling predictions. We show how parameterizing complementarity — in the spirit of Frisch's “utility acceleration†— separately from income effects is necessary to achieve both. HANK models equipped with such complementarity deliver plausible fiscal multipliers and simultaneously resolve two key challenges in the literature: a “trilemma†of matching marginal propensities to earn (MPEs) and to consume (MPCs), and a Catch-22 “dilemma†of resolving the forward guidance puzzle. We establish these results analytically in a tractable HANK framework and confirm them in a calibrated quantitative HANK model. Standard utility functions, however, constrain either complementarity or income effects — or both — thereby forcing multipliers to depend exclusively on one or the other. We introduce two flexible parametric forms that allow arbitrary, independent calibration of complementarity and income effects: a quasi-separable “GHH-CRRA†utility and a “CCRRA†(constant complementarity and relative risk aversion) specification. |
| JEL: | D11 E32 E52 E62 |
| Date: | 2025–11 |
| URL: | https://d.repec.org/n?u=RePEc:cpr:ceprdp:20804 |
| By: | John Mori |
| Abstract: | We consider the social aggregation of preferences over lotteries in the presence of other-regarding preferences. If society respects each individual's sovereignty, an axiom we propose akin to Sen's Liberalism, then society's utility is a linear combination of individuals' self-regarding utilities. That is, other-regarding preferences can only influence the weights society places on each individual. We next characterize the unique weighting method under which society's weight ratio between two individuals is the geometric mean of that of all individuals. The first distinguishing axiom concerns the consistency of sequential aggregation, while the second concerns consensus across changes in individuals' other-regarding preferences. We extend the first result to a setting with feasibility constraints and a setting with subjective uncertainty. |
| Date: | 2026–06 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2606.25904 |
| By: | Xuehan Jiang; Xi Zhi Lim |
| Abstract: | Risky consumption generates information when uncertainty is resolved. This paper axiomatically characterizes the consumption-information trade-off even when the analyst does not observe an agent's future problems. A subjective future menu underpins the agent's willingness to sacrifice current consumption for future information. By carefully separating objective risk from subjective risk, we decompose the certainty equivalent of an act into a standard risk premium and a novel information premium. To facilitate applications, we introduce an Arrow-Debreu-Pratt parameterization that yields a tractable model, capturing risk aversion and information incentives with a single coefficient for each. Finally, we show that heterogeneity in risk-taking may arise from differing opportunities to capitalize on information, rather than being solely attributable to differences in risk aversion. |
| Date: | 2026–06 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2606.16380 |
| By: | Philip Trammell; Charles I. Jones |
| Abstract: | Real GDP per person is a widely used proxy for living standards, but it can be a poor welfare measure when new goods or quality improvements matter, when nonmarket goods are significant, and when preferences are nonhomothetic --- all of which are true in practice. We propose an alternative that is robust to these concerns: under weak conditions, the growth rate of the value of a statistical life (VSL), together with standard Euler-equation objects, identifies the growth rate of lifetime utility. The intuition is that people routinely trade off consumption against mortality risk, and their willingness to pay for small risk reductions reveals the value of remaining lifetime utility. Implementing this approach for the United States suggests that lifetime utility may have risen by more than a factor of five since 1940, whereas conventional consumption-based calculations using a stable log/CRRA flow utility imply much smaller gains, on the order of a doubling. This calculation is sensitive to measures of the growth rate of the VSL, the rate of time preference, and the interest rate. For example, if the correct interest rate is 4 percentage points higher than the T-bill rate, then lifetime utility would be measured to have declined by more than half since 1940. |
| JEL: | E01 O4 |
| Date: | 2026–06 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:35382 |
| By: | Saverio Gaudio, Francesco; Poilly, Céline |
| Abstract: | The variety effect, arising from monopolistic competition and increasing returns to specialization, acts as an amplification mechanism in the transmission of aggregate, especially uncertainty, shocks. By generating endogenous fluctuations in aggregate productivity through changes in the range of available products, it shapes the joint dynamics of households' marginal utility, firms' profits, and relative prices. Thus, it ultimately reinforces the risk channels through which (uncertainty) shocks propagate to the economy. When the equity risk-premium channel dominates the precautionary-saving one, the variety effect implies deeper uncertainty-driven recessions. However, the relative importance and amplification of these channels depend on the source of perturbation. |
| Keywords: | Product variety; Firm entry and exit; Uncertainty shocks; Risk premia; Precautionary savings |
| JEL: | E21 E32 G12 |
| Date: | 2026–02 |
| URL: | https://d.repec.org/n?u=RePEc:cpr:ceprdp:21112 |
| By: | D. Sonedda; M. Matranga; G. Vernasca; M. Rossi; F. Figari |
| Abstract: | We study the interaction between need- and merit-based university grants in a non-selective higher education system. Using administrative data from a northern Italian university, we analyse how eligibility criteria affect enrolment, academic performance, and labour market outcomes. We document a trade-off between the two criteria, with merit requirements acting as endogenous screening. We rationalise this trade-off with a three-period model predicting that merit thresholds increase effort among students with higher expected ability but may discourage effort among students at risk of falling short, as losing the grant reduces expected utility. We support these predictions using a difference-in-differences estimator for multiple treatments, separately analysing students switching into and out of need- and merit-based eligibility. Our results show that grants target disadvantaged but academically strong students, generate perverse incentive effects that vary by gender, and fail to retain a substantial share of initial recipients. |
| Keywords: | University Grants, Educational Outcomes, Non-selective higher education |
| JEL: | I22 I23 J24 |
| Date: | 2026 |
| URL: | https://d.repec.org/n?u=RePEc:cns:cnscwp:202611 |
| By: | Mingyang Liu; Gabriele Farina; Asuman Ozdaglar |
| Abstract: | Nash equilibrium (NE) arises from selfish utility maximization, yet its social welfare can be arbitrarily far from optimal. Moreover, computing an NE is intractable in general. We study augmented game models in which players use budget-balanced internal transfers to improve incentives before play. We first introduce \emph{Self-Enforcing Transfer Equilibrium} (SETE), where players commit to nonnegative peer-to-peer transfers that are paid only if the recipient does not deviate from a prescribed strategy. For polymatrix games, we show that every stationary point of the social welfare function, in particular any socially optimal strategy profile, can be sustained as a SETE. This induces a Nash equilibrium in the agent normal form of the corresponding augmented game. We further propose a polynomial-time algorithm and a decentralized learning dynamic to compute such product-form equilibria. We then introduce \emph{Mediated Self-Enforcing Transfer Equilibrium} (M-SETE), where a mediator makes both the payment schedule and the prescribed strategies binding offers. This additional enforcement resolves the agent-normal-form limitation: an M-SETE is a Nash equilibrium of the augmented game itself, not merely of its agent normal form, and any socially optimal strategy profile can be supported as an M-SETE in any finite game while preserving budget balance. Thus, internal transfers improve welfare and computation while preserving independent play on the equilibrium path. When full sequential-game stability is required, binding mediation provides the corresponding implementation. |
| Date: | 2026–06 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2606.20960 |
| By: | Bram van Os (Vrije Universiteit Amsterdam); Rasmus Lönn (Erasmus University Rotterdam); Dick van Dijk (Erasmus University Rotterdam) |
| Abstract: | We put forward a Dynamic Regularized Parametric (DRP) approach for active portfolio policies. We build upon the parametric policy framework of Brandt, Santa-Clara and Valkanov (2009) that directly links the portfolio weights to a limited set of asset characteristics. This yields a parsimonious specification that avoids modeling the joint distribution of returns, and as such remains applicable for large asset universes. We relax the assumption that policy coefficients are constant over time, to accommodate that the relevance of specific characteristics for future asset performance may vary. Dynamic policy coefficients are obtained by maximizing the conditional expected utility for each time period, with transaction costs being limited through a trading regularization. This regularized optimization problem results in an elegant filter to update the policy coefficients, balancing between adapting to valuable new, yet inherently noisy, information and providing a stable strategy that avoids costly rebalancing. We demonstrate that for a mean-variance utility investor, our framework yields an intuitive analytical solution. In an empirical application using the full universe of stocks from the NYSE, AMEX and Nasdaq, we find that the DRP approach produces substantial gains in out-of-sample portfolio performance, where both incorporating dynamics and regularization are important to achieve this. |
| Keywords: | Asset allocation, Parametric policies, Trading costs, Regularization |
| JEL: | C55 G11 |
| Date: | 2026–01–21 |
| URL: | https://d.repec.org/n?u=RePEc:tin:wpaper:20260004 |
| By: | Chari, Anusha; Dilts Stedman, Karlye; Lundblad, Christian |
| Abstract: | This paper defines risk-on risk-off (RORO), an elusive terminology in pervasive use, as the variation in global investor risk aversion. Our high-frequency RORO index captures time-varying investor risk appetite across multiple dimensions: advanced economy credit risk, equity market volatility, funding conditions, and currency dynamics. The index exhibits risk-off skewness and pronounced fat tails, suggesting its amplifying potential for extreme, destabilizing events. Compared with the conventional VIX measure, the RORO index reflects the multifaceted nature of risk, underscoring the diverse provenance of investor risk sentiment. Practical applications of the RORO index highlight its significance for international portfolio reallocation and return predictability. |
| Keywords: | Risk-on Risk-off; Global investor risk aversion; Extreme events; Tail risk; Return predictability |
| JEL: | F21 F36 F65 G11 G12 G15 G23 |
| Date: | 2025–12 |
| URL: | https://d.repec.org/n?u=RePEc:cpr:ceprdp:20932 |
| By: | Kengo NUTAHARA |
| Abstract: | This paper compares alternative ways of modeling money illusion in New Keynesian frameworks. We examine nominal consumption in utility, real-wage misperception, and inflation misperception under labor-augmenting technological growth. The first two approaches generally introduce direct dependence on the price level or require additional preference normalizations to preserve the benchmark balanced-growth path. Modeling money illusion as misperception of current and expected inflation preserves the standard growth structure while generating wedges in labor supply and intertemporal demand. Inflation misperception provides a tractable benchmark for future quantitative macroeconomic analysis. |
| Date: | 2026–07 |
| URL: | https://d.repec.org/n?u=RePEc:cnn:wpaper:26-009e |
| By: | Yilong Xu; Maarten Boksem; Charles N. Noussair; Stefan T. Trautmann; Gijs van de Kuilen; Alan Sanfey |
| Abstract: | In theory, individuals\' higher order risk attitudes of prudence and temperance influence saving and investment decisions. Prudent individuals save more when their future income becomes more uncertain, and temperate individuals prefer less risky investments in the presence of greater background risks. In a controlled experiment, we measure individuals' higher order risk attitudes directly, using two different elicitation methods. Participants then make saving and investment decisions under varying levels of background risk. We find strong effects of background risk on saving and investment. Moreover, individual prudence measures correlate with the strength of precautionary saving, while individual temperance measures do not do so with investment. The risk attitudes acquired with the two elicitation methods are strongly correlated with each other. The representative individual is risk averse and prudent, and neutral towards temperance. |
| Keywords: | high-order risks, precautionary saving, portfolio choice, risky decision-making |
| JEL: | C91 D15 D81 E21 E22 G51 |
| Date: | 2025–10 |
| URL: | https://d.repec.org/n?u=RePEc:exc:wpaper:2025-04 |
| By: | Shawn Berry |
| Abstract: | Deciding where to live involves a complex balance between commuting and moving, as households must weigh housing affordability, transportation expenses, access to workplaces, and social ties. Traditional urban economic theories focus on the balance between housing expenses and commuting costs, while modern studies also consider housing affordability, transportation access, and utility maximization. However, few studies have combined these elements into a clear mathematical model that can be used for both policy analysis and household decision-making. This paper introduces an algebraic model for deciding whether to commute or move, expanding on traditional residential location theories by including direct housing and commuting expenses, income-related affordability limits, indirect social and service access costs, and location-based utility within a single utility-maximization framework. The model uses the common 30% housing affordability rule as a constraint, acknowledging that residential choices are also shaped by social networks, access to institutions, neighborhood ties, and quality-of-life factors. The decision rule derived from the model integrates direct financial costs with weighted social benefits and indirect access costs to assess when moving offers more overall utility than staying put and commuting. Unlike complex discrete-choice, nested-logit, or agent-based models, this framework offers a mathematically clear, understandable, and flexible decision model that can easily be expanded to include more household characteristics, transportation options, or policy factors. The model advances urban economics, migration studies, and housing affordability research by providing a practical analytical tool for assessing residential mobility decisions within financial and behavioral limits. |
| Date: | 2026–06 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2606.31780 |
| By: | Dannin J. Eccles; Roger Lee |
| Abstract: | We consider a class of partial-information portfolio optimization problems in which the drift of a risky asset is driven by two latent stochastic factors evolving at distinct time scales. We show that the filtered estimate of the latent mean-reversion level is driven by the difference between fast and slow exponential moving average (EMA)-type processes of the trailing price history, yielding a Moving Average Convergence Divergence (MACD)-type signal, along with a deterministic Volterra correction. Under logarithmic, power, and exponential utility, we derive candidate optimal strategies in explicit feedback form and establish admissibility and verification results. In particular, the results provide a mathematical foundation for the endogenous emergence of MACD-type trading signals as estimators of latent drift information contained in observed price paths. |
| Date: | 2026–07 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2607.01705 |
| By: | Masaaki Fujii (Graduate School of Economics, The University of Tokyo) |
| Abstract: | This work solves the equilibrium price formation problem for the risky stock by combining mean-field game theory with the binomial tree framework, adapting the classic approach of Cox, Ross & Rubinstein. For agents with exponential and recursive utilities of exponential-type, we prove the existence of a unique mean-field market-clearing equilibrium and derive an explicit analytic formula for equilibrium transition probabilities of the stock price on the binomial lattice. The agents face stochastic terminal liabilities and incremental endowments that depend on unhedgeable common and idiosyncratic factors, in addition to the stock price path. We also incorporate an external order ow. Furthermore, the analytic tractability of the proposed approach allows us to extend the framework in two important directions: First, we incorporate multi-population heterogeneity, allowing agents to differ in functional forms for their liabilities, endowments, and risk coefficients. Second, we relax the rational expectations hypothesis by modeling agents operating under subjective probability measures which induce stochastically biased views on the stock transition probabilities. Our numerical examples illustrate the qualitative effects of these components on the equilibrium price distribution. |
| Date: | 2026–07 |
| URL: | https://d.repec.org/n?u=RePEc:cfi:fseres:cf630 |