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on Utility Models and Prospect Theory |
| By: | Min Dai; Yuchao Dong; Yanwei Jia; Xun Yu Zhou |
| Abstract: | The classical Merton investment problem predicts deterministic, state-dependent portfolio rules; however, laboratory and field evidence suggests that individuals often prefer randomized decisions leading to stochastic and noisy choices. Fudenberg et al. (2015) develop the additive perturbed utility theory to explain the preference for randomization in the static setting, which, however, becomes ill-posed or intractable in the dynamic setting. We introduce the recursive perturbed utility (RPU), a special stochastic differential utility that incorporates an entropy-based preference for randomization into a recursive aggregator. RPU endogenizes the intertemporal trade-off between utilities from randomization and bequest via a discounting term dependent on past accumulated randomization, thereby avoiding excessive randomization and yielding a well-posed problem. In a general Markovian incomplete market with CRRA preferences, we prove that the RPU-optimal portfolio policy (in terms of the risk exposure ratio) is Gaussian and can be expressed in closed form, independent of wealth. Its variance is inversely proportional to risk aversion and stock volatility, while its mean is based on the solution to a partial differential equation. Moreover, the mean is the sum of a myopic term and an intertemporal hedging term (against market incompleteness) that intertwines with policy randomization. Finally, we carry out an asymptotic expansion in terms of the perturbed utility weight to show that the optimal mean policy deviates from the classical Merton policy at first order, while the associated relative wealth loss is of a higher order, quantifying the financial cost of the preference for randomization. |
| Date: | 2026–02 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2602.13544 |
| By: | Oumar Mbodji |
| Abstract: | We study the Merton portfolio management problem within a complete market, non constant time discount rate and general utility framework. The non constant discount rate introduces time inconsistency which can be solved by introducing sub game perfect strategies. Under some asymptotic assumptions on the utility function, we show that the subgame perfect strategy is the same as the optimal strategy, provided the discount rate is replaced by the utility weighted discount rate $\rho(t, x)$ that depends on the time $t$ and wealth level $x$. A fixed point iteration is used to find $\rho$. The consumption to wealth ratio and the investment to wealth ratio are given in feedback form as functions of the value function. |
| Date: | 2026–02 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2602.18157 |
| By: | Miguel C. Herculano |
| Abstract: | Parametric Portfolio Policies (PPP) estimate optimal portfolio weights directly as functions of observable signals by maximizing expected utility, bypassing the need to model asset returns and covariances. However, PPP ignores policy risk. We show that this is consequential, leading to an overstatement of expected utility and an understatement of portfolio risk. We develop Bayesian Parametric Portfolio Policies (BPPP), which place a prior on policy coefficients thereby correcting the decision rule. We derive a general result showing that the utility gap between PPP and BPPP is strictly positive and proportional to posterior parameter uncertainty and signal magnitude. Under a mean--variance approximation, this correction appears as an additional estimation-risk term in portfolio variance, implying that PPP overexposes when signals are strongest and when risk aversion is high. Empirically, in a high-dimensional setting with 242 signals and six factors over 1973--2023, BPPP delivers higher Sharpe ratios, substantially lower turnover, larger investor welfare, and lower tail risk, with advantages that increase monotonically in risk aversion and are strongest during crisis episodes. |
| Date: | 2026–02 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2602.21173 |
| By: | Joseph Root; Evan Sadler |
| Abstract: | We demonstrate that a ubiquitous feature of network games, bilateral strategic interactions, is equivalent to having player utilities that are additively separable across opponents. We distinguish two formal notions of bilateral strategic interactions. Opponent independence means that player i's preferences over opponent j's action do not depend on what other opponents do. Strategic independence means that how opponent j's choice influences i's preference between any two actions does not depend on what other opponents do. If i's preferences jointly satisfy both conditions, then we can represent her preferences over strategy profiles using an additively separable utility. If i's preferences satisfy only strategic independence, then we can still represent her preferences over just her own actions using an additively separable utility. Common utilities based on a linear aggregate of opponent actions satisfy strategic independence and are therefore strategically equivalent to additively separable utilities--in fact, we can assume a utility that is linear in opponent actions. |
| Date: | 2026–02 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2602.16071 |
| By: | Fujio Takata (Graduate School of Economics, Kobe University) |
| Abstract: | This paper deals with a dynamic portfolio with dividends. The portfolio consists of a risky asset and a safe one. Investors initially buy the portfolio and enjoy their consumption based on the dividends over time. During their lifetime, they reinvest the funds after the dividends are paid. In short, investors adopt a strategy of buying and holding. They decide on a portfolio and the dividend rate to maximize their utility in every period, in a series of separate decisions. In this situation, there seems to be a tradeoff between dividends and reinvestment, to the possible detriment of the portfolio. Thus, we focus on establishing an optimal path for dividends. JEL Classification: G-11; G-12; G-23; G-32. |
| Keywords: | CRRA type utility function, Dividend, Ito's lemma, Portfolio choice. |
| Date: | 2026–02 |
| URL: | https://d.repec.org/n?u=RePEc:koe:wpaper:2601 |
| By: | Maria Andraos; Mario Ghossoub |
| Abstract: | We study a monopolistic insurance market with hidden information, where the agent's type $\theta$ is private information that is unobservable to the insurer, and it is drawn from a continuum of types. The hidden type affects both the loss distribution and the risk attitude of the agent. Within this framework, we show that a menu of contracts is incentive efficient if and only if it maximizes social welfare, subject to incentive compatibility and individual rationality constraints. This equivalence holds for general concave utility functionals. In the special case of Yaari Dual Utility, we provide a semi-explicit characterization of optimal incentive-efficient menus of contracts. We do this under two different settings: (i) the first assumes that types are ordered in a way such that larger values of $\theta$ correspond to more risk-averse types who face stochastically larger losses; whereas (ii) the second assumes that larger values of $\theta$ correspond to less risk-averse types who face stochastically larger losses. In both settings, the structure of optimal incentive-efficient menus of contracts depends on the level of the social welfare weight. Moreover, at the optimum, higher types receive greater coverage in exchange for higher premia. Additionally, optimal menus leave the lowest type indifferent, with the insurer absorbing all surplus from the lowest type; and they exhibit efficiency at the top, that is, the highest type receives full coverage. |
| Date: | 2026–02 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2602.09967 |
| By: | Simon Finster; Paul W. Goldberg; Edwin Lock; Matilde Tullii |
| Abstract: | We explore stability and fairness considerations in decentralized networked markets with bilateral contracts, building on the trading networks framework [Hatfield et al., 2013]. In our trading network game, we show that a well-defined subset of Nash equilibria can be supported as competitive equilibria. Considering an offer-based trading dynamic as well as a stochastic price clock market, we prove new convergence results to Nash equilibrium and competitive equilibrium, providing a rationale for stability properties in decentralized, dynamic trading networks. Turning to the tension between fairness and (core) stability, we prove several negative results: inessential agents always receive zero utility in any core outcome, and even essential agents can get zero utility in all core outcomes. |
| Date: | 2026–02 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2602.20868 |
| By: | Maria Andraos; Mario Ghossoub; Bin Li; Benxuan Shi |
| Abstract: | We study Stackelberg Equilibria (Bowley optima) in a monopolistic centralized sequential-move insurance market, with a profit-maximizing insurer who sets premia using a distortion premium principle, and a single policyholder who seeks to minimize a distortion risk measure. We show that equilibria are characterized as follows: In equilibrium, the optimal indemnity function exhibits a layer-type structure, providing full insurance over any loss layer on which the policyholder is more pessimistic than the insurer's pricing functional about tail losses; and no insurance coverage over loss layers on which the policyholder is less pessimistic than the insurer's pricing functional about tail losses. In equilibrium, the optimal pricing distortion function is determined by the policyholder's degree of risk aversion, whereby prices never exceed the policyholder's marginal willingness to insure tail losses. Moreover, we show that both the insurance coverage and the insurer's expected profit increase with the policyholder's degree of risk aversion. Additionally, and echoing recent work in the literature, we show that equilibrium contracts are Pareto efficient, but they do not induce a welfare gain to the policyholder. Conversely, any Pareto-optimal contract that leaves no welfare gain to the policyholder can be obtained as an equilibrium contract. Finally, we consider a few examples of interest that recover some existing results in the literature as special cases of our analysis. |
| Date: | 2026–02 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2602.16401 |
| By: | Athanasakis, Kostas; Loupas, Marios Athanasios; Kyriopoulos, Ilias |
| Abstract: | Objectives Health Technology Assessment (HTA) is a cornerstone of evidence-based decision-making in healthcare, with Economic Evaluation (EE) constituting an integral part of this process. A key methodological parameter in EEs is the discount rate, which allows for consistent valuation of future costs and benefits. In this study, we use Greece as a case study to provide an empirically grounded estimation of a country-specific social discount rate (SDR), combining international best practices with national economic conditions, projections and societal preferences. Methods For the analysis, we employ the Social Rate of Time Preference framework via an extended version of the Ramsey formula. The model parameters, i.e. pure rate of time preference, elasticity of marginal utility of consumption, expected per capita consumption growth, and the variance of consumption growth, were estimated based on national datasets on mortality, taxation, GDP growth, and demographic trends. The base-case estimate of the SDR was tested for robustness through a series of one-way sensitivity analyses (OWSA). Results The base-case estimate for the SDR in Greece was estimated at 3.42%. The OWSA revealed that the SDR was mostly influenced by variations in expected per capita consumption growth and pure rate of time preference. Conclusion This study provides an empirically grounded estimate of a country-specific social discount rate for Greece. The estimated value, lies well within interanationally used values in EEs. Our analysis underlines the importance of macroeconomic evidence and trends and highlights the need of future/periodic reassessments of the SDR to maintain alignment with economic and societal changes. |
| Keywords: | social discount rate; social rate of time preference; economic evaluation; health technology assessment; Greece; health policy; Health policy; Health technology assessment; Social discount rate; Economic evaluation; Social rate of time preference |
| JEL: | N0 |
| Date: | 2026–04–30 |
| URL: | https://d.repec.org/n?u=RePEc:ehl:lserod:137388 |
| By: | Mario Ayala; Benjamin Vallejo Jim\'enez |
| Abstract: | We revisit the classical Merton consumption--investment problem when risky-asset returns are modeled by stochastic differential equations interpreted through a general $\alpha$-integral, interpolating between It\^{o}, Stratonovich, and related conventions. Holding preferences and the investment opportunity set fixed, changing the noise interpretation modifies the effective drift of asset returns in a systematic way. For logarithmic utility and constant volatilities, we derive closed-form optimal policies in a market with $n$ risky assets: optimal consumption remains a fixed fraction of wealth, while optimal portfolio weights are shifted according to $\theta_\alpha^\ast = V^{-1}(\mu-r\mathbf{1})+\alpha\, V^{-1}\operatorname{diag}(V)\mathbf{1}$, where $V$ is the return covariance matrix and $\operatorname{diag}(V)$ denotes the diagonal matrix with the same diagonal as $V$. In the single-asset case this reduces to $\theta_\alpha^\ast=(\mu-r)/\sigma^{2}+\alpha$. We then show that genuinely state-dependent effects arise when asset volatility is driven by a stochastic factor correlated with returns. In this setting, the $\alpha$-interpretation generates an additional drift correction proportional to the instantaneous covariation between factor and return noise. As a canonical example, we analyze a Heston stochastic volatility model, where the resulting optimal risky exposure depends inversely on the current variance level. |
| Date: | 2026–02 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2602.08527 |
| By: | Pasha Andreyanov; Ilia Krasikov; Alex Suzdaltsev |
| Abstract: | We study independent private values auction environments in which the auctioneer's revenue depends nonlinearly on bidders' interim winning probabilities. Our framework accommodates heterogeneity among bidders and places no ad hoc constraints on the mechanisms available to the auctioneer. Within this general setting, we show that feasibility of interim winning probabilities can be tested along a unidimensional curve -- the principal curve -- and use this insight to explicitly characterize the extreme points of the feasible set. We then combine our results on feasibility and extremality to solve for the optimal auction under a natural regularity condition. We show that the optimal mechanism allocates the good based on principal virtual values, which extend Myerson's virtual values to nonlinear settings and are constructed to equalize bidders' marginal revenue along the principal curve. We apply our approach to the classical linear model, settings with endogenous valuations due to ex ante investments, and settings with non-expected utility preferences, where previous results were largely limited either to symmetric environments with symmetric allocations or to two-bidder environments. |
| Date: | 2026–02 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2602.17812 |
| By: | Kitamura, Kazuhito |
| Abstract: | This paper deepens the "Equilibrium Theory Endogenizing Imbalances" based on asset dynamics, as presented in the previous study (Kitamura, 2025), by incorporating concepts from thermodynamics and statistical mechanics. The objective is to bridge to a qualitative theory of development, encompassing issues such as the sustainability of economic growth and the creation of innovation. While the previous work proposed a model where imbalances are perpetuated through asset preference and capital diffusion, this study extends the framework into a model where "effective asset potential"—defined as the asset level divided by the rate of return on assets—acts as the driving force behind capital flows. It demonstrates a mechanism in which the capital efficiency of each nation significantly determines its economic trajectory. Consequently, this paper reveals that individual economies exist under a tension between "subjective equilibrium" aimed at utility maximization, and the "pressure of entropy increase" inherent in asset dynamics. Through observations using multilateral data, the global economy has polarized into "self-organizing economies" that concentrate and accumulate capital, and "diffusive economies" that primarily disperse and dissipate capital. This paper presents a novel perspective that views the global economy as a "dissipative structure" maintained through the interdependence of these distinct phases. Based on this analysis, the paper argues that for an economic system to remain sustainable, it is essential to maintain the gradient of asset potential within the system properly by eliminating "stagnation" through innovation and redistribution policies. Ultimately, this paper proposes that what economics terms "equilibrium" is equivalent to "thermal death" in physics; therefore, the goal of economics should be the avoidance rather than the realization of such a state, making the perspective of "entropy management". |
| Keywords: | Asset Dynamics; Economic Entropy; Effective Asset Potential; Coefficient of Capital Satiation; Dissipative Structure |
| JEL: | A10 C50 E00 F00 O10 R10 |
| Date: | 2026–02–01 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:127971 |