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on Utility Models and Prospect Theory |
| By: | Konstantinos Georgalos; Nathan Nabil |
| Abstract: | In an attempt to elucidate the classic violations of expected utility theory, the behavioural economics literature heavily relies on the influential work of Tversky and Kahneman (1992), specifically the Cumulative Prospect Theory (CPT) model and the Heuristics-and-Biases program. While both approaches have significantly contributed to our understanding of decision-making under uncertainty, empirical evidence remains inconclusive. In this study, we investigate the performance of each approach across a wide range of choice environments and increasing cognitive load, encompassing gains, losses, time pressure, and complexity. Utilising data from various studies and employing Bayesian inference, we assess the performance of CPT in comparison to an adaptive cognitive toolbox model of heuristics. For subjects classified as toolbox decision makers, we examine the content (i.e., which heuristics) and the size of the toolbox (i.e., how many heuristics). Our findings reveal that as the choice environment objectively increases in complexity, individuals transition from using sophisticated expectation-based utility models to relying on a set of simplification heuristics for decision-making. We quantify the relationship between toolbox usage and complexity, showing a significant and positive correlation between the two. Furthermore, our results indicate that as task complexity rises, individuals tend to employ smaller toolboxes with fewer heuristics for decision-making. |
| Keywords: | Complexity, Toolbox models, Heuristics, Risky choice, Bayesian modelling |
| JEL: | C91 D81 D91 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:lan:wpaper:400814162&r=upt |
| By: | Romain Fillon (CIRED - Centre International de Recherche sur l'Environnement et le Développement - Cirad - Centre de Coopération Internationale en Recherche Agronomique pour le Développement - EHESS - École des hautes études en sciences sociales - AgroParisTech - ENPC - École des Ponts ParisTech - Université Paris-Saclay - CNRS - Centre National de la Recherche Scientifique, UMR PSAE - Paris-Saclay Applied Economics - AgroParisTech - Université Paris-Saclay - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement); Céline Guivarch (CIRED - Centre International de Recherche sur l'Environnement et le Développement - Cirad - Centre de Coopération Internationale en Recherche Agronomique pour le Développement - EHESS - École des hautes études en sciences sociales - AgroParisTech - ENPC - École des Ponts ParisTech - Université Paris-Saclay - CNRS - Centre National de la Recherche Scientifique); Nicolas Taconet (CIRED - Centre International de Recherche sur l'Environnement et le Développement - Cirad - Centre de Coopération Internationale en Recherche Agronomique pour le Développement - EHESS - École des hautes études en sciences sociales - AgroParisTech - ENPC - École des Ponts ParisTech - Université Paris-Saclay - CNRS - Centre National de la Recherche Scientifique, TU - Technical University of Berlin / Technische Universität Berlin, PIK - Potsdam Institute for Climate Impact Research) |
| Abstract: | We investigate the implications of absolute risk aversion with respect to intertemporal utility, i.e. temporal risk aversion, in the presence of a stylized climate tipping risk affecting productivity irreversibly. Optimal climate policy is more stringent under temporal risk aversion, in order to reduce all present and future probabilities of crossing the tipping point and avoid a situation where all generations are badly off. Temporal risk aversion implies a 30% increase in the social cost of carbon (SCC) under our benchmark calibration and for a 10% irreversible increase in the level of economic damage from climate change. The optimal SCC under temporal risk aversion increases sharply with the level of damage brought by a potential tipping point. |
| Keywords: | Stochastic climate-economy modeling, Risk-sensitive recursive preferences, Environmental policy, Risk aversion, Environmental Economics, Climate change |
| Date: | 2023–09 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-04250702&r=upt |
| By: | Ian Jewitt; Daniel Quigley |
| Abstract: | We consider a class of persuasion games in which the sender has rank-dependent (Yaari (1987)) preferences. Like much of the recent Bayesian persuasion literature, we allow the sender to choose from a rich set of information structures and assume the receiver’s action depends only on her posterior expectation of a scalar state variable. Conjugate to the standard problem, our sender’s utility is linear in posterior the mean, but may be nonlinear in probabilities. We geometrically characterize the sender’s optimal commitment payoff and identify the corresponding optimal information structure. When the state is continuously distributed, communication takes a monotone partitional form. Our characterization admits a simple analysis of comparative statics—for instance, we find that “grading on a curve” is a feature of optimal design. Finally, we apply our analysis to several problems of economic interest including information design in auctions and elections, as well as the design of equilibrium insurance contracts in the face of the ‘favorite-longshot’ bias. |
| Date: | 2023–08–16 |
| URL: | http://d.repec.org/n?u=RePEc:oxf:wpaper:1022&r=upt |
| By: | Ponthiere, Gregory |
| Abstract: | Welfare States do not insure citizens against the risk of premature death, i.e., the risk of having a short life. Using a dynamic OLG model with risky lifetime, this paper compares two insurance devices reducing well-being volatility due to the risk of early death: (i) an ante-mortem age-based statistical discrimination policy that consists of an allowance given to all young adults (including the unidentified adults who will die early); (ii) a post-mortem subsidy on accidental bequests due to early death. Each policy is financed by taxing old-age consumption. Whereas each device can yield full insurance, the youth allowance is shown to imply a higher lifetime well-being at the stationary equilibrium. The marginal utility of consumption exceeding the marginal utility of giving when being dead, the youth allowances system is, despite imperfect targeting, a more effi cient mechanism of insurance against the risk of early death. |
| Keywords: | premature death, mortality risk, social insurance, inheritance, lifecycle models |
| JEL: | J10 J17 I31 E21 H55 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:glodps:1342&r=upt |
| By: | Bursztyn, Leonardo; Handel, Benjamin R.; Jiménez Durán, Rafael; Roth, Christopher |
| Abstract: | Individuals might experience negative utility from not consuming a popular product. For example, being inactive on social media can lead to social exclusion or not owning luxury brands can be associated with having a low social status. We show that, in the presence of such spillovers to non-users, standard measures that take aggregate consumption as given fail to appropriately capture welfare. We propose a new methodology to measure welfare that accounts for these consumption spillovers, which we apply to estimate the consumer surplus of two popular social media platforms, TikTok and Instagram. In large-scale, incentivized experiments with college students, we show that, while the standard welfare measure suggests a large and positive surplus, our measure accounting for consumption spillovers indicates a negative surplus, with a large share of active users deriving negative utility. We also shed light on the drivers of consumption spillovers to non-users in the case of social media and show that, in this setting, the "fear of missing out" plays an important role. Our framework and estimates highlight the possibility of product market traps, where large shares of consumers are trapped in an inefficient equilibrium and would prefer the product not to exist. |
| JEL: | D62 D91 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cbscwp:279570&r=upt |
| By: | Fehr, Ernst (University of Zurich); Epper, Thomas (CNRS); Senn, Julien (University of Zurich) |
| Abstract: | Parsimony is a desirable feature of economic models but almost all human behaviors are characterized by vast individual variation that appears to defy parsimony. How much parsimony do we need to give up to capture the fundamental aspects of a population's distributional preferences and to maintain high predictive ability? Using a Bayesian nonparametric clustering method that makes the trade-off between parsimony and descriptive accuracy explicit, we show that three preference types - an inequality averse, an altruistic and a predominantly selfish type - capture the essence of behavioral heterogeneity. These types independently emerge in four different data sets and are strikingly stable over time. They predict out-of-sample behavior equally well as a model that permits all individuals to differ and substantially better than a representative agent model and a state-of-the-art machine learning algorithm. Thus, a parsimonious model with three stable types captures key characteristics of distributional preferences and has excellent predictive power. |
| Keywords: | distributional preferences, altruism, inequality aversion, preference heterogeneity, stability, out-of-sample prediction, parsimony, Bayesian nonparametrics |
| JEL: | D31 D63 C49 C90 |
| Date: | 2023–10 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp16535&r=upt |
| By: | Konstantinos Georgalos; Nathan Nabil |
| Abstract: | In this paper we aim to investigate how the complexity of a decision-task may change an agents strategic behaviour as a result of increased cognitive fatigue. In this framework, complexity is defined as a function of the number of outcomes in a lottery. Using Bayesian inference techniques, we quantitatively specify and estimate adaptive toolbox models of cognition, which we rigorously test against popular expectation based models; modified to account for complexity aversion. We find that for the majority of the subjects, a toolbox model performs best both in-sample, and with regards to its predictive capacity out-of-sample, suggesting that individuals result to heuristics when the complexity of a task overwhelms their cognitive load. |
| Keywords: | Complexity aversion, Toolbox models, Heuristics, Risky choice, Bayesian modelling |
| JEL: | C91 D91 D81 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:lan:wpaper:400814269&r=upt |
| By: | Christos Genakos; Costas Roumanias; Tommaso Valletti |
| Abstract: | We present novel evidence from a large panel of UK consumers who receive personalized reminders from a specialist price-comparison website about the precise amount they could save by switching to their best-suited alternative mobile telephony plan. We document three phenomena. First, even self-registered consumers with positive savings exhibit inertia. Second, we show that being informed about potential savings has a positive and significant effect on switching. Third, controlling for savings, the effect of incurring overage payments is significant and similar in magnitude to the effect of savings: paying an amount that exceeds the recurrent monthly fee weighs more on the switching decision than being informed that one can save that same amount by switching to a less inclusive plan. We interpret this asymmetric reaction on switching behavior as potential evidence of loss aversion. In other words, when facing complex and recurrent tariff plan choices, consumers care about savings but also seem to be willing to pay upfront fees in order to get "peace of mind". |
| Keywords: | tariff plan choice, inertia, switching, loss aversion, mobile telephony |
| Date: | 2023–08–01 |
| URL: | http://d.repec.org/n?u=RePEc:cep:poidwp:079&r=upt |
| By: | Picard, Julien; Banerjee, Sanchayan |
| Abstract: | Fighting the climate crisis requires changing many aspects of our consumption habits. Previous studies show that a first climate-friendly action can lead to another. Does deciding not to eat meat increase our willingness to do more for the environment? Can encouraging vegetarianism alter this willingness? Using an online randomised control trial, we study the side effects of a social norm nudge promoting vegetarianism on environmental donations. We develop an experimental design to estimate these side effects and a utility maximisation framework to understand their mechanisms. Using an instrumental variable, we find that choosing not to eat meat increases donations to pro-environmental charities. We use machine learning to find that the social norm nudge crowds out donations from the population segment prone to choosing vegetarian food after seeing the nudge. However, the nudge led another group to make less carbon-intensive food choices without affecting their donations. Our results suggest that whilst social norm nudges are effective on specific population segments, they can also reduce the willingness of some groups to do more. |
| Keywords: | social norm; meat; climate change; behavioural spillovers; side effects |
| JEL: | C30 C93 D91 Z10 |
| Date: | 2023–09–13 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:120566&r=upt |
| By: | Tongseok Lim |
| Abstract: | Given the marginal distribution information of the underlying asset price at two future times $T_1$ and $T_2$, we consider the problem of determining a model-free upper bound on the price of a class of American options that must be exercised at either $T_1$ or $T_2$. The model uncertainty consistent with the given marginal information is described as the martingale optimal transport problem. We show that if the American option payoff satisfies a suitable convexity condition, then any option exercise scheme associated with any market model that jointly maximizes the expected option payoff must be nonrandomized. |
| Date: | 2023–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2310.14473&r=upt |
| By: | Marina Chugunova (Max Planck Institute for Innovation and Competition); Wolfgang Luhan (University of Portsmouth) |
| Abstract: | As technology-assisted decision-making is becoming more widespread, it is important to understand how the algorithmic nature of the decisionmaker affects how decisions are perceived by the affected people. We use a laboratory experiment to study the preference for human or algorithmic decision makers in re-distributive decisions. In particular, we consider whether algorithmic decision maker will be preferred because of its unbiasedness. Contrary to previous findings, the majority of participants (over 60%) prefer the algorithm as a decision maker over a human—but this is not driven by concerns over biased decisions. Yet, despite this preference, the decisions made by humans are regarded more favorably. Participants judge the decisions to be equally fair, but are nonetheless less satisfied with the AI decisions. Subjective ratings of the decisions are mainly driven by own material interests and fairness ideals. For the latter, players display remarkable flexibility: they tolerate any explainable deviation between the actual decision and their ideals, but react very strongly and negatively to redistribution decisions that do not fit any fairness ideals. Our results suggest that even in the realm of moral decisions algorithmic decision-makers might be preferred, but actual performance of the algorithm plays an important role in how the decisions are rated. |
| Keywords: | delegation; algorithm aversion; redistribution; fairness; |
| JEL: | C91 D31 D81 D9 O33 |
| Date: | 2023–10–24 |
| URL: | http://d.repec.org/n?u=RePEc:rco:dpaper:439&r=upt |
| By: | Timon Ivens; Carsten Lausberg |
| Abstract: | Most real estate decisions are multi-criteria by nature. The obvious means to support such decisions are multi-criteria models, developed in the field of operations research (OR) decades ago and applied in many industries ever since. But not in the real estate sector. Here, OR is still a foreign concept, confined to some exotic niches and academic circles. The aim of this paper is to demonstrate that mathematical decision models can be applied to practical real estate problems and can help to improve decision quality. We use OR for commercial portfolio transactions, which are particularly complex due to the exponential increase in the flow of information, which quickly exceeds the information processing capacity of humans. The research design follows a mixed-methods approach. Based on literature research and interviews with industry experts, a decision model using Analytical Hierarchy Process (AHP) and Elimination Et Choix Traduisant La Realité (ELECTRE) is designed to prioritise properties from a target portfolio. The model architecture includes measures to reduce human decision-making biases, which is a requirement of Behavioral Operations Research (BOR). Then, data from a medium-sized portfolio transaction in Germany is used to test the model. The result is a list of properties ranked in the order of their alignment with the investment objectives, offering an entirely rational solution. Debriefing interviews with the decision-makers support the assumption that this solution is superior to most bounded rational solutions, which were discussed during the acquisition process. |
| Keywords: | Behavioral Operations Research; Decision Support; Multi-criteria decision making; Real Estate Portfolio Transaction |
| JEL: | R3 |
| Date: | 2023–01–01 |
| URL: | http://d.repec.org/n?u=RePEc:arz:wpaper:eres2023_318&r=upt |
| By: | Uduakobong E. Akpan; Olusegun A. Ogunba; Timothy T. Ayodele |
| Abstract: | The study assessed the degree to which the traditional NPV captured the risk and uncertainty inherent in real estate development projects in Lagos, Nigeria, using case studies. This was with a view to enhancing real estate investment decision making in developing countries of Africa. Two commercial real estate developments were selected as case studies for the study. Probabilistic risk analysis models (risk adjusted discount rate and certainty equivalent models) were used to assess the risk inherent in the development projects while real option analysis (Samuelson Mckean Model) was used to test the effect of flexibility on the investments (uncertainty analysis). The methodology involved first carrying out an appraisal of the case studies using the traditional NPV. Thereafter, the appraisal outcomes of the NPV analysis were compared to outcomes using contemporary models (risk and uncertainty analysis). The findings of the study showed that the contemporary models - which were not much in use in the study area - provided much more profound investment advice for clients and a much more robust basis for client decision making than the traditional NPV model. The study concluded that contemporary models deserve to be in much more use in the developing economies of Africa. |
| Keywords: | Development appraisal; NPV; real option analysis; Risk Analysis |
| JEL: | R3 |
| Date: | 2023–01–01 |
| URL: | http://d.repec.org/n?u=RePEc:afr:wpaper:afres2023-026&r=upt |
| By: | Jose M. Betancourt |
| Abstract: | This paper presents new conditions under which the stationary distribution of a stochastic network formation process can be characterized in terms of a generating function. These conditions are given in terms of a transforming function between networks: if the total transformation between two networks is independent of how these networks transform into each other (by adding or deleting links), then the process is reversible and a generating function can be constructed. When the network formation process is given by discrete choices of link formation, this procedure is equivalent to proving that the game with the associated utilities is a potential game. This implies that the potential game characterization is related to reversibility and tractability of network formation processes. I then use the characterized stationary distribution to study long-run properties of simple models of homophilic dynamics and international trade. The effects of adding forward-looking agents and switching costs are also discussed. |
| Date: | 2023–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2310.10764&r=upt |