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on Utility Models and Prospect Theory |
| By: | Emma Kroell; Mogens Steffensen |
| Abstract: | We study an investor's optimal portfolio choice problem when they account for the impact of a possible future green transition, whose timing is uncertain. We model the green transition as a discontinuity in the stock price processes, driven by a single jump process with constant intensity, in which 'green' stocks increase in value and 'brown' stocks decrease in value. The investor is ambiguous about the timing of the green transition and designs an investment strategy which is robust to this risk. The investor has constant relative risk aversion preferences over both wealth and model ambiguity, which introduce a multiplicative ambiguity penalty for power utility and an additive ambiguity penalty for log utility. We separate the problem into pre- and post-transition cases, derive the solution, and provide a verification theorem. We further show that the log utility, ambiguity-neutral, and worst-case problems are obtained as special cases of our general problem. In a case study with one green and one brown stock, we show that when the stock prices are positively correlated, an investor who is aware of transition risk increases their investment in the green stock and reduces their investment in the brown stock, compared to when they ignore the possibility of a transition. We illustrate the difference between an ambiguity-averse and a risk-averse investor, and show how an ambiguity-averse investor re-allocates their portfolio as their view on the probability of a green transition changes. |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2610.33597 |
| By: | Jaehyun Kim; Hoi Ying Wong |
| Abstract: | Shortfall aversion describes a form of consumption habit formation in which an individual's utility depends on consumption relative to the historical consumption peak. This study develops a duality framework for a broad class of utility functions, with and without discounting, avoiding the need for determining the local optimality required by the HJB approaches commonly adopted in the literature. We show that shortfall aversion can instead be incorporated directly into the dual problem through a singular-control mechanism characterized by a variational inequality. Furthermore, we establish that the resulting value function strictly dominates those obtained in the existing literature while remaining attainable under an admissible optimal control. We demonstrate that the suboptimality of existing solutions stems from their myopic treatment of updates to the consumption peak, whereas our duality approach enlarges the admissible class to treat the consumption peak as a separate nondecreasing control and determines its optimal evolution through duality, accounting for future consumption opportunities. These results reveal a previously unrecognized advantage of the dual formulation and provide a more general and flexible framework for consumption optimization under shortfall aversion. |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2610.32350 |
| By: | Ayush Gupta |
| Abstract: | This paper studies decision problems where the decision maker’s choice of action affects the probability distribution of a payoff relevant random variable. We establish sufficient conditions for the existence of an expected utility maximizing action in such settings. The main requirement is a mild continuity condition on the family of possible distributions. We also show that this condition is a minimal requirement. Our result does not require common assumptions such as the monotone likelihood ratio property (MLRP) or the convexity of distribution functions condition (CDFC). It can therefore be used to prove the existence of an optimal action in many settings where existing results do not apply, including an important class of problems where the support of the random variable depends on the decision maker’s choice and the density functions are not pointwise continuous. |
| Keywords: | Endogenous uncertainty; u lity maximiza on; existence theorem |
| JEL: | D8 C6 |
| Date: | 2026–11 |
| URL: | https://d.repec.org/n?u=RePEc:bon:boncrc:crctr224_2025_794 |
| By: | Chengfeng Shen; Felix K\"{u}bler |
| Abstract: | We consider the Ramsey problem of optimal government policy and give examples where lotteries are essential for the optimal solution. When markets are complete and the representative agent's coefficient of relative prudence is bounded, lotteries are typically not optimal. For the incomplete markets case, we prove analytically that lotteries improve welfare for some calibrations with CRRA utility, and we give a simple numerical example for this claim. When the agent's coefficient of relative risk aversion is unbounded for small consumption, lotteries typically improve welfare and can be used to approximate the first-best solution arbitrarily well in both the complete and the incomplete markets cases. However, in the complete markets case, when debt constraints are not too tight and the representative agent is sufficiently patient, lotteries can be purified in the sense that there is a deterministic solution that gives the same value. |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2610.32681 |
| By: | Srikanth B. Pai (Assistant Professor at Madras School of Economics, Chennai.) |
| Abstract: | An opposite-order platform profile occurs when parties choose platforms in the opposite order from their ideal points. Such an outcome undermines the usual ideological interpretation of party competition: the party identified as left chooses the right-hand platform, while the party identified as right chooses the left-hand platform. We study a two-party ordinal spatial voting model in which voter and party preferences are single-peaked. Under full turnout, we show that single-peakedness alone rules out opposite-order equilibria. With endogenous abstention, we identify an additional ordinal condition: parties agree on how to rank deviations on either side of their ideal points. We call this cross-side agreement. Cardinal utilities that are commonly used in the literature, like symmetric single-peaked utilities and common translated utility shapes, satisfy this condition. Under single-peakedness and cross-side agreement, opposite-order equilibria are impossible even with abstention. The assumption is tight: we construct an example admitting a unique pure-strategy Nash equilibrium with opposite order in which cross-side agreement fails.Length: 17pages |
| Keywords: | spatial voting, electoral competition, abstention, single-peaked preferences, opposite order Classification-JEL: : D72, D71, C72 |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:mad:wpaper:2026-313 |
| By: | Nico Lombardi (Hanse-Wissenschaftskolleg - Institute for Advanced Study); Paolo Nerini (Department of Economics, European University Institute (EUI)); Vincenzo Platino (University of Naples Federico II and CSEF); Antonio Villanacci (University of Florence) |
| Abstract: | We consider a pure exchange economy with a finite number of commodities and households, in which preferences are affected by the welfare of others, measured in terms of wealth, and households are allowed to transfer resources to one another. Economies are described by endowments of commodities and utility functions. We establish generic regularity, that is, for an open and dense subset of economies, the set of equilibria is finite and each equilibrium admits a local differentiable representation as a function of the fundamentals. |
| Keywords: | Interdependent preferences, transfers, competitive equilibrium, regular economies. |
| JEL: | C62 D50 D51 D62 |
| Date: | 2026–10–17 |
| URL: | https://d.repec.org/n?u=RePEc:sef:csefwp:800 |
| By: | Gabri\"el M. J. Gelissen; Fengyi Yuan |
| Abstract: | We develop a data-driven approach to dynamic portfolio selection that combines vine-copula simulation with reinforcement learning. The investor has constant relative risk aversion and maximises expected terminal utility with a running penalty on the conditional value-at-risk (CVaR) of one-period losses. We estimate a conditional vine model from historical returns and use it to generate joint scenarios for CVaR evaluation and conditional paths for training a recurrent portfolio policy. Under uniform local derivative bounds, we propagate edgewise pair-copula parameter errors through the conditional transforms to obtain power-law stability bounds in Hellinger distance and total variation. In a finite-horizon investment model, we combine these estimates with a marginal and structural approximation budget to bound policy values, optimal values and the true-market loss of policies selected under a fitted model, with separate simulation and numerical optimisation terms. On a seven-asset panel comprising US and Chinese equities and gold, the selected ensemble of ten trained policies achieves a compound annual growth rate of 34.13% and a Sharpe ratio of 2.31 over 22 complete monthly holding periods, exceeding the corresponding values of six classical and vine-based benchmarks. Combining simulated and historical training data reduces monthly target-to-target turnover by 41.5% relative to training on historical data alone, while maintaining comparable growth. |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2610.20037 |
| By: | Olivier F\'eron; Ruben Haalebos |
| Abstract: | We study dynamic portfolio decarbonization under incomplete information about firms' carbon intensities and the underlying transition state. The investor maximizes expected utility of terminal wealth net of a penalty on perceived cumulative financed emissions. Asset returns and carbon intensities depend on a stochastic transition factor, while the investor may need to infer the current transition state, its long-run mean and firms' carbon intensities from market observations and periodic noisy disclosures. The optimal strategy combines a Merton-type component with climate-dependent expected-return adjustments, a direct carbon intensity penalty and intertemporal hedging demands associated with stochastic carbon intensities and learning. In a numerical application, incomplete information has limited effects on welfare and target satisfaction when prior beliefs are well specified. By contrast, biased beliefs generate welfare losses in either direction but asymmetric environmental consequences: optimistic and pessimistic beliefs induce opposite portfolio tilts and therefore affect the probability of exceeding the cumulative emissions target differently. |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2610.18332 |
| By: | Malte Kornemann (University of Bonn); Philipp Schirmer (Leibniz Institute for Financial Research SAFE) |
| Abstract: | Most economic decisions require aggregating multiple attributes into an overall evaluation. We develop and experimentally test a theory where aggregation is error-prone and, in response, attributes are weighted optimally given an environment of likely options. We characterize these decision weights, which generically differ from attributes’ impact on utility, and the bias they induce in choice. When attributes are independently distributed among likely options, higher-variance attributes are over-weighted, and this bias increases in the level of aggregation errors. We test the theory in an experiment by first manipulating between subjects which attribute varies more in choice options, and then comparing choices between options that are identical across subjects. Consistent with the model’s predictions, choice probabilities shift toward the option favored by the high-variance attribute, in our baseline treatments by about 10 percentage points. We also test the effect of aggregation complexity by lowering the number of attributes. Compared to the baseline, this reduces the shift in choice probabilities by about 72%. We apply our model to purchases where base and add-on prices may be displayed separately. A consumer reacts to a short-term change in the display as if it were a price change, while her reaction to a long-run change depends on the details of the environment. Consumer welfare is generally maximized by a fully aggregated price. |
| Keywords: | Aggregation errors, cognitive noise, multi-attribute choice, decision weights, complexity, adaptation |
| JEL: | C91 D01 D81 D91 |
| Date: | 2026–11 |
| URL: | https://d.repec.org/n?u=RePEc:ajk:ajkdps:442 |
| By: | Lisa Bruttel (University of Potsdam, Berlin School of Economics, CEPA) |
| Abstract: | This paper introduces a simple incentivized measure of individual attitudes towards strategic uncertainty. This measure is based on the idea that the size of the difference between the expected profit from playing a game and the value that an individual places on playing that game provides information about how much they like or dislike the strategic uncertainty involved. This measure explains trusting decisions in the trust game, where standard risk aversion measures have no explanatory power. Furthermore, it correlates across different games and predicts behavior associated with strategic uncertainty outside the laboratory. |
| Keywords: | strategic uncertainty, risk, trust, elicitation method, laboratory experiment |
| JEL: | C91 D81 D83 D91 |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:pot:cepadp:107 |
| By: | Alkhowaiter, Meshal |
| Abstract: | This paper develops a theoretical framework for understanding how minimum wage policies may create a “poverty trap” that reduces low-wage workers’ incentives to invest in human capital. While minimum wage increases provide immediate income benefits, beyond a certain threshold they diminish expected returns to education and training, thereby reducing occupational mobility. I formalize this relationship through a utility maximization model incorporating time discounting, opportunity costs, and uncertainty. The framework derives explicit conditions under which an inverted-U relationship emerges between minimum wage levels and human capital investment, including bounded skill premia, education affordability constraints, and wage-dependent present bias. Recent empirical work by Alessandrini and Milla (2024) provides partial support, finding minimum wage increases lead to higher community college enrollment but lower university enrollment, consistent with the model’s predictions. The analysis contributes to minimum wage policy debates by highlighting potential trade-offs between short-term income support and long-term economic mobility, suggesting complementary policies are needed. |
| Keywords: | human capital;minimum wage;occupational mobility;poverty trap;skill acquisition |
| JEL: | J24 J31 D91 |
| Date: | 2026–09–28 |
| URL: | https://d.repec.org/n?u=RePEc:ehl:lserod:141461 |
| By: | Andrey Itkin |
| Abstract: | We study a local stochastic volatility (LSV) model in which the variance factor follows a generalized Langevin equation (GLE) with colored noise, and past returns act on variance through a memory kernel with state-dependent amplitudes. For kernels given by finite sums of exponentials, we prove existence, uniqueness, and non-explosion under a growth condition linking the volatility map to the potential. In a one-mode family with a polynomial potential, feedback through log returns can cause explosion exactly when the squared volatility factor grows faster than the restoring force. Under structural and nondegeneracy conditions, an exact reduced Markovian state has a smooth density solving a deterministic forward equation. The Dupire conditional expectation therefore requires no stochastic partial differential equation. Under a bounded Sharpe ratio, exponential utility selects the minimal entropy martingale measure, whose premium solves a quadratic backward stochastic differential equation. Under a regularity hypothesis, which we verify in special cases with and without leverage, the premium depends only on the current state, and the squared VIX equals the expected average future local stochastic variance. Finally, a regularized calibration problem with bid--ask constraints admits a minimizer whenever a feasible point has finite objective value. |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2610.18706 |
| By: | Selman Erol (Carnegie-Mellon University); Rakesh V. Vohra (University of Pennsylvania) |
| Abstract: | Confidence and conformal sets are used to inform decisions. To employ them, a decision maker must give it a probabilistic interpretation, and that interpretation determines an ambiguity set: the probability distributions over states she regards as possible. This paper characterizes when a proffered confidence/conformal set admits a coherent probabilistic interpretation, a property we call rationalizability. We then study decision making over a rationalizable confidence/conformal set. A common practice assigns zero probability to states outside the proffered set. This replaces the original coverage requirement with one that can become incompatible with additional probabilistic information. The rationalizable set, however, preserves the original guarantee and remains compatible with information refinements. As information accumulates and the ambiguity set shrinks toward a singleton, the associated robust decision rule converges to Bayesian expected-loss minimization. This consistency under information refinement is our normative justification for the coherent interpretation. |
| Keywords: | ambiguity sets, confidence sets, credible sets, conformal prediction, robust decision making, partial identification |
| JEL: | D81 C44 C11 |
| Date: | 2026–08–26 |
| URL: | https://d.repec.org/n?u=RePEc:pen:papers:26-021 |
| By: | Titing Cui; Michael Hamilton; Jourdain Lamperski; Kasra Tari |
| Abstract: | We study the unit-demand pricing problem under \textit{min-buying} behavior, where customers purchase the lowest-priced item that yields non-negative utility. In contrast to the quasi-linear model, we show that uniform pricing becomes substantially more effective under min-buying. First, we study symmetric environments. We show that for min-buying customers with independent and identically distributed valuations, a uniform price across items is optimal. We then extend this optimality result to all valuations drawn from exchangeable and affiliated distributions. However, uniform pricing is not optimal in all symmetric environments: for min-buying customers we construct an exchangeable and non-affiliated valuation distribution for which the gap between uniform pricing and optimal item pricing is logarithmic in the number of items. This gap is tight and matches the worst-case gap in the quasi-linear setting. Next, we consider asymmetric environments in which valuations are independent but not identically distributed. When these valuations are regular and customers are min-buying, we show that a uniform price guarantees approximately 69.86\% of the optimal item-pricing revenue and this is tight. Overall, our results highlight that the value of non-uniform pricing substantially diminishes, and often disappears entirely, under more conservative demand models in which customers engage in satisficing behaviors such as min-buying. |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2610.17450 |
| By: | Jonas Hanetho |
| Abstract: | In incomplete markets, contingent claims cannot in general be replicated exactly, and hedging must therefore be formulated as an optimization problem over admissible trading strategies. This paper studies the relation between quadratic hedging and entropic hedging in a discrete-time incomplete market when strategies are restricted to bounded finite-dimensional parametric classes. These restrictions induce admissible gain sets that are compact and convex in \(L^2\), providing a common well-posed setting for both the restricted mean-square hedging problem and the restricted exponential-utility hedging problem. The main contribution is to establish a uniform small-risk-aversion expansion of the entropic risk functional over the restricted gain set and to use this uniformity to obtain convergence of the corresponding minimizers. Under a uniform exponential integrability assumption, the restricted entropic hedging gains converge in \(L^2\) to the unique restricted quadratic hedge as the risk-aversion parameter tends to zero. The theoretical result is illustrated numerically in a regularized discrete-time stochastic volatility model of Heston type. |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2610.12594 |
| By: | Huiquan Zhang (Graduate School of Economics, Kobe University, JAPAN); Junyi Shen (Research Institute for Economics and Business Administration, Kobe University, JAPAN) |
| Abstract: | As environmental, social, and governance (ESG) information increasingly reaches consumers through certifications, labels, and package claims, it remains unclear whether such information translates into measurable preferences and willingness to pay (WTP). Focusing on Chin's fast-moving consumer goods (FMCG) market, this study examines consumer preferences, willingness to pay, and preference heterogeneity for ESG labels in two product categories: bottled drinks and shampoo. A discrete choice experiment is employed, and the data are analyzed using multinomial logit (MNL), random parameters logit (RPL), and latent class logit (LCL) models to estimate the marginal utilities of ESG labels across product contexts and consumer segments. The results show that consumers generally exhibit positive preferences for ESG labels and make meaningful trade-offs between label attributes and price, while substantial heterogeneity exists across labels, product categories, and consumer segments. Among the tested labels, ISO Certification shows the strongest and most consistent positive effect across both product categories and is associated with the highest WTP. The findings highlight differences in the valuation of specific ESG-related cues across product contexts and consumer groups, suggesting that how such information reaches consumers warrants attention alongside its ESG dimension. |
| Keywords: | ESG labels; Willingness to pay; Discrete choice experiment; Chinese FMCG market; Consumer preferences |
| JEL: | C35 D12 Q56 |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:kob:dpaper:dp2026-29 |