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on Utility Models and Prospect Theory |
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Issue of 2023‒06‒26
eleven papers chosen by |
| By: | Dimand, Robert W. |
| Abstract: | Commitment to the behaviorist approach to utility theory, to the usefulness of mathematics in economic analysis and to equalization of the marginal utility of income as a principle of just taxation brought Irving Fisher and Ragnar Frisch to attempt to measure the marginal utility of income and led them to collaborate in forming the Econometric Society and sponsoring the establishment of the Cowles Commission, institutions advancing economic theory in connection to mathematics and statistics and led Frisch to pioneer an axiomatic approach to utility and microeconomic theory. |
| Date: | 2023–05–17 |
| URL: | http://d.repec.org/n?u=RePEc:osf:socarx:vmzua&r=upt |
| By: | Laurence Carassus; Johannes Wiesel |
| Abstract: | We investigate an expected utility maximization problem under model uncertainty in a one-period financial market. We capture model uncertainty by replacing the baseline model $\mathbb{P}$ with an adverse choice from a Wasserstein ball of radius $k$ around $\mathbb{P}$ in the space of probability measures and consider the corresponding Wasserstein distributionally robust optimization problem. We show that optimal solutions converge to the uniform diversification strategy when uncertainty is increasingly large, i.e. when the radius $k$ tends to infinity. |
| Date: | 2023–06 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2306.01503&r=upt |
| By: | Abdellaoui, Mohammed; Kemel, Emmanuel; Panin, Amma (Université catholique de Louvain, LIDAM/CORE, Belgium); Vieider, Ferdinand M. |
| Abstract: | We present a novel method—called risk equivalents—that uses a single measure to elicit discount rates while avoiding concerns about the shape of the utility function. The method is valid under discounted expected utility (DEU), and also under several of its behavioral extensions including more general models that account for a biased perception of time and risk (such as time- or likelihood-insensitivity). We implement the method in a field experiment in India measuring inter-temporal discount rates for money and the consumption of tea.We empirically observe that discount rates elicited by traditional methods are related to utility curvature, whereas discount rates elicited by risk equivalents are not. Risk equivalents also mitigate differences in discount rates measured for money and for tea, suggesting that unaddressed utility curvature may play a role in results that demonstrate good-specific discounting. Risk equivalents are general, fast and tractable, three features that are particularly useful in field studies. |
| Keywords: | Time discounting ; money vs consumption ; utility confound |
| JEL: | D03 D81 D91 |
| Date: | 2023–02–10 |
| URL: | http://d.repec.org/n?u=RePEc:cor:louvco:2023007&r=upt |
| By: | Matthew D. Rablen (Department of Economics, University of Sheffield, 9 Mappin Street, Sheffield, S1 4DT, UK.) |
| Abstract: | Loss aversion, risk aversion, and the probability weighting function (PWF) are three central concepts in explaining decision making under risk. I examine interlinkages be- tween these concepts in a model of decision making that allows for loss averse/tolerant stochastic reference dependence and optimism/pessimism over probability distribu- tions. I give a preference interpretation to commonly observed shapes of PWF and to risk aversion. In particular, I establish a connection between loss aversion and both risk aversion and the inverse-S PWF: loss aversion is a necessary condition to observe each of these phenomena. The results extend to distinct PWFs in the gain and loss domains, as under prospect theory. |
| Keywords: | Probability Weighting; Rank Dependent Expected Utility; Loss Aversion; Risk Aversion; Reference Dependence; Optimism; Pessimism; Prospect Theory |
| JEL: | D91 D81 D01 |
| Date: | 2023–06 |
| URL: | http://d.repec.org/n?u=RePEc:shf:wpaper:2023013&r=upt |
| By: | Heinz Welsch (University of Oldenburg, Department of Economics) |
| Abstract: | The literature on subjective well-being (SWB) and the environment has found robust evidence of positive net marginal SWB from pro-environmental behavior (PEB), that is, positive marginal SWB net of the associated costs in terms of money, time and effort (Finding 1). Accordingly, people could increase their SWB (utility) by behaving more pro-environmentally. In addition, net marginal SWB was found to be larger with respect to more costly than with respect to less costly PEBs (Finding 2). Finding 1 is at odds with rational choice theory’s demand that marginal utility be equalized with marginal costs, that is, net marginal utility be zero. The finding can be (and has been) explained by decision error, that is, a failure in forecasting the well-being consequences of an act of choice. This paper uses the rational-choice decision-error framework to show that if (i) observed levels of PEB are the result of rational choice and (ii) there is positive net marginal SWB at observed PEB levels due to decision error, then net marginal SWB from a PEB is increasing in its marginal costs. The ability of the rational-choice decision error framework to explain not only Finding 1 but Finding 2 provides empirical support for that framework. |
| Keywords: | pro-environmental behavior; subjective well-being; decision error; rational choice; affective forecasting |
| Date: | 2023–05 |
| URL: | http://d.repec.org/n?u=RePEc:old:dpaper:441&r=upt |
| By: | Dehez, Pierre (Université catholique de Louvain, LIDAM/CORE, Belgium) |
| Abstract: | A cooperative product game is a transferable utility game defined by associating the product of given players' weights to coalitions. This idea has been introduced by Rosales (2014) in an unpublished memo. Here we analyze a modified version and cover the Shapley value to which we provide an axiomatic foundation. |
| Date: | 2023–03–01 |
| URL: | http://d.repec.org/n?u=RePEc:cor:louvco:2023010&r=upt |
| By: | Bertrand Achou; Philippe De Donder; Franca Glenzer; Minjoon Lee; Marie-Louise Leroux |
| Abstract: | Marginal utility of financial resources when needing long-term care, and the related incentives for precautionary savings and insurance, may vary significantly by whether one receives care at home or in a nursing home. In this paper, we develop strategic survey questions to estimate those differences. All else equal, we find that the marginal utility is significantly higher when receiving care at home rather than in a nursing home. We then use these estimates within a quantitative life cycle model to evaluate the impact of the expected choice of care setting (home versus nursing home) on precautionary savings and insurance valuation. The estimated marginal utility differences imply a significant increase in the incentives to save when expecting to receive care at home. Larger incentives to self-insure also translate to a higher valuation of additional subsidies for home care than for nursing homes, shedding light on an efficient way to expand public long-term care subsidies. We also examine how the magnitude of our results quantitatively varies with the existing public long-term care subsidies. |
| Keywords: | long-term care, marginal utility, home care, nursing home, savings |
| JEL: | D14 E21 G51 I10 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10482&r=upt |
| By: | Jacob K Goeree |
| Abstract: | General equilibrium, the cornerstone of modern economics and finance, rests on assumptions many markets do not meet. Spectrum auctions, electricity markets, and cap-and-trade programs for resource rights often feature non-convexities in preferences or production that can cause non-existence of Walrasian equilibrium and render general equilibrium vacuous. Yquilibrium complements general equilibrium with an optimization approach to (non-) convex economies that does not require perfect competition. Yquilibrium coincides with Walrasian equilibrium when the latter exists. Yquilibrium exists even if Walrasian equilibrium ceases to and produces optimal allocations subject to linear, anonymous, and (approximately) utility-clearing prices. |
| Date: | 2023–05 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2305.06256&r=upt |
| By: | de Callatay, Pierre (Université catholique de Louvain, LIDAM/CORE, Belgium); Mauleon, Ana (Université catholique de Louvain, LIDAM/CORE, Belgium); Vannetelbosch, Vincent (Université catholique de Louvain, LIDAM/CORE, Belgium) |
| Abstract: | We propose the concept of local-k farsighted consistent network for analysing network formation games where players only consider a limited number of feasible networks. A network g is said to be local-k farsightedly consistent if, for any network g' within the distance-k neighbourhood of g, either g is not defeated by g' , or g defeats g' . We show that if the utility function is (componentwise) egalitarian or satisfies reversibility or excludes externalities across components, then local-k farsightedness is more likely to be a good proxy for what would happen when players have full knowledge of all feasible networks. |
| Keywords: | Networks ; local farsightedness ; stability |
| JEL: | A14 C70 D20 |
| Date: | 2023–01–20 |
| URL: | http://d.repec.org/n?u=RePEc:cor:louvco:2023003&r=upt |
| By: | Giancarlo Corsetti; Luca Dedola; Sylvain Leduc |
| Abstract: | How should monetary policy respond to excessive capital inflows that appreciate the currency, widen the external deficit and cause overheating? Using the workhorse open-macro model, we derive a quadratic approximation of the utility-based global loss function in incomplete market economies, and solve for the optimal targeting rules under cooperation. The optimal monetary stance is expansionary if the exchange rate pass-through (ERPT) on import prices is complete, contractionary if nominal rigidities reduce the ERPT. Excessive capital inflows, however, may lead to currency undervaluation instead of overvaluation for some parameter values. The optimal stance is then invariably expansionary to support domestic demand. |
| Keywords: | Currency misalignments, trade imbalances, asset markets and risk sharing, optimal targeting rules, international policy cooperation, exchange rate pass-through |
| Date: | 2022–11 |
| URL: | http://d.repec.org/n?u=RePEc:rsc:rsceui:2022/71&r=upt |
| By: | Fehr, Ernst (University of Zurich); Charness, Gary (University of California, Santa Barbara) |
| Abstract: | We review the vast literature on social preferences by assessing what is known about their fundamental properties, their distribution in the broader population, and their consequences for important economic and political behaviors. We provide, in particular, an overview of the empirically identified characteristics of distributional preferences and how they are affected by merit, luck, and risk considerations as well as by concerns for equality of opportunity. In addition, we identify what is known about belief-dependent social preferences such as reciprocity and guilt aversion. The evidence indicates that the big majority of individuals have some sort of social preference while purely self- interested subjects are a minority. Our review also shows how the findings from laboratory experiments involving social preferences provide a deeper understanding of important field phenomena such as the consequences of wage inequality on work morale, employees' resistance to wage cuts, individuals' self-selection into occupations and sectors that are more or less prone to morally problematic behaviors, as well as issues of distributive politics. However, although a lot has been learned in recent decades about social preferences, there are still many important, unresolved, yet exciting, questions waiting to be tackled. |
| Keywords: | social preferences, altruism, inequality aversion, image concerns, reciprocity |
| JEL: | D0 D2 D9 H0 J0 P0 |
| Date: | 2023–05 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp16200&r=upt |