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on Utility Models and Prospect Theory |
| By: | Simon Gaechter (University of Nottingham); Eric Johnson (Columbia University); Andreas Herrmann (University of St Gallen) |
| Abstract: | Loss aversion can occur in riskless and risky choices. Yet, there is no evidence whether people who are loss averse in riskless choices are also loss averse in risky choices. We measure individual-level loss aversion in riskless choices in an endowment effect experiment by eliciting both WTA and WTP from each of our 360 subjects (randomly selected customers of a car manufacturer). All subjects also participate in a simple lottery choice task which arguably measures loss aversion in risky choices. We find substantial heterogeneity in both measures of loss aversion. Loss aversion in the riskless choice task and loss aversion in the risky choice task are highly significantly and strongly positively correlated. We find that in both choice tasks loss aversion increases in age, income, and wealth, and decreases in education. |
| Keywords: | Loss aversion, endowment effect, field experiments |
| JEL: | C91 C93 D81 |
| Date: | 2007–07 |
| URL: | http://d.repec.org/n?u=RePEc:cdx:dpaper:2007-02&r=upt |
| By: | Kin Chung Lo (Department of Economics, York University) |
| Abstract: | Nash equilibrium presumes that players have expected utility preferences, and therefore the beliefs of each player are represented by a probability measure. Motivated by Ellsberg-type behavior, which contradicts the probabilistic representation of beliefs, we generalize Nash equilibrium in n-player strategic games to allow for preferences conforming to the maxmin expected utility model of Gilboa and Schmeidler [Journal of Mathematical Economics, 18 (1989), 141–153]. With no strings attached, our equilibrium concept can be characterized by the suitably modified epistemic conditions for Nash equilibrium. |
| Keywords: | Agreeing to disagree, Correlated equilibrium, Epistemic conditions, Knightian uncertainty, Multiple priors, Nash equilibrium |
| JEL: | C72 D81 |
| Date: | 2007–09 |
| URL: | http://d.repec.org/n?u=RePEc:yca:wpaper:2007_5&r=upt |
| By: | Akito Matsumoto |
| Abstract: | This paper analyzes the role of nonseparable utility and nontradables in business cycles and portfolio choice. I find that nonseparability in utility can change the portfolio choice significantly. Unlike previous results in literature, the optimal portfolio of the traded-good sector equities is no longer a well diversified portfolio and becomes sensitive to parameter values. As a result, the model often generates extreme home bias or anti-home bias portfolios implying that some frictions in asset markets, which prevent agents from holding these extreme portfolios, can explain the lack of international risk sharing. |
| Date: | 2007–07–17 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:07/163&r=upt |
| By: | Nicolás Figueroa; Vasiliki Skreta |
| Abstract: | This paper considers a general optimal auction problem, with many goods and with a buyer’s utility that can depend non-linearly in his type. We point out that incentive compatibility constraints may be binding even if virtual utilities are strictly increasing in the buyer’s type. More importantly, optimal mechanisms may involve randomizations between different allocations. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:edj:ceauch:232&r=upt |
| By: | Massimo Guidolin; Giovanna Nicodano |
| Abstract: | In the context of an international portfolio diversification problem, we find that small capitalization equity portfolios become riskier in bear markets, i.e. display negative co-skewness with other stock indices and high co-kurtosis. Because of this feature, a power utility investor ought to hold a well-diversified portfolio, despite the high risk premium and Sharpe ratios offered by small capitalization stocks. On the contrary small caps command large optimal weights when the investor ignores variance risk, by incorrectly assuming joint normality of returns. The dominant factor in inducing such shifts in optimal weights is represented by the co-skewness, the predictable, time-varying covariance between returns and volatilities. We calculate that if an investor were to ignore co-skewness and co-kurtosis risk, he would suffer a certainty-equivalent reduction in utility equal to 300 basis points per year under the steady-state distribution for returns. Our results are qualitatively robust when both European and North American small caps are introduced in the analysis. Therefore this paper offers robust evidence that predictable covariances between means and variances of stock returns may have a first order effect on portfolio composition. |
| Keywords: | Investments, Foreign ; Stocks |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2007-030&r=upt |
| By: | Dirk Bergemann (Cowles Foundation, Yale University); Karl Schlag |
| Abstract: | We consider a robust version of the classic problem of optimal monopoly pricing with incomplete information. In the robust version of the problem the seller only knows that demand will be in a neighborhood of a given model distribution. We characterize the optimal pricing policy under two distinct, but related, decision criteria with multiple priors: (i) maximin expected utility and (ii) minimax expected regret. While the classic monopoly policy and the maximin criterion yield a single deterministic price, minimax regret always prescribes a random pricing policy, or equivalently, a multi-item menu policy. The resulting optimal pricing policy under either criterion is robust to the model uncertainty. Finally we derive distinct implications of how a monopolist responds to an increase in ambiguity under each criterion. |
| Keywords: | Monopoly, Optimal pricing, Robustness, Multiple priors, Regret |
| JEL: | C79 D82 |
| Date: | 2005–07 |
| URL: | http://d.repec.org/n?u=RePEc:cwl:cwldpp:1527r&r=upt |
| By: | Philippe Jehiel; Oliver Compte |
| Date: | 2007–09–07 |
| URL: | http://d.repec.org/n?u=RePEc:cla:levrem:122247000000001552&r=upt |
| By: | Juan D Carrillo; Isabelle Brocas |
| Date: | 2007–09–03 |
| URL: | http://d.repec.org/n?u=RePEc:cla:levrem:122247000000001473&r=upt |
| By: | Sarajevs, Vadims (BOFIT) |
| Abstract: | The impact of an unanticipated monetary shock in a small open economy with dollarization, factor price rigidities, and nontradeables is re-examined in an optimizing intertemporal general equilibrium model. The framework of an earlier study is extended to incorporate foreign real money balances into the repre-sentative agent's utility function and to account for the phenomenon of dollarization so characteristic of transition economies. The major finding is that in the event of small monetary shocks, the presence of dollarization does not alter the outcome that relates the sign of response of consumption, current account balance, and other macroeconomic variables to the difference between intertemporal and intratemporal elasticities of substitutions of the total consumption index. The solution also shows that the elasticity of intertemporal substitution of money services and the share of traded goods in total consumption - a proxy for openness of the economy - are the crucial parameters in determining the response and the possibility of overshooting of the model variables, with economic openness playing a stabilizing role for the econ-omy in the event of monetary shocks. |
| Keywords: | new open-economy macroeconomics; monetary shocks; dollarization; factor price rigidities; nontradeables; current account |
| JEL: | F31 F32 F41 F47 |
| Date: | 2007–09–13 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:bofitp:2000_012&r=upt |
| By: | Pérez Truglia, Ricardo Nicolás |
| Abstract: | Since consumers are not thought to derive "intrinsic" utility from the consumption of status goods, the common vision among economists insists that relative concerns make everyone unhappy. Using a signaling-type model, I show that conspicuous consumption is a natural and efficient response of people to the absence of certain markets, especially when income is associated to desirable characteristics. Thus, reducing inequality may not be as welfare-improving as usually thought. I test this conjecture based on panel data for 10,000 respondents in Russia for 2000-2002, exploiting two identification strategies. The following results emerge: i. Regional expenditures inequality increases the marginal utility derived from consumption; ii. The "direct" distaste for inequality has been considerably underestimated by the literature; iii. The model is consistent with a utility function first concave and then convex; iv. The results remain unchanged after controlling for the income equivalence scale elasticity and a wide range of recent theories on Economics of Happiness. |
| Keywords: | Happiness; well being; life satisfaction; income; expenditures; conspicuous consumption; inequality; welfare; signaling; Friedman-Savage utility function; income equivalence scale elasticity; comparison income; reference group; non-market goods and services. |
| JEL: | C33 D31 D61 |
| Date: | 2007–01–29 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:4700&r=upt |
| By: | Voorneveld, M. (Tilburg University, Center for Economic Research) |
| Abstract: | In classical game theory, players have finitely many actions and evaluate outcomes of mixed strategies using a von Neumann-Morgenstern utility function. Allowing a larger, but countable, player set introduces a host of phenomena that are impossible in finite games. Firstly, in coordination games, all players have the same preferences: switching to a weakly dominant action makes everyone at least as well off as before. Nevertheless, there are coordina- tion games where the best outcome occurs if everyone chooses a weakly dominated action, while the worst outcome occurs if everyone chooses the weakly dominant action. Secondly, the location of payoff-dominant equilibria behaves capriciously: two coordination games that look so much alike that even the consequences of unilateral deviations are the same may nevertheless have disjoint sets of payoff-dominant equilibria. Thirdly, a large class of games has no (pure or mixed) Nash equilibria. Following the proverb \the grass is always greener on the other side of the hedge", greener-grass games model constant discontent: in one part of the strategy space, players would rather switch to its complement. Once there, they'd rather switch back. |
| Keywords: | coordination games;dominant strategies;payoff-dominance;nonexistence of equi- librium;tail events. |
| JEL: | C72 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:kubcen:200762&r=upt |
| By: | Christian Belzil (GATE CNRS, Institute for the Study of Labor (IZA)) |
| Abstract: | This paper considers the estimation of sequential schooling decisions made by agents who are endowed with subjective beliefs about their own ability. I use unique Italian panel data which provide information on i) the curvature of the per-period utility function, ii) schooling decisions, iii) post-schooling earnings, in order to estimate the future component of the differences in intertemporal utilities of school and work independently from the present component, (as in Geweke and Keane, 1995, 2001), and evaluate the importance of “present bias”. Under certain conditions, which include imposing equality between the modal belief and true ability, I recover individual specific subjective probability distributions. I estimate both the degree of confidence (a measure of spread) and the incidence of over (and under) estimation. I find that the future component of intertemporal utilities dominates schooling decisions. I find a strong incidence of under-estimation among the more able and a much smaller incidence of over-estimation among the low ability group. At the medium ability spectrum, there is evidence of some over-estimation. The degree of confidence is high and imply that agents have a substantial amount of inside information (36% of the population act on a degenerate subjective distribution). Overall, the variance of the objective ability heterogeneity distribution is 4 times as large the variance of the distribution characterizing subjective beliefs. |
| Keywords: | dynamic programming, education, over-confidence, present bias, rational expectation, subjective distributions |
| JEL: | J24 |
| Date: | 2007–07 |
| URL: | http://d.repec.org/n?u=RePEc:gat:wpaper:0717&r=upt |
| By: | C. Mirjam van Praag (University of Amsterdam; Tinbergen Institute; Max Planck Institute of Economics; IZA Institute for the Study of Labour); Peter H. Versloot (University of Amsterdam; Tinbergen Institute) |
| Abstract: | This paper examines to what extent recent empirical evidence can collectively and systematically substantiate the claim that entrepreneurship has important economic value. Hence, a systematic review is provided that answers the question: What is the contribution of entrepreneurs to the economy in comparison to non-entrepreneurs? We study the relative contribution of entrepreneurs to the economy based on four measures that have most widely been studied empirically. Hence, we answer the question: What is the contribution of entrepreneurs to (i) employment generation and dynamics, (ii) innovation, and (iii) productivity and growth, relative to the contributions of the entrepreneurs' counterparts, i.e. the 'control group'? A fourth type of contribution studied is the role of entrepreneurship in increasing individuals' utility levels. Based on 57 recent studies of high quality that contain 87 relevant separate analyses, we conclude that entrepreneurs have a very important - but specific - function in the economy. They engender relatively much employment creation, productivity growth and produce and commercialize high quality innovations. They are more satisfied than employees. More importantly, recent studies show that entrepreneurial firms produce important spillovers that affect regional employment growth rates of all companies in the region in the long run. However, the counterparts cannot be missed either as they account for a relatively high value of GDP, a less volatile and more secure labor market, higher paid jobs and a greater number of innovations and they have a more active role in the adoption of innovations. |
| Keywords: | entrepreneur, entrepreneurship, self-employment, productivity, economic development, growth, employment, innovation, patents, R+D, utility, remuneration, income. |
| JEL: | D24 D31 E23 E24 J21 J28 J31 L26 M13 |
| Date: | 2007–09–12 |
| URL: | http://d.repec.org/n?u=RePEc:jrp:jrpwrp:2007-061&r=upt |