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on Utility Models and Prospect Theory |
| By: | Holden , Stein (Centre for Land Tenure Studies, Norwegian University of Life Sciences) |
| Abstract: | This paper studies the risk preferences of poor rural households in Malawi and compares the Holt and Laury (2002) (HL) multiple price list approach with hypothetical real-world framing and monetary incentive-compatible framing with the Tanaka, Camerer and Nguyen (2010) (TCN) monetary framing approach to elicit prospect theory parameters. The consistency of the results, the role of and potential bias attributable to measurement error, and correlations with socioeconomic characteristics are assessed. The study shows that measurement error can lead to upward bias in risk aversion estimates and over-weighting of low probabilities. The hypothetical real–world HL framing experiments are associated with higher sensitivity to background variation such as exposure to a recent drought shock and distance to markets/poor market access. |
| Keywords: | expected utility theory; prospect theory; risk preferences; loss aversion; probability weighting; field experiment; multiple price lists; measurement error; Malawi |
| JEL: | C93 D03 O12 |
| Date: | 2014–11–18 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:nlsclt:2014_010&r=upt |
| By: | Ahrens, Steffen; Pirschel, Inske; Snower, Dennis J. |
| Abstract: | We present a new theory of wage adjustment, based on worker loss aversion. In line with prospect theory, the workers’ perceived utility losses from wage decreases are weighted more heavily than the perceived utility gains from wage increases of equal magnitude. Wage changes are evaluated relative to an endogenous reference wage, which depends on the workers’ rational wage expectations from the recent past. By implication, employment responses are more elastic for wage decreases than for wage increases and thus firms face an upward-sloping labor supply curve that is convexly kinked at the workers’ reference price. Firms adjust wages flexibly in response to variations in labor demand. The resulting theory of wage adjustment is starkly at variance with past theories. In line with the empirical evidence, we find that (1) wages are completely rigid in response to small labor demand shocks, (2) wages are downward rigid but upward flexible for medium sized labor demand shocks, and (3) wages are relatively downward sluggish for large shocks. |
| Keywords: | downward wage sluggishness; loss aversion |
| JEL: | D03 D21 E24 |
| Date: | 2014–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10288&r=upt |
| By: | Mikolaj Czajkowski (Faculty of Economic Sciences, University of Warsaw, Poland); Nick Hanley (School of Geography and Sustainable Development, University of St. Andrews); Jacob LaRiviere (Department of Economics, University of Tennessee) |
| Abstract: | This paper develops a choice model for environmental public goods which allows for consumers to learn about their preferences through consumption experiences. We develop a theoretical model of Bayesian updating, perform comparative statics over the model, and show how the theoretical model can be consistently incorporated into a reduced form econometric model. Our main findings are that in a Random Utility Model (RUM) discrete choice model, a subject’s scale should increase and the variability of scale should decrease with experience if subjects are Bayesians. We then estimate the model using field data regarding preferences for one particular public good, water quality. We find strong evidence that additional experience increases scale, thereby makes consumer preferences more predictable from the econometrician’s perspective. We find supportive but less convincing evidence that experience decreases the variability of scale across subjects. |
| Keywords: | Bayesian updating,choice experiment,learning,scale, scale variance |
| JEL: | C51 D83 Q51 H43 |
| Date: | 2014–09 |
| URL: | http://d.repec.org/n?u=RePEc:sss:wpaper:2014-05&r=upt |
| By: | Ali, Bouchrika; FakhriI, Issaoui; Habib, Jouber |
| Abstract: | The aim of this paper is to introduce the Contingent valuation Method (CVM) as an efficient method allowing to modify the utility level, of an economic agent to following the consumption of environmental goods. In the absence of the market for natural assets, the CVM allows us to create a hypothetical market to evaluate the economic value of those assets by purchase and sale transactions. However, this valuation can be constrained with the quality problem of the physical nature of those environmental assets. The theoretical framework had shown that a change in the utility function and consumer surplus on the one hand, price and profit of the monopoly on the other hand, is be needed to keep the measures of economic efficiency and social equity. |
| Keywords: | CVM, Environmental assets, utility function, willingness to pay (WTP) |
| JEL: | Q51 Q58 |
| Date: | 2014–12–06 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:60421&r=upt |
| By: | Stifel, David; Woldehanna, Tassew |
| Abstract: | We use Arndt and Simler.s utility-consistent approach to calculating poverty lines to analyse poverty in Ethiopia in 2000, 2005, and 2011. Poverty reduction was steady but uneven, with gains greatest in urban areas in the first half of the decade, and in |
| Keywords: | poverty measurement, utility-consistent poverty lines, inequality, Ethiopia |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:unu:wpaper:wp2014-125&r=upt |
| By: | Maria Vittoria Levati (Department of Economics (University of Verona)); Stefan Napel (University of Bayreuth); Ivan Soraperra (Department of Economics (University of Verona)) |
| Keywords: | Ambiguity aversion, majority voting, dictatorship |
| JEL: | C91 C92 D71 D81 |
| Date: | 2014–08 |
| URL: | http://d.repec.org/n?u=RePEc:ver:wpaper:13/2014&r=upt |
| By: | Kvaløy, Ola (UiS); Eriksen, Kristoffer (UiS); Luzuriaga , Miguel (UiS) |
| Abstract: | We present an experimental study on how people take risk with other people’s money. We use three different elicitation methods, and study how each subject makes decisions both on behalf of own money and on behalf of another individual’s money. We find that a majority of subjects make different decisions on behalf of others than on behalf of themselves. Approximately one third of the subjects increase risk-taking when it is on behalf of another subject, while one third reduces risk-taking. In sum, we find a weak tendency of lower risk-taking with other’s money compared with own money. We also find that subjects on average think that others are more risk averse than themselves. Moreover, subjects believe that other participants take less risk with their own money than with other people’s money. |
| Keywords: | Risk-taking; Experiment; Social preferences |
| JEL: | C91 G11 |
| Date: | 2014–11–20 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:stavef:2014_021&r=upt |
| By: | Di Caro, Paolo |
| Abstract: | Decisions of investing in sovereign assets involve both risk and ambiguity. Ambiguity arises from unknown elements characterizing the value of a generic sovereign. In presence of ambiguity, ambiguity-averse investors are prone to pay for obtaining summary information such as ratings which reduces ambiguity. Ambiguity-neutral and ambiguity-averse investors, then, make decisions on the basis of different informative sources. By presenting a simple model of sovereign rating under ambiguity, three facts occurring in today’s financial markets are explained. Sovereign ratings influence decisions of investment of ambiguity-sensitive individuals. Rating-dependent regulations create distortions in financial markets by institutionalising specific summary signals. Providing ratings may be a profitable activity. Some final suggestions propose future areas of theoretical and empirical research. |
| Keywords: | risk, ambiguity, ambiguity aversion, sovereign rating, value of information |
| JEL: | D8 D81 G1 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:60295&r=upt |
| By: | Postek, K.S. (Tilburg University, Center For Economic Research); den Hertog, D. (Tilburg University, Center For Economic Research); Melenberg, B. (Tilburg University, Center For Economic Research) |
| Abstract: | In this paper we study distributionally robust constraints on risk measures (such as standard deviation less the mean, Conditional Value-at-Risk, Entropic Value-at-Risk) of decision-dependent random variables. The uncertainty sets for the discrete probability distributions are defined using statistical goodness-of-fit tests and probability metrics such as Pearson, likelihood ratio, Anderson-Darling tests, or Wasserstein distance. This type of constraints arises in problems in portfolio optimization, economics, machine learning, and engineering. We show that the derivation of a tractable robust counterpart can be split into two parts: one corresponding to the risk measure and the other to the uncertainty set. We also show how the counterpart can be constructed for risk measures that are nonlinear in the probabilities (for example, variance or the Conditional Value-at-Risk). We provide the computational tractability status for each of the uncertainty set-risk measure pairs that we could solve. Numerical examples including portfolio optimization and a multi-item newsvendor problem illustrate the proposed approach. |
| Keywords: | risk measure; robust counterpart; nonlinear inequality; robust optimization; support functions |
| JEL: | C1 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:tiu:tiucen:c3a1df3e-f338-4989-806a-d2c4caa79d56&r=upt |
| By: | Orlik, Anna; Veldkamp, Laura |
| Abstract: | A fruitful emerging literature reveals that shocks to uncertainty can explain asset returns, business cycles and financial crises. The literature equates uncertainty shocks with changes in the variance of an innovation whose distribution is common knowledge. But how do such shocks arise? This paper argues that people do not know the true distribution of macroeconomic outcomes. Like Bayesian econometricians, they estimate a distribution. Using real-time GDP data, we measure uncertainty as the conditional standard deviation of GDP growth, which captures uncertainty about the distribution’s estimated parameters. When the forecasting model admits only normally-distributed outcomes, we find small, acyclical changes in uncertainty. But when agents can also estimate parameters that regulate skewness, uncertainty fluctuations become large and counter-cyclical. The reason is that small changes in estimated skewness whip around probabilities of unobserved tail events (black swans). The resulting forecasts resemble those of professional forecasters. Our uncertainty estimates reveal that revisions in parameter estimates, especially those that affect the risk of a black swan, explain most of the shocks to uncertainty. |
| Keywords: | forecasting; rare events; Uncertainty |
| JEL: | C1 E3 G1 |
| Date: | 2014–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10147&r=upt |
| By: | Marielle Brunette (Laboratoire d'Economie Forestière, INRA - AgroParisTech); Stéphane Couture (Unité de mathématiques et informatique appliquées de Toulouse, INRA); Serge Garcia (Laboratoire d'Economie Forestière, INRA - AgroParisTech) |
| Abstract: | In this article, we estimate the demand of French private forest owners for forest insurance against fire risk. For this purpose, we combine experimental data and real-world data on forest owners’ characteristics. Our econometric approach consists in estimating both insurance participation and coverage-level decisions, while accounting for sample selection issues. Our results clearly show that the type of public assistance is a significant determinant in the insurance decision. Other attributes of the experiment such as the expected loss only explain coverage-level decisions, whereas the existence of an ambiguity concerning the probability of fire occurrence positively affects both insurance participation and coverage-level decisions. |
| Keywords: | Insurance, Forest, Fire risk, Ambiguity, Public compensation, Experimental data |
| JEL: | C51 D81 Q23 Q28 |
| Date: | 2014–12 |
| URL: | http://d.repec.org/n?u=RePEc:lef:wpaper:2014-12&r=upt |
| By: | Maria Ana Vitorino (University of Minnesota); Ali Hortacsu (University of Chicago); Elisabeth Honka (The University of Texas at Dallas) |
| Abstract: | Does advertising serve to (i) increase awareness of a product, (ii) increase the likelihood that the product is considered carefully, or (iii) does it shift consumer utility conditional on having considered it? We utilize a detailed data set on consumers' shopping behavior and choices over retail bank accounts to investigate advertising's eect on product awareness, consideration, and choice. Our data set has information regarding the entire purchase funnel, i.e. we observe the set of retail banks that the consumers are aware of, which banks they considered, and which banks they chose to open accounts with. We formulate a structural model that accounts for each of the three stages of the shopping process: awareness, consideration, and choice. Advertising is allowed to aect each of these separate stages of decision-making. Our model also endogenizes the choice of consideration set by positing that consumers undertake costly search. Our results indicate that advertising in this market is primarily a shifter of awareness, as opposed to consideration or choice. Along with advertising, branch density, marital status, race and income are very signicant drivers of awareness. We also find that consumers face non-trivial search/consideration costs that lead the average consumer to consider only 2.2 banks out of the 6.7 they are aware of. Conditional on consideration, branch density, the consumer's current primary bank (i.e. inertia), interest rates and education are the primary drivers of the final choice. |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed014:574&r=upt |
| By: | Pierre-Alexandre Mahieu (LEMNA, University of Nantes); François-Charles Wolff (LEMNA, University of Nantes and INED); Jason Shogren (Department of Economics and Finance, University of Wyoming) |
| Abstract: | Interval bidding allows people to report a range of values for a non-market good. Herein we allow people to choose their distribution over this range endogenously. Using elephant protection as our motivating example, our results suggest the shape of the distribution greatly varies across people and the degree of uncertainty is proportional to their willingness to pay. We also find that both the expected willingness to pay and the degree of uncertainty differ when the valuation exercise is real versus hypothetical. |
| Keywords: | Contingent Valuation, Uncertainty, Distribution format. |
| JEL: | C5 Q51 |
| Date: | 2014–12 |
| URL: | http://d.repec.org/n?u=RePEc:fae:wpaper:2014.16&r=upt |
| By: | Andries, Marianne; Eisenbach, Thomas M. (Federal Reserve Bank of New York); Schmalz, Martin C. |
| Abstract: | We study general equilibrium asset prices in a multi-period endowment economy when agents’ risk aversion is allowed to depend on the maturity of the risk. We find horizon-dependent risk aversion preferences generate a decreasing term structure of risk premia if and only if volatility is stochastic. Our model can thus justify the recent empirical results on the term structure of risk premia if the pricing of volatility risk is downward sloping (in absolute value) in the data and if downward-sloping term structures of returns on a given market are driven solely by exposures to volatility risk. We test these predictions by estimating the price of volatility risk using index options data and by showing that the value premium is related to the exposure to volatility risk. |
| Keywords: | risk aversion; term structure; volatility risk |
| JEL: | D03 D90 G02 G12 |
| Date: | 2014–12–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:703&r=upt |
| By: | Bossone, Biagio |
| Abstract: | This study analyzes the emergence of secular stagnation as the consequence of a rise in the preference for liquidity. Such a rise is caused by a persistent set of pessimistic expectations. This study also investigates the effectiveness of a broad range of demand-management policies in dealing with secular stagnation. To obtain these results, this study uses a model where agents derive utility from holding assets of different degrees of liquidity. In this environment, rational expectations interact with changes in market sentiment, to produce secular stagnation. |
| Keywords: | helicopter money,liquidity preference,market sentiment,quantitative easing,pessimistic (optimistic) expectations,utility analysis |
| JEL: | E2 E3 E4 E5 E61 E62 E63 G11 G12 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:ifwedp:201447&r=upt |
| By: | Benoît, Jean-Pierre; Dubra, Juan |
| Abstract: | Numerous experiments have demonstrated the possibility of attitude polarization. For instance, Lord, Ross & Lepper (1979) partitioned subjects into two groups, according to whether or not they believed the death penalty had a deterrent effect, and presented them with a set of studies on the issue. Believers and skeptics both become more convinced of their initial views; that is, the population polarized. Many scholars have concluded that attitude polarization shows that people process information in a biased manner. We argue that not only is attitude polarization consistent with an unbiased evaluation of evidence, it is to be expected in many circumstances where it arises. At the same time, some experiments do not find polarization, under the conditions in which our theory predicts the absence of polarization. |
| Keywords: | Attitude Polarization; Confirmation Bias; Bayesian Decision Making. |
| JEL: | C9 C91 D81 D90 |
| Date: | 2014–11–20 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:60129&r=upt |
| By: | Torben G. Andersen (Northwestern University, NBER, and CREATES); Nicola Fusari (The Johns Hopkins University Carey Business School); Viktor Todorov (Northwestern University) |
| Abstract: | We study the dynamic relation between market risks and risk premia using time series of index option surfaces. We find that priced left tail risk cannot be spanned by market volatility (and its components) and introduce a new tail factor. This tail factor has no incremental predictive power for future volatility and jump risks, beyond current and past volatility, but is critical in predicting future market equity and variance risk premia. Our findings suggest a wide wedge between the dynamics of market risks and their compensation, with the latter typically displaying a far more persistent reaction following market crises. |
| Keywords: | Option Pricing, Risk Premia, Jumps, Stochastic Volatility, Return Predictability, Risk Aversion, Extreme Events |
| JEL: | C51 C52 G12 |
| Date: | 2014–12–15 |
| URL: | http://d.repec.org/n?u=RePEc:aah:create:2014-56&r=upt |
| By: | Björn Bartling; Florian Engl; Roberto A. Weber |
| Abstract: | We test the claim that game form misconception among subjects making choices through the Becker-DeGroot-Marschak (BDM) value elicitation procedure provides an explanation for the endowment effect, as suggested by Cason and Plott (forthcoming). We employ a design that allows us to clearly identify whether subjects comprehend the incentive properties of a price-list version of the BDM procedure. We find a robust endowment effect, even among those subjects whose elicited valuations for a known monetary value and whose ability to calculate the payoffs resulting from their choices indicate no misconception of the task. We conclude that game form misconceptions alone are unlikely to account for behavioral patterns like the endowment effect. |
| Keywords: | Endowment effect, game from misconception, BDM mechanism, experimental methods, replicable audio files of instructions |
| JEL: | C91 D03 |
| Date: | 2014–11 |
| URL: | http://d.repec.org/n?u=RePEc:zur:econwp:180&r=upt |