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on Utility Models and Prospect Theory |
| By: | Ungureanu, S. |
| Abstract: | The paper shows that bounded rationality, in the form of limited knowledge of utility, is an explanation for common stylized facts of prospect theory like loss aversion, status quo bias and non-linear probability weighting. Locally limited utility knowledge is considered within a classical demand model framework, suggesting that costs of inefficient search for optimal consumption will produce a value function that obeys the loss aversion axiom of Tversky and Kahneman (1991). Moreover, since this adjustment happens over time, new predictions are made that explain why the status quo bias is reinforced over time. This search can also describe the behavior of a consumer facing an uncertain future wealth level. The search cost justifies non-linear forms of probability weighting. The effects that have been observed in experiments will follow as a consequence. |
| Keywords: | status quo bias; reference dependence; loss aversion; cost of choice; search costs; probability weighting; transaction costs; bounded rationality. |
| Date: | 2015–01–15 |
| URL: | http://d.repec.org/n?u=RePEc:cty:dpaper:8124&r=upt |
| By: | Görlitz, Katja (Free University of Berlin); Tamm, Marcus (RWI) |
| Abstract: | This study analyzes how risk attitudes change when individuals become parents using longitudinal data for a large and representative sample of individuals. The results show that men and women experience a considerable increase in risk aversion which already starts as early as two years before becoming a parent, is largest shortly after giving birth and disappears when the child becomes older. These findings show that parenthood leads to considerable changes in individual risk attitudes over time. Thus, analyses using risk preferences as the explanatory variable for economic outcomes should be careful in interpreting the findings as causal effects. |
| Keywords: | risk aversion, risk preferences, preference stability, parenthood, children, gender differences |
| JEL: | D1 D81 J13 J16 |
| Date: | 2015–03 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp8947&r=upt |
| By: | Erhan Bayraktar; Xiang Yu |
| Abstract: | This paper studies the utility maximization problem on the terminal wealth with both random endowments and proportional transaction costs. To deal with unbounded random payoffs from some illiquid claims, we propose to work with the acceptable portfolios defined via the consistent price system (CPS) such that the liquidation value processes stay above some stochastic thresholds. In the market consisting of one riskless bond and one risky asset, we obtain a type of the super-hedging result for some workable contingent claims. Based on this characterization of the working space, the existence and uniqueness of the optimal solution for the utility maximization problem are established using the convex duality analysis. As an important application of the duality theory, we provide some sufficient conditions for the existence of a shadow price process with random endowments in a generalized form as well as in the classical sense using our definition of acceptable portfolios. |
| Date: | 2015–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1504.00310&r=upt |
| By: | Courty, Pascal; Nasiry, Javad |
| Abstract: | The uniform pricing puzzle for vertically differentiated products states that a monopolist sells high and low quality products at the same price despite the fact that quality is perfectly observable and that there are no significant costs of adjusting prices. The puzzle is relevant for movies, books, music, and mobile apps, among others. We show that the puzzle can be resolved by accounting for consumer loss aversion in monetary and consumption utilities and by assuming that consumers face a random utility shock. The novelty of our approach is that the reference transaction is endogenously set as part of a `personal equilibrium' and includes only past purchases of products of the same quality. |
| Keywords: | expectations-based loss aversion; personal equilibrium; uniform pricing puzzle; vertically differentiated products |
| JEL: | D03 D21 L1 L2 |
| Date: | 2015–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10523&r=upt |
| By: | KORNEK, Urik (Postdam Institute for Climate Impact Research); LESSMANN, Kai (Postdam Institute for Climate Impact Research); TULKENS, Henry (Université catholique de Louvain, CORE, Belgium) |
| Abstract: | To study the stability of coalitions in the standard game theoretic model of international environmental agreements, two alternative concepts are used: potential internal stability and core stability. Both concepts make use of the possibility of reallocating payoffs within a coalition through transfers, formulated in terms of transferable utility among the players. For international applications where players are countries, such as done in the growing literature on integrated assessment models, non-transferable utility games would be economically better suited. In this note, we provide a framework for comparing the treatment of coalitions in five game theoretically minded integrated assessment models, from that point of view. Under way, we extend the definition of the two stability concepts to games without transferable utility, assuming instead the transferability of some physical good. We also show that potential internal stability and blocking power of coalitions can be tested by solving a simple optimization problem. |
| Date: | 2014–11–05 |
| URL: | http://d.repec.org/n?u=RePEc:cor:louvco:2014035&r=upt |
| By: | Carole Treibich (Aix-Marseille University (Aix-Marseille School of Economics), CNRS, & EHESS) |
| Abstract: | Using an original dataset collected among motorcyclists in New Delhi (2011), this paper compares three different survey measures of risk attitudes: self-assessment, hypothetical lotteries and income prospect choices. While previous research on risk aversion measurement methods in developing countries mainly looked at specific groups such as rural farmers or students, the dataset I use covers a large and heterogeneous urban population. I first show that all measurements are positively and highly correlated with one another, this being even more the case within methodologies and within domains. Subsequently, I investigate the predictive power of these different individual risk-aversion measurements on occupation choices and health decisions. Most of my elicited risk preferences appear to predict risky health behaviors well. Puzzling results are found with the lotteries and may be interpreted either as evidence of risk-compensation between domains or as an incapacity to capture the desired characteristic. Finally, thanks to information on religious beliefs and practices, I am able to verify that cultural background does not impact on the relationship between risk preferences and risky conducts. Overall, this analysis highlights that elicitation of risk-aversion measurements through surveys in a developing country like India thus appears possible. |
| Keywords: | risk aversion measurement, India, survey design, risky conducts |
| Date: | 2015–04–03 |
| URL: | http://d.repec.org/n?u=RePEc:aim:wpaimx:1517&r=upt |
| By: | Beranek, Benjamin (University of Nottingham); Cubitt, Robin (University of Nottingham); Gächter, Simon (University of Nottingham) |
| Abstract: | This paper reports data from three subject pools (n=717 subjects) using techniques based on those of Loewenstein, et al. (1989) and Blanco, et al. (2011) to obtain parameters, respectively, of stated and revealed inequality aversion. We provide a replication opportunity for those papers, with two innovations: (i) a design which allows stated and revealed preferences to be compared at the individual level; (ii) assessment of robustness of findings across subjects from a UK university, a Turkish university and Amazon Mechanical Turk. Our findings on stated aversion to inequality are qualitatively similar to those of Loewenstein, et al. in each of our subject pools, whereas there are notable differences between some of our findings on revealed preference and those of Blanco, et al. We find that revealed advantageous inequality aversion is often stronger than revealed dis-advantageous inequality aversion. In most subject pools, we find some (weak) correlation between corresponding parameters of stated and revealed inequality aversion. |
| Keywords: | inequality aversion, replication, revealed and stated preferences, robustness across subject pools, MTurk |
| JEL: | C90 |
| Date: | 2015–03 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp8954&r=upt |
| By: | Toomas Hinnosaar |
| Abstract: | Risk-neutral sellers can extract high profits from risk-loving buyers by selling them lotteries. To limit this problem, gambling is heavily regulated in most countries. I show that protecting risk-loving buyers against profit-maximizing sellers is essentially impossible. Even if buyers are risk-loving in the weakest sense, the seller can construct a nonrandom winner-pays auction that ensures unbounded profits. The result holds even if the seller cannot use any mechanism that resembles a lottery and only requires that buyers are asymptotically risk loving. This condition is satisfied, for example, when preferences satisfy Savage’s axioms or with prospect theory preferences. |
| Keywords: | risk-loving agents, auctions, gambling, prospect theory |
| JEL: | D82 D44 C72 D81 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:cca:wpaper:404&r=upt |
| By: | DECANCQ, Koen (University Antwerp); NEUMANN, Dirk (Université catholique de Louvain, CORE, Belgium) |
| Abstract: | We discuss and compare five measures of individual well-being, namely income, an objective composite well-being index, a measure of subjective well-being, equivalent income, and a well-being measure based on the von Neumann-Morgenstern utilities of the individuals. After examining the information requirements of these measures, we illustrate their implementation using data from the German Socio-Economic Panel (SOEP) for 2010. We find sizeable differences in the characteristics of the individuals identified as worst off according to the different well-being measures. Less than 1% of the individuals belong to the bottom decile according to all five measures. Moreover, the measures lead to considerably different well-being rankings of the individuals. These findings highlight the importance of the choice of well-being measure for policy making. |
| Keywords: | income, composite well-being index, life satisfaction, equivalent income, von Neumann-Morgenstern utility function, worst off, Germany |
| JEL: | D31 D63 I30 |
| Date: | 2014–10–31 |
| URL: | http://d.repec.org/n?u=RePEc:cor:louvco:2014050&r=upt |
| By: | Jacob LaRiviere (Department of Economics, University of Tennessee); Mikolaj Czajkowski (University of Warsaw, Department of Economic Sciences, Poland); Nick Hanley (Department of Geography and Sustainable Development, University of St. Andrews); Katherine Simpson (Economics Division, University of Stirling, Scotland) |
| Abstract: | We use a novel field experiment which jointly tests two implicit assumptions of updating models in a joint framework: that new information leads to new knowledge and that new knowledge can affect economic decisions. In the experiment, we elicit subjects’ prior knowledge state about a good’s attributes, exogenously vary how much new information about good attributes we provide to subjects, elicit subjects’ valuation for the good, and elicit posterior knowledge states about the same good attributes. Testing for changes in knowledge jointly with changes in preferences allows us to horserace updating models more completely than previous studies since we observe ex ante and ex post knowledge states. Our results are consistent with a model of incomplete learning, fatigue and either confirmation bias or costly search coupled with unbiased priors. |
| Keywords: | Learning, Information, Bayesian Updating, Behavioral Economics |
| JEL: | D83 D81 Q51 |
| Date: | 2015–03 |
| URL: | http://d.repec.org/n?u=RePEc:sss:wpaper:2015-09&r=upt |
| By: | Szekeres, Szabolcs |
| Abstract: | A number of governments have already adopted the policy of applying Declining Discount Rates (DDRs) to long lived projects, a move that will significantly affect public sector investment decisions. This paper argues that such policy is misguided, and revisits the discussion that led to it. A 2009 paper by Christian Gollier and Martin L. Weitzman is widely regarded as having solved the Weitzman-Gollier Puzzle, which is that the definition of expected present value (EPV) proposed by Weitzman’s in 1998 is inconsistent with the calculation of expected future values (EFV) when market interest rates are stochastic but perfectly auto-correlated. The inconsistency is actually due to the fact that Weitzman’s EPV formulation is incorrect. When it is replaced by the correct formulation, the puzzle disappears, and risk neutral certainty equivalent rates (CERs) turn out to be growing, rather than declining under the assumptions of Weitzman’s model. This removes the justification for the use of DDRs. This paper shows that Gollier and Weizmann (2009) fail to resolve the puzzle. Adding risk aversion to Weitzman’s 1998 model to derive risk adjusted CERs cannot resolve the inconsistency between alternative methods of computing expected monetary yields, because investors’ risk aversion only affects their own valuations, not market yields. If monetary CERs increase, the underlying efficiency of investment projects must generally match the growing monetary CERs of capital markets for them to be worth investing in, even for risk averse investors. The distant future should only not be discounted at increasing discount rates if Weitzman’s 1998 assumption of perfectly auto-correlated interest rates fails to hold sufficiently. |
| Keywords: | Discount rate, uncertainty, declining discount rate, benefit-cost analysis, negative compounding. |
| JEL: | D61 H43 |
| Date: | 2015–04–03 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:63437&r=upt |
| By: | Decancq, Koen (CES, Univerity of Antwerp); Fleurbeay, Marc (Princeton University); Maniquet, François (Université catholique de Louvain, CORE, Belgium) |
| Abstract: | We propose a new class of multidimensional poverty indices. To aggregate and weight the different dimensions of poverty, we rely on the preferences of the concerned agents rather than on an arbitrary weighting scheme selected by the analyst. The Pareto principle is, therefore, satisfied among the poor. The indices add up individual measures of poverty that are computed as a convex transform of the fraction of the poverty line vector to which the agent is indifferent. The axiomatic characterization of this class is grounded on new principles of interpersonal poverty comparisons and of inequality aversion among the poor. We illustrate our approach with Russian survey data between 1995 and 2005. We find that, compared to standard poverty indices, our preference sensitive indices lead to considerable differences in the identification of the poor and in subgroup poverty comparisons. |
| Keywords: | multidimensional poverty measurement, preferences |
| JEL: | D63 D71 |
| Date: | 2015–02–23 |
| URL: | http://d.repec.org/n?u=RePEc:cor:louvco:2015008&r=upt |