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on Utility Models and Prospect Theory |
| By: | Carlo Zappia |
| Abstract: | Even though Daniel Ellsberg’s 1961 article “Risk, ambiguity and the Savage axioms” is well-known and increasingly quoted in current decision theory, introducing the counterexample to Bayesian decision-making that got the normative value of Savage’s theory into trouble, its philosophical background remains totally unknown. This paper examines Ellsberg’s motivations in presenting his critique first to his fellow decision theorists at Harvard and RAND in the late 1950s and it goes into his reasons for giving a philosophical justification and defence of the paradox in his doctoral thesis of 1962. By concentrating mainly on Ellsberg’s all-encompassing analysis of decision-making in his thesis, the paper shows that a number of relevant issues connected to the paradox can be thrown light on. These range from its historical background to the way to test the normative value of decision theory through experiments, and a taxonomy of decision rules based on alternative probabilistic set-ups. Crucially, the paper argues that Ellsberg subscribed to a generalised version of the Bayesian approach, one that informs the developments of the multiple prior approach in current decision theory, but finds its origins in Keynes’s Treatise on Probability |
| Keywords: | Ambiguity, Ellsberg Paradox, decision theory |
| JEL: | B21 D21 |
| Date: | 2015–09 |
| URL: | http://d.repec.org/n?u=RePEc:usi:wpaper:716&r=upt |
| By: | Matija Kovacic (Department of Economics, University Of Venice Cà Foscari); Francesco Costantini (Department of Humanities, University Of Udine); Juliana Bernhofer (Department of Economics, University Of Venice Cà Foscari) |
| Abstract: | This paper explores the relationship between linguistic variation and individual attitudes toward uncertainty and risky behavior. According to linguistic relativity hypothesis, linguistic differences in grammatical structure may induce speakers of different languages to conceptualize and experience the world differently. We develop a specific linguistic marker that classifies languages according to the number of non-indicative moods in irrealis contexts in their respective grammars. These grammatical categories are concerned with the expression of situations involving uncertainty, and the frequency of their use may be closely related to the overall degree of uncertainty perceived by individuals. Using data from the Survey of Health, Aging and Retirement in Europe (SHARE) and World Value Survey (WVS), we show that speakers of languages where non-indicative moods are used more intensively are on average more risk averse. Linguistic markers are then used to instrument the individual attitudes toward risk in order to quantify a direct causal effect of risk aversion on the propensity to invest in risky financial assets. We show that higher risk aversion causes a significantly lower propensity to invest in risky assets. |
| Keywords: | Language, Risk Aversion, Financial Assets Accumulation, Instrumental Variables |
| JEL: | D14 D81 D91 C36 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:ven:wpaper:2015:34&r=upt |
| By: | Antoinette BAUJARD (University of Lyon, UJM, GATE L-SE (UMR CNRS 5824), France); Muriel GILARDONE (Normandie University, University of Caen Basse-Normandie, CREM (UMR CNRS 6211), France) |
| Abstract: | According to the standard reading, Sen’s contribution to justice consists in the defense of a capability theory, i.e. of a simple switch of focus from utility to capability. This paper aims to undermine this standard reading. We claim that this capability-theory view amounts to the application of formal welfarism to capabilities: social welfare is the aggregation of individual welfares, where welfare is properly defined by capabilities. We show that this view is inconsistent with Sen’s idea of justice, because the latter requires agents to be involved in the definition of what should count for the evaluation of social states, and how it should count. The value attributed to agency in Sen’s idea of justice is such that the process of choosing better policies trumps the substantive definition of what welfare should be. We defend instead a heuristic account of the status of capability in Sen’s thought: capability was introduced to make a point against welfarism; it is an argumentative step that does not imply a definitive commitment to a capability theory. We conclude that a fruitful discussion of his alternative theory of justice requires that we relocate his main contribution: we should see it as pertaining to a theory of public reasoning, not a theory based on a specific material of justice. |
| Keywords: | Capability, capability theory, welfarism, justice, operationalization, paternalism, agency, public reasoning |
| JEL: | A13 B41 D63 D79 I31 |
| Date: | 2015–12 |
| URL: | http://d.repec.org/n?u=RePEc:tut:cccrwp:2015-02-ccr&r=upt |
| By: | Becker, Anke; Dohmen, Thomas J; Enke, Benjamin; Falk, Armin; Huffman, David; Sunde, Uwe |
| Abstract: | This paper presents the Global Preference Survey, a globally representative dataset on risk and time preferences, positive and negative reciprocity, altruism, and trust. We collected these preference data as well as a rich set of covariates for 80,000 individuals, drawn as representative samples from 76 countries around the world, representing 90 percent of both the world's population and global income. The global distribution of preferences exhibits substantial variation across countries, which is partly systematic: certain preferences appear in combination, and follow distinct economic, institutional, and geographic patterns. The heterogeneity in preferences across individuals is even more pronounced and varies systematically with age, gender, and cognitive ability. Around the world, our preference measures are predictive of a wide range of individual-level behaviors including savings and schooling decisions, labor market and health choices, prosocial behaviors, and family structure. We also shed light on the cultural origins of preference variation around the globe using data on language structure. |
| Keywords: | cultural variation; economic preferences |
| JEL: | D01 D03 F00 |
| Date: | 2015–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:11006&r=upt |
| By: | Zuhe Zhang (University of Melbourne - University of Melbourne); Benjamin Rubinstein (University of Melbourne - University of Melbourne); Christos Dimitrakakis (Université de Lille Sciences humaines et sociales, Chalmers University of Technology [Gothenburg]) |
| Abstract: | We study how to communicate findings of Bayesian inference to third parties, while preserving the strong guarantee of differential privacy. Our main contributions are four different algorithms for private Bayesian inference on proba-bilistic graphical models. These include two mechanisms for adding noise to the Bayesian updates, either directly to the posterior parameters, or to their Fourier transform so as to preserve update consistency. We also utilise a recently introduced posterior sampling mechanism, for which we prove bounds for the specific but general case of discrete Bayesian networks; and we introduce a maximum-a-posteriori private mechanism. Our analysis includes utility and privacy bounds, with a novel focus on the influence of graph structure on privacy. Worked examples and experiments with Bayesian naïve Bayes and Bayesian linear regression illustrate the application of our mechanisms. |
| Keywords: | posterior sampling,Bayesian inference,differential privacy |
| Date: | 2016–02–10 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-01234215&r=upt |
| By: | Valerii Salov |
| Abstract: | The prospects of Kahneman and Tversky, Mega Million and Powerball lotteries, St. Petersburg paradox, premature profits and growing losses criticized by Livermore are reviewed under an angle of view comparing mathematical expectations with awards received. Original prospects have been formulated as a one time opportunity. An award value depends on the number of times the game is played. The random sample mean is discussed as a universal award. The role of time in making a risky decision is important as long as the frequency of games and playing time affect their number. A function of choice mapping properties of two-point random variables to fractions of respondents choosing them is proposed. |
| Date: | 2015–12 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1512.08792&r=upt |
| By: | Hetschko, Clemens; Preuss, Malte |
| Abstract: | Using German panel data, we assess the causal effect of job loss, and thus of an extensive income shock, on risk attitude. In line with predictions of expected utility reasoning about absolute risk aversion, losing one´s job reduces the willingness to take risks. This effect strengthens in previous hourly wage, begins to manifest itself as soon as an employee perceives the threat of job loss and is of a transitory nature. The change in stated risk attitude matches observable job finding behaviour, confirming the behavioural validity of our results. |
| Keywords: | absolute risk aversion,income shock,job loss,plant closure,general risk attitude |
| JEL: | D81 J64 J65 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:fubsbe:201532&r=upt |
| By: | Miura, Shinji |
| Abstract: | Saving brings an economic loss. The author intends to publish a paper, which gives a foundation of this paradox of thrift by connecting money circulation analysis and welfare economics in the case where saving is limited to hoarding. As an introduction of the intended paper, this paper provides a simple explanation for hoarding loss using some graphs. Under certain conditions, the representative agent hoards money in order to increase utility, but the hoarding actually decreases it against agent’s rational intention. This irrationality of rationality occurs because the agent maximizes their utility while lowering the budget of the entire relevant term. This conclusion is derived from the agent making the decision with an ignorance of the whole expenditure reflux. Since the interest of a selfish agent is limited to their private range, the agent ignores the objective truth. |
| Keywords: | Money Circulation; Welfare Economics; Under-Consumption; Paradox of Thrift; Intertemporal Choice |
| JEL: | D60 E21 E40 |
| Date: | 2015–12–27 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:68551&r=upt |
| By: | Siddiqi, Hammad |
| Abstract: | Based on experimental and anecdotal evidence, an anchoring-adjusted option pricing model is developed in which the volatility of the underlying stock return is used as a starting point that gets adjusted upwards to form expectations about call option volatility. I show that the anchoring price lies within the bounds implied by risk-averse expected utility maximization when there are proportional transaction costs. The anchoring model provides a unified explanation for key option pricing puzzles. Two predictions of the anchoring model are empirically tested and found to be strongly supported with nearly 26 years of options data. |
| Keywords: | Anchoring, Implied Volatility Skew, Covered Call Writing, Zero-Beta Straddle, Leverage Adjusted Option Returns |
| JEL: | G02 G12 G13 |
| Date: | 2015–12–30 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:68595&r=upt |
| By: | Schmitt, Rebecca |
| Abstract: | This paper provides a descriptive decision model that is based on a single behavioral pattern: human beings strive for consistency between what they do, what they think and what they perceive. This pattern manifests in the decision maker’s aim to bring his attitudes, beliefs and behavior into balance. Drawing principally on the theory of cognitive dissonance by Festinger (1957), the model shows how the concept of attitudes and the concept of preferences are interwoven by the human need for consistency. It closes the conceptual gap between preferences and attitudes. The model is an alternative approach to additive utility models, such as the one by Fehr and Schmidt (1999). Models of this class are not capable of explaining behavioral discontinuities in the mini ultimatum game. In contrast, the attitude-based model covers this behavioral pattern. |
| Keywords: | Preference Formation, Attitudes, Cognitive Dissonance, Preference Reversal, Additive Utility, Ultimatum Game |
| JEL: | C7 D11 Z1 |
| Date: | 2015–09 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:68480&r=upt |
| By: | Louis R. Eeckhoudt; Roger J. A. Laeven |
| Abstract: | Under expected utility the local index of absolute risk aversion has played a central role in many applications. Besides, its link with the "global" concepts of the risk and probability premia has reinforced its attractiveness. This paper shows that, with an appropriate approach, similar developments can be achieved in the framework of Yaari's dual theory and, more generally, under rank-dependent utility. |
| Date: | 2015–12 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1512.08037&r=upt |
| By: | Cadsby, Bram (University of Guelph); Engle-Warnick, Jim (McGill University); Fang, Tony (Memorial University of Newfoundland); Song, Fei (Ryerson University) |
| Abstract: | Tournaments are widely used to assign bonuses and determine promotions because of the link between relative performance and rewards. However, performing relatively well (poorly) may also yield psychological benefits (pain). This may also stimulate effort. Through a real-effort artefactual field experiment with factory workers and university students as a comparison group in China, we examine how both psychological and financial incentives, together with attitudes toward risk, may influence motivation and performance. We provided performance-ranking information both privately and publicly, with and without rank-based financial incentives. Our results show that performance-ranking information had a significant motivational effect on average performance for students, but not for that of workers. Adding financial incentives based on rank provided little evidence of further improvement. Much of the difference between workers and students can be explained by differences in attitudes toward risk. Indeed, for both groups financial and psychological incentive effects are both inversely related to individual levels of risk aversion, and are positive and significant both for workers and for students who are sufficiently risk-tolerant. |
| Keywords: | tournament, peer pressure, performance feedback, social comparison, incentives, risk aversion, artefactual field experiment |
| JEL: | J30 J24 J33 C93 C91 |
| Date: | 2015–12 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp9565&r=upt |
| By: | Takashi Kamihigashi (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan) |
| Abstract: | This paper shows that regime-switching sunspot equilibria easily arise in a one-sector growth model with aggregate decreasing returns and arbitrarily small externalities. We construct a regime-switching sunspot equilibrium in the case where the utility function of consump-tion is linear. We also construct a stochastic optimal growth model whose optimal process is a regime-switching sunspot equilibrium of the original economy in the case where there is no capital externality. We illustrate our results with numerical examples. |
| Date: | 2015–12 |
| URL: | http://d.repec.org/n?u=RePEc:kob:dpaper:dp2015-42&r=upt |
| By: | Demian Pouzo; Ignacio Presno |
| Abstract: | This paper studies how international investors' concerns about model misspecification affect sovereign bond spreads. We develop a general equilibrium model of sovereign debt with endogenous default wherein investors fear that the probability model of the underlying state of the borrowing economy is misspecified. Consequently, investors demand higher returns on their bond holdings to compensate for the default risk in the context of uncertainty. In contrast with the existing literature on sovereign default, we match the bond spreads dynamics observed in the data together with other business cycle features for Argentina, while preserving the default frequency at historical low levels. |
| Date: | 2015–12 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1512.06960&r=upt |