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on Utility Models and Prospect Theory |
| By: | Martin M. Andreasen (Aarhus University and CREATES); Kasper Jørgensen (Aarhus University and CREATES) |
| Abstract: | This paper extends the class of Epstein-Zin-Weil preferences with a new utility kernel that disentangles uncertainty about the consumption trend (long-run risk) from short-term variation around this trend (cyclical risk). Our estimation results show that these preferences enable the long-run risk model to explain asset prices with a low relative risk aversion (RRA) of 9.8 and a low intertemporal elasticity of substitution (IES) of 0:11. We also show that the proposed preferences allow an otherwise standard New Keynesian model to match the equity premium, the bond premium, and the risk-free rate puzzle with a low IES of 0:07 and a low RRA of 5. |
| Keywords: | Bond premium puzzle, Equity premium puzzle, Long-run risk, Perturbation Approximation, Risk-free rate puzzle. |
| JEL: | E44 G12 |
| Date: | 2016–05–09 |
| URL: | http://d.repec.org/n?u=RePEc:aah:create:2016-16&r=upt |
| By: | Robert E. Hall |
| Abstract: | Over the past few decades, worldwide real interest rates have trended downward. The real interest rate describes the terms of trade between risk-tolerant and risk-averse investors. Debt pays off equally across contingencies at a given future date, so debt is valuable to risk-averse investors to smooth consumption across those contingencies. In an equilibrium with trade between investors who differ in attitudes toward risk, the risk-tolerant investors will borrow from the risk-averse ones, shifting the risk to those whose preferences favor taking on risk. In the case where investors have preferences that are additively separable in future states and in time, attitudes toward risk are heterogeneous among investors if they differ in the curvature of their utility kernels and differ in their beliefs about the probabilities of outcomes, especially adverse outcomes. If the composition of investors shifts toward those with higher curvature (higher coefficients of relative risk aversion) and toward investors who believe in higher probabilities of bad events, the real interest rate falls. The paper calculates likely magnitudes of the decline and presents evidence in favor of a shift in the composition of investors toward the more risk-averse. The downward trend in real interest rates is a significant problem for monetary policy but is helpful to heavily indebted countries. |
| JEL: | E43 G12 |
| Date: | 2016–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:22196&r=upt |
| By: | Alan Moreira; Tyler Muir |
| Abstract: | Managed portfolios that take less risk when volatility is high produce large, positive alphas and increase factor Sharpe ratios by substantial amounts. We document this fact for the market, value, momentum, profitability, return on equity, and investment factors in equities, as well as the currency carry trade. Our portfolio timing strategies are simple to implement in real time and are contrary to conventional wisdom because volatility tends to be high after the onset of recessions and crises when selling is typically viewed as a mistake. Instead, our strategy earns high average returns while taking less risk in recessions. We study the portfolio choice implications of these results. We find volatility timing provides large utility gains to a mean variance investor, with increases in lifetime utility ranging from 50-90%. Contrary to conventional wisdom, we show that long horizon investors can benefit from volatility timing even when time-variation in volatility is completely driven by discount rate volatility. |
| JEL: | G0 G12 |
| Date: | 2016–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:22208&r=upt |
| By: | Chavez, Daniel; Palma, Marco; Collart, Alba J. |
| Abstract: | The literature on choice experiments has been dealing with ways to refine preference elicitation from subjects and predictive power of models. Technological advances such as eye tracking has improved our understanding on how much of the attributes and attribute levels presented to participants is being considered in the decision making process in these kind of experiments. This study investigates subjects’ degree of attendance to attributes and how it influences their choices. The amount of time the subjects spent observing each attribute, relative to all available information on each choice set is used to estimate the attribute attendance. This indicates the revealed attendance to the attributes in the experiment. A simple econometric approach compares the parameter estimates from revealed attribute attendance adjusted models using data from an eye tracking device and a model endogenously inferring the probabilities of using information from each attribute in the choice. The results show that the assumption that participants use all the available information to make their decisions produces significant differences in the parameter estimates, leading to potential bias. The results also illustrate that model fit and predictive power is greatly increased by using revealed attendance levels using eye tracking measures. The most significant improvement however, is to endogenously infer attribute attendance; even more so with revealed attendance indicators. |
| Keywords: | Choice Experiments, Eye-Tracking, Attribute Attendance, Agribusiness, Institutional and Behavioral Economics, Research Methods/ Statistical Methods, C91, C18, |
| Date: | 2016–01–22 |
| URL: | http://d.repec.org/n?u=RePEc:ags:saea16:230011&r=upt |
| By: | Serafin Grundl; Yu Zhu |
| Abstract: | This paper shows point identification in first-price auction models with risk aversion and unobserved auction heterogeneity by exploiting multiple bids from each auction and variation in the number of bidders. The required exclusion restriction is shown to be consistent with a large class of entry models. If the exclusion restriction is violated, but weaker restrictions hold instead, the same identification strategy still yields valid bounds for the primitives. We propose a sieve maximum likelihood estimator. A series of Monte Carlo experiments illustrate that the estimator performs well in finite samples and that ignoring unobserved auction heterogeneity can lead to a significant bias in risk-aversion estimates. In an application to U.S. Forest Service timber auctions we find that the bidders are risk neutral, but we would reject risk neutrality without accounting for unobserved auction heterogeneity. |
| Keywords: | Econometric and statistical methods |
| JEL: | C57 C14 D44 L00 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:16-23&r=upt |
| By: | Wei Ma |
| Abstract: | This paper studies general equilibrium theory, for both complete and incomplete markets, under Knightian uncertainty. Noting that the preference represented by Knightian uncertainty induces a set of complete preferences, we set ourselves the task of inquiring the relationship between an equilibrium under Knightian uncertainty and its counterpart under the induced complete preferences. It is shown that they are actually equivalent. The importance of this result is due toits applications, among which the existence of equilibria under Knightian uncertainty and their computation follow at once from the existing knowledge on general equilibrium theory under complete preferences. Moreover, by means of that equivalence, we are in a position to investigate the problem of efficiency and indeterminacy of equilibria under Knightian uncertainty. |
| Keywords: | general equilibrium, Knightian uncertainty, Pareto optimality |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:rza:wpaper:588&r=upt |
| By: | Murphy, Geraldine; O'Donoghue, Cathal; Hynes, Stephen; Murphy, Eithne |
| Abstract: | Understanding what influences farmers’ decisions to participate in a voluntary agri-environmental scheme (AES) is essential for gauging scheme success. The Rural Environment Protection Scheme (REPS) was a voluntary AES that was available to all Irish farmers from 1994 to 2009. This paper models the participation decision of Irish farmers in REPS using a 15-year panel dataset. The approach taken is novel: actual values for gross outputs, direct costs and working hours are compared to simulated counterfactual values using a conditional logit framework. Model results show that Irish farmers behave rationally by maximising utility from both consumption and leisure but that their preferences differ by region and over time. In addition, the participation functions of viable and non-viable farmers are dissimilar in a number of ways. Policy makers may therefore need to target both groups of farmers using separate schemes in the future. |
| Keywords: | Multiple or Simultaneous Equation Models, Models with Panel Data, Agricultural and Natural Resource Economics, Environmental and Ecological Economics, Agricultural and Food Policy, Environmental Economics and Policy, C33, Q5, |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:ags:iaae15:212517&r=upt |
| By: | Broadway, Barbara (Melbourne Institute of Applied Economic and Social Research); Kalb, Guyonne (Melbourne Institute of Applied Economic and Social Research); Li, Jinhu (Melbourne Institute of Applied Economic and Social Research); Scott, Anthony (Melbourne Institute of Applied Economic and Social Research) |
| Abstract: | This paper analyses doctors' supply of after-hours care, and how it is affected by personal and family circumstances as well as the earnings structure. We use detailed survey data from a large sample of Australian General Practitioners to estimate a structural, discrete-choice model of labour supply and after-hours care. This allows us to jointly model how many daytime-weekday hours a doctor works, and his or her probability of providing after-hours care. The underlying utility function varies across individual and family characteristics. We simulate labour supply responses to an increase in doctors' hourly earnings, both in a daytime-weekday setting and for after-hours care. Among doctors overall, men and women increase their daytime-weekday working hours if their hourly earnings in this setting increases, but only to a very small extent. Men's labour supply elasticities do not change if their family circumstances change, but for women the small behavioural response disappears completely if they have preschool-aged children. Doctors are somewhat more likely to provide after-hours care if their hourly earnings in that setting increases, but again the effect is very small and is only evident in some sub-groups. Moreover, higher earnings in weekday-daytime practice reduces the probability of providing after-hours care, particularly for men. Increasing doctors' earnings appears to be at best relatively ineffective in encouraging increased provision of after-hours care, and may even prove harmful if incentives are not well-targeted. |
| Keywords: | labour supply, after-hours care, wage elasticity, health workforce, MABEL |
| JEL: | I11 J22 J44 J21 |
| Date: | 2016–04 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp9910&r=upt |
| By: | Becchetti, Leonardo (Associazione Italiana per la Cultura della Cooperazione e del Non Profit); Conzo, Pierluigi (Associazione Italiana per la Cultura della Cooperazione e del Non Profit) |
| Abstract: | The life satisfaction literature generally focuses on how life events affect subjective well-being. Through a contingent valuation survey we test whether well-being preferences have significant impact on life satisfaction. A sample of respondents is asked to simulate a policymaker decision consisting in allocating scarce financial resources among 11 well-being domains. Consistently with the utility misprediction hypothesis, we find that the willingness to invest more in the economic well-being domain is negatively correlated with life satisfaction. Our findings are shown to be robust when we account for unobservables related to economic fragility and non-random sample selection. Reverse causality and omitted variable bias are controlled for with instrumental variables and a sensitivity analysis on departures from exogeneity assumptions. Subsample estimates document that the less educated are more affected by the problem. |
| Keywords: | life satisfaction; well-being preferences; utility misprediction; subjective well-being |
| JEL: | A13 D64 H50 I31 |
| Date: | 2014–07–16 |
| URL: | http://d.repec.org/n?u=RePEc:ris:aiccon:2014_137&r=upt |
| By: | Arthur Lewbel (Boston College); Krishna Pendakur (Simon Fraser University) |
| Abstract: | We prove a new identification theorem showing nonparametric identification of the joint distribution of random coefficients in general nonlinear and additive models. This differs from existing random coefficients models by not imposing a linear index structure for the regressors. We then model unobserved preference heterogeneity in consumer demand as utility functions with random Barten scales. These Barten scales appear as random coefficients in nonlinear demand equations. Using Canadian data, we compare estimated energy demand functions with and without random Barten scales. We find that unobserved preference heterogeneity substantially affects the estimated consumer surplus costs of an energy tax. |
| Keywords: | unobserved heterogeneity, nonseparable errors, random utility parameters, random coefficients, equivalence scales, consumer surplus, welfare calculations |
| JEL: | C14 D12 D13 C21 |
| Date: | 2015–11 |
| URL: | http://d.repec.org/n?u=RePEc:sfu:sfudps:dp15-12&r=upt |
| By: | Acikgoz, Omer |
| Abstract: | I prove existence of stationary recursive competitive equilibrium in Bewley economies with production under specifications in which (i) utility function is allowed to be unbounded, and (ii) the underlying discrete idiosyncratic productivity process can take any form, aside from mild restrictions. Some of the intermediate results provide theoretical basis for assumptions often made in the quantitative macroeconomics literature. By providing an example, I illustrate that equilibrium is not necessarily unique, even under typical specifications of the model, and discuss the underlying reasons for multiplicity. |
| Keywords: | Recursive Competitive Equilibrium, Bewley/Huggett/Aiyagari model, Existence, Uniqueness |
| JEL: | C62 E00 E21 |
| Date: | 2015–12–30 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:71066&r=upt |
| By: | Melo, Grace |
| Abstract: | Contingent valuation (CV) or defensive behavior data is often used to estimate the economic value of water quality. Although combining these data (i.e., stated and revealed preferences) mitigates the potential bias from using either type of information, the costs of collecting both could overwhelm the benefits. We attempt to find a convenient estimation method by using a proxy indicator for revealed preferences in the analysis of stated preference data. Specifically, this study explores the effect of individuals’ reported defensive behavior on their stated preferences for groundwater quality. Logit models based on random utility theory were estimated using referendum CV data at household level collected in Maine, US. The results suggest that failure in accounting for defensive behavior in the valuation could result in a bias willingness to pay estimate for groundwater quality. We also found that the monetary value for groundwater quality was small, even though subsoil water constituted an important drinking water supply in the survey period. The results also revealed that respondents’ averting behavior were mainly influenced by their perception of groundwater quality. Implications of our findings for welfare analysis are discussed. |
| Keywords: | contingent valuation, averting behavior, groundwater quality, Environmental Economics and Policy, Research Methods/ Statistical Methods, Q5, Q2, H23, |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:ags:saea16:230001&r=upt |
| By: | Roger E.A. Farmer |
| Abstract: | This paper constructs a general equilibrium model with two types of people where asset price fluctuations are caused by random shocks to the price level that reallocate consumption across generations. In this model, asset prices are volatile, and price-earnings ratios are persistent, even though there is no fundamental uncertainty and financial markets are sequentially complete. I show that the model can explain a substantial risk premium while generating smooth time series for consumption and financial assets across types. In my model, asset price fluctuations are Pareto inefficient and there is a role for treasury or central bank intervention to stabilize asset prices. |
| JEL: | E0 G12 |
| Date: | 2016–05 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:22228&r=upt |
| By: | Williams, Angelica; Coble, Keith H.; Williams, Brian; Dicks, Michael; Knippenberg, Ross |
| Abstract: | This study uses a choice experiment survey to examine pet owner’s preferences for Pet Health Insurance policies. Our results indicate that pet insurance premium, reimbursement level, unlimited benefits and wellness included in pet health insurance plan have significant effects on pet owners' purchase decisions. |
| Keywords: | Health Economics and Policy, Institutional and Behavioral Economics, |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:ags:saea16:230144&r=upt |
| By: | Yasuhiro Sakai (Faculty of Economics, Shiga University) |
| Abstract: | The purpose of this paper is to discuss and compare two giants in the history of economic thought, J.M. Keynes and F.H. Knight, with special reference to risk, probability, and uncertainty. It is in 1921 that both of them published apparently published similar books on the economics of risk and uncertainty. While Knight's contribution on risk and uncertainty is now well recognized, Keynes's accomplishments on probability and uncertainty have been rather ignored in the shadow of his most famous book The General Theory of Employment, Interest and Money (1936). This paper aims to focus on his earlier yet equally important book A Treatise on Probability (1921), and shed a new light on his outstanding ideas and everlasting influences on his later work including The General Theory. It is really interesting to see that Keynes's concept of probability and uncertainty can be well compared to Knight's distinction between a measurable risk and a non-measurable uncertainty. |
| Keywords: | Keynes, Knight, risk, probability, uncertainty |
| Date: | 2016–03 |
| URL: | http://d.repec.org/n?u=RePEc:shg:dpapea:15&r=upt |
| By: | James C. Cox; John A. List; Michael Price; Vjollca Sadiraj; Anya Samek |
| Abstract: | The literature exploring other regarding behavior sheds important light on interesting social phenomena, yet less attention has been given to how the received results speak to foundational assumptions within economics. Our study synthesizes the empirical evidence, showing that recent work challenges convex preference theory but is largely consistent with rational choice theory. Guided by this understanding, we design a new, more demanding test of a central tenet of economics—the contraction axiom—within a sharing framework. Making use of more than 325 dictators participating in a series of allocation games, we show that sharing choices violate the contraction axiom. We advance a new theory that augments standard models with moral reference points to explain our experimental data. Our theory also organizes the broader sharing patterns in the received literature. |
| JEL: | C9 C93 D01 D03 |
| Date: | 2016–05 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:22234&r=upt |
| By: | Jakub Steiner; Colin Stewart; Filip Matejka |
| Abstract: | We solve a general class of dynamic rational-inattention problems in which an agent repeatedly acquires costly information about an evolving state and selects actions. The solution resembles the choice rule in a dynamic logit model, but it is biased towards an optimal default rule that is independent of the realized state. The model provides the same fit to choice data as dynamic logit, but, because of the bias, yields different counterfactual predictions. We apply the general solution to the study of (i) the status quo bias; (ii) inertia in actions leading to lagged adjustments to shocks; and (iii) the tradeoff between accuracy and delay in decision-making. |
| Keywords: | Rational inattention; stochastic choice; dynamic logit; information acquisition |
| JEL: | D81 D83 D90 |
| Date: | 2016–05–04 |
| URL: | http://d.repec.org/n?u=RePEc:tor:tecipa:tecipa-559&r=upt |