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on Utility Models and Prospect Theory |
|
Issue of 2016‒11‒20
twenty-one papers chosen by |
| By: | Fausto Corradin; Domenico Sartore |
| Abstract: | The condition of Risk Aversion implies that the Utility Function must be concave. Taking into account the dependence of the Utility Function on the wealth that in turn depends on the return, we consider a return with any type of two-parameter distribution. It is possible to define Risk and Return as a generic function of these two parameters. This paper determines the Differential Conditions for the definitions of Risk and Return that maintain the Risk Aversion property in the 3D space of the Risk, Return and Expected Utility Function. As a particular case, Standard Deviation, Value at Risk and Expected Shortfall of the Truncated Normal variable with CRRA Utility Function are analyzed. Only the Standard Deviation respects the Differential Conditions and maintains the concavity of the Expected Utility Function downward. |
| Keywords: | Concavity, CRRA Utility Function, Expected Utility Function, Expected Shortfall, Differential Conditions, Quadratic Utility Function, Standard Deviation, Transformation Parametric Functions, Truncated Normal Distribution |
| JEL: | G11 G14 G23 G24 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:ven:wpaper:2016:30&r=upt |
| By: | Jan Heufer (Erasmus University Rotterdam, The Netherlands); Paul van Bruggen (Erasmus University Rotterdam, The Netherlands) |
| Abstract: | Varian (1988) showed that the utility maximization hypothesis cannot be falsified when only a subset of goods is observed. We show that this result does not hold under the assumptions that unobserved prices and expenditures remain constant. These assumptions are naturally satisfied in laboratory settings where the world outside the lab remains unchanged during the experiment. Hence for so-called induced budget experiments the Generalized Axiom of Revealed Preference is a necessary and sufficient condition for utility maximization in general, not just in the lab. Lab experiments are therefore a valid tool to put the utility maximization hypothesis to the test. |
| Keywords: | Afriat's Theorem; Experimental Economics; GARP; Revealed Preference; Utility Maximization |
| JEL: | C14 C91 D11 D12 |
| Date: | 2016–11–10 |
| URL: | http://d.repec.org/n?u=RePEc:tin:wpaper:20160095&r=upt |
| By: | Jong-Hee Hahn (Yonsei University); Jinwoo Kim (Seoul National University); Sang-Hyun Kim (University of East Anglia); Jihong Lee (Seoul National University) |
| Abstract: | This paper proposes a theory of price discrimination based on consumer loss aver- sion. A seller offers a menu of bundles before a consumer learns his willingness to pay, and the consumer experiences gain-loss utility with reference to his prior (rational) ex- pectations about contingent consumption. With binary consumer types, the seller fnds it optimal to abandon screening under an intermediate range of loss aversion if the low willingness-to-pay consumer is suffciently likely. We also identify suffcient conditions under which partial or full pooling dominates screening with a continuum of types. Our predictions are consistent with several observed practices of price discrimination. |
| Keywords: | Reference-dependent preferences, loss aversion, price discrimination, per- sonal equilibrium, preferred personal equilibrium. |
| JEL: | D03 D42 D82 D86 L11 |
| Date: | 2016–11 |
| URL: | http://d.repec.org/n?u=RePEc:yon:wpaper:2016rwp-97&r=upt |
| By: | Dominique, C-Rene |
| Abstract: | Concepts such as marginal utility, expected-utility, etc. are severely criticized in some quarters where economists are accused of performing mathematical operations in ordinal spaces. Haplessly, economists’ counterclaims are far from being substantive. This note shows that there exists an order-isomorphism relating preference ordering to a substantive set of real numbers and thus obviates the need for a utility index. |
| Keywords: | Ordinal Spaces, Binary Relation, Poset, Total Pre-ordering, Isomorphisms. |
| JEL: | D4 D5 |
| Date: | 2016–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:75030&r=upt |
| By: | Oechssler, Jörg; Rau, Hannes; Roomets, Alex |
| Abstract: | We run an experiment that gives subjects the opportunity to hedge away ambiguity in an Ellsberg-style experiment. Subjects are asked to make two bets on the same draw from an ambiguous urn, with a coin flip deciding which bet is paid. By modifying the timing of the draw, coin flip, and decision, we are able to test the reversal-of-order axiom, particularly as it relates to the ability of the Random-Lottery Incentive System (RLIS) to prevent cross-task contamination in an ambiguity setting. We find that we cannot reject that the reversal-of-order axiom holds. This suggests that hedging could still be possible when carefully implementing RLIS. However, we also find low levels of ambiguity hedging across the board, suggesting the existence of the hedging possibility does not necessarily represent a common problem in ambiguity experiments. |
| Keywords: | Ellsberg paradox; hedging; reversal of order axiom; experiment. |
| Date: | 2016–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:awi:wpaper:621&r=upt |
| By: | John Bryant (Vocat International) |
| Abstract: | Chapter from a book entitled Entropy Man, which deals with the relationships between the disciplines of thermodynamics and economics. Chapter 1 illusrates how entropy impacts on the world in which we live. Chapter 2 is a short history of human development. Chapter 3 covers such concepts as the distribution of income, elasticity, the first and second laws of thermodynamics and utility. Chapter 4 explores production and consumption. Chapter 5 explores the relationship between economic entropy and money, illustrated by data of the UK and USA economies. Chapter 7 explores the relationship between economic entropy and employment. Chapter 8 sets out the key dynamics of resources.Chapter 9 illustrates trends in non-renewable resources of oil, gas, coal, nuclear power, steel, cement and Aluminium. Chapter 10 illustrates trends in renewable resources, including humankind, water, land and soil, cereals and grain, meat, fish, the greeen revolution, and renewable energy, including hydro-electric power, wind and solar energy. Chapter 11 is a summary of trends relating to climate change and economic output, and chapter 12 summarises how economics and entropy relate to a sustainable world. |
| Keywords: | Thermodynamics, economics, Le Chatelier, entropy, utility, money, equilibrium, value, energy, interest, elasticity, employment, climate change |
| JEL: | A1 C02 C68 D5 E O |
| Date: | 2015–03 |
| URL: | http://d.repec.org/n?u=RePEc:voc:wpaper:em201502&r=upt |
| By: | John Bryant (Vocat International) |
| Abstract: | Chapter from a book entitled Entropy Man, which deals with the relationships between the disciplines of thermodynamics and economics. Chapter 1 illusrates how entropy impacts on the world in which we live. Chapter 2 is a short history of human development. Chapter 3 covers such concepts as the distribution of income, elasticity, the first and second laws of thermodynamics and utility. Chapter 4 explores production and consumption. Chapter 5 explores the relationship between economic entropy and money, illustrated by data of the UK and USA economies. Chapter 7 explores the relationship between economic entropy and employment. Chapter 8 sets out the key dynamics of resources.Chapter 9 illustrates trends in non-renewable resources of oil, gas, coal, nuclear power, steel, cement and Aluminium. Chapter 10 illustrates trends in renewable resources, including humankind, water, land and soil, cereals and grain, meat, fish, the greeen revolution, and renewable energy, including hydro-electric power, wind and solar energy. Chapter 11 is a summary of trends relating to climate change and economic output, and chapter 12 summarises how economics and entropy relate to a sustainable world. |
| Keywords: | Thermodynamics, economics, Le Chatelier, entropy, utility, money, equilibrium, value, energy, interest, elasticity, employment, climate change |
| JEL: | A1 C02 C68 D5 E O |
| Date: | 2015–03 |
| URL: | http://d.repec.org/n?u=RePEc:voc:wpaper:em201506&r=upt |
| By: | Sanjit Dhami; Mengxing Wei; Ali al-Nowaihi |
| Abstract: | We consider a public goods game which incorporates guilt-aversion/surprise- seeking and the attribution of intentions behind these emotions (Battigalli and Dufwenberg, 2007; Khalmetski et al., 2015). We implement the induced beliefs method (Ellingsen et al., 2010) and a within-subjects design using the strategy method. Previous studies mainly use dictator games - whose results may not be robust to adding strategic components. We …nd that guilt-aversion is far more important than surprise-seeking; and that the attribution of intentions behind guilt- aversion/surprise-seeking is important. Our between-subjects analysis confirms the results of the within-subjects design. |
| Keywords: | Public goods games; psychological game theory; surprise-seeking/guilt- aversion; attribution of intentions; induced beliefs method; strategy method; within- subjects design. |
| JEL: | D01 D03 H41 |
| URL: | http://d.repec.org/n?u=RePEc:lec:leecon:16/17&r=upt |
| By: | John Bryant (Vocat International) |
| Abstract: | Chapter from a book entitled Entropy Man, which deals with the relationships between the disciplines of thermodynamics and economics. Chapter 1 illustrates how entropy impacts on the world in which we live. Chapter 2 is a short history of human development. Chapter 3 covers such concepts as the distribution of income, elasticity, the first and second laws of thermodynamics and utility. Chapter 4 explores production and consumption. Chapter 5 explores the relationship between economic entropy and money, illustrated by data of the UK and USA economies. Chapter 7 explores the relationship between economic entropy and employment. Chapter 8 sets out the key dynamics of resources. Chapter 9 illustrates trends in non-renewable resources of oil, gas, coal, nuclear power, steel, cement and Aluminium. Chapter 10 illustrates trends in renewable resources, including humankind, water, land and soil, cereals and grain, meat, fish, the greeen revolution, and renewable energy, including hydro-electric power, wind and solar energy. Chapter 11 is a summary of trends relating to climate change and economic output, and chapter 12 summarises how economics and entropy relate to a sustainable world. |
| Keywords: | Thermodynamics, economics, Le Chatelier, entropy, utility, money, equilibrium, value, energy, interest, elasticity, employment, climate change |
| JEL: | A1 C02 C68 D5 E O |
| Date: | 2015–03 |
| URL: | http://d.repec.org/n?u=RePEc:voc:wpaper:em201501&r=upt |
| By: | Horst Hanusch (Institute of Economics, University of Augsburg, Augsburg) |
| Abstract: | The study intends (1) to look at the importance of individual rationality as the main principle of economic behaviour, incorporated best in the concept of "homo oeconomicus". (2) to show how the third technological revolution, the "digitalization of society", may transform individual behaviour in the three pillars of an economic system (real, financial, public). One major achievement of main stream economics of Western style is the "homo oeconomicus". Behind this concept stands the idea of rational man relevant for all parts in economic systems. It allows a consequent application of profit and efficiency maximizing in the real and financial sector and of vote and utility maximization in the public sector as agents' behaviour. Psychology, sociology, behaviourism, anthropology are strictly against the idea of the "homo oeconomicus". Evolutionary and Neo-Schumpeterian Economics also claim that it is wrong because it doesn’t allow to include uncertainty considerations which are a condition sine-qua-non for innovation, change and prosperity. But, is this concept completely wrong? Or is it perhaps relevant for specific parts of an economic system, if they develop within the process of digital revolution? These are the questions which will be tackled in the paper. The analysis will follow a comprehensive approach, looking at the three institutional pillars of an economy, the financial, the real and the public sector trying to work out the effects of digitalization on the patterns of behaviour. All in all, the effects of digitalization can be summarized as follows: In the financial pillar it modifies the culture of doing business from "symbiotic capitalism" to "financial capitalism" with prevailing olympic rationality. In the industrial pillar it induces changes from short term maximizing "managerial capitalism" to a long term oriented "entrepreneurial capitalism". In the public pillar it may open ways to institutional change, at least partially, from a "bureaucratic tax state" to a system of "social capitalism" with high potentials for enabling individual creativity and resilience capabilities. |
| Keywords: | Behavioural Economics , Neo-Schumpeterianism |
| JEL: | B52 D00 O1 |
| Date: | 2016–11 |
| URL: | http://d.repec.org/n?u=RePEc:aug:augsbe:0330&r=upt |
| By: | Jean-Robert Tyran (Department of Economics, University of Copenhagen); Alexander K. Wagner (The Vienna Center for Experimental Economics, University of Vienna) |
| Abstract: | Standard economic reasoning assumes that people vote instrumentally, i.e., that the sole motivation to vote is to influence the outcome of an election. In contrast, voting is expressive if voters derive utility from the very act of expressing support for one of the options by voting for it, and this utility is independent of whether the vote affects the outcome. This paper surveys experimental tests of expressive voting with a particular focus on the low-cost theory of expressive voting. The evidence for the low-cost theory of expressive voting is mixed. |
| Keywords: | Expressive Voting, Experiment, Public Choice, Political Economy |
| JEL: | C91 C92 D72 |
| Date: | 2016–09–12 |
| URL: | http://d.repec.org/n?u=RePEc:kud:kuiedp:1612&r=upt |
| By: | Konstantinos Georgalos; Enrica Carbone; Gerardo Infante |
| Abstract: | This paper focuses on comparing individual and group decision making, in a stochastic inter-temporal problem in two decision environments, namely risk and ambiguity. Using a consumption/saving laboratory experiment, we investigate behaviour in four treatments: (1) individual choice under risk; (2) group choice under risk; (3) individual choice under ambiguity and (4) group choice under ambiguity. Comparing decisions within and between decision environments, we find an anti-symmetric pattern. While individuals are choosing on average closer to the theoretical optimal predictions, compared to groups in the risk treatments, groups tend to deviate less under ambiguity. Within decision environments, individuals deviate more when they choose under ambiguity, while groups are better planners under ambiguity rather than under risk. We argue that the results might be driven by differences in the levels of ambiguity and risk attitudes between individuals and groups, extending the frequently observed pattern of groups behaving closer to risk and ambiguity neutrality, to its dynamic dimension. |
| Keywords: | Risk, Ambiguity, Inter-temporal Optimisation, Group Decision Making, Learning, Experiment |
| JEL: | C91 C92 D11 D91 E21 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:lan:wpaper:138739716&r=upt |
| By: | Belzil, Christian (Ecole Polytechnique, Paris); Sidibé, Modibo (Duke University) |
| Abstract: | Using a unique field experiment from Canada, we estimate individual preference over risk and time and show considerable heterogeneity in both dimensions and relatively stable distributions across our various specifications, which include hyperbolic, quasi-hyperbolic discounting as well as subjective failure probability over future payments. We investigate the predictive power (transportability) of the estimated preference parameters when used to explain the take-up decision of higher education grants where financial stakes are approximately seven to fifty times larger than the cash transfers used to elicit preferences. We find that both long-run discount factors and subjective payment failure risk parameters have a high degree of transportability across tasks, while parameters characterizing short-run discount preferences are irrelevant when considering higher-stakes decisions. |
| Keywords: | discounting, risk aversion, time inconsistency, transportability |
| JEL: | C91 D12 D81 |
| Date: | 2016–11 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp10348&r=upt |
| By: | Niu, Cuizhen; Wong, Wing-Keung; Zhu, Lixing |
| Abstract: | Farinelli and Tibiletti (2008) propose a general risk-reward performance measurement ratio. Due to its simplicity and generality, the F-T ratios have gained much attentions. F-T ratios are ratios of average gains to average losses with respect to a target, each raised by some power index. Omega ratio and Upside Potential ratio are both special cases of F-T ratios. In this paper, we establish the consistency of F-T ratios with respect to first-order stochastic dominance. It is shown that second-order stochastic dominance is not consistent to the F-T ratios. This point is illustrated by a simple example. |
| Keywords: | Stochastic Dominance, Upside Potential Ratio, Farinelli and Tibiletti ratio. |
| JEL: | C00 D81 G10 |
| Date: | 2016–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:75027&r=upt |
| By: | Cettolin, Elena; Riedl, Arno (General Economics 1 (Micro)); Tran, Thu Giang (General Economics 1 (Micro)) |
| Abstract: | The decision how to share resources with others often needs to be taken under uncertainty on its allocational consequences. Although risk preferences are likely important, existing research is silent about how social and risk preferences interact in such situations. In this paper we provide experimental evidence on this question. In a first experiment givers are not exposed to risk while beneficiaries’ final earnings may be larger or smaller than the allocation itself, depending on the realized state of the world. In a second experiment, risk affects the earnings of givers but not of beneficiaries. We find that individuals’ risk preferences are predictive for giving in both experiments. Increased risk exposure of beneficiaries tends to decrease giving whereas increased risk exposure of givers has no effect. Giving under risk is strongly correlated with giving in the absence of risk. We find limited support for existing models of ex-post and ex-ante fairness. Our results point to the importance of incorporating risk preferences in models of social preferences. |
| JEL: | C91 D03 D64 D81 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:unm:umagsb:2016035&r=upt |
| By: | Chan, Raymond H.; Clark, Ephraim; Wong, Wing-Keung |
| Abstract: | This paper presents some interesting new properties of third order stochastic dominance (TSD) for risk-averse and risk-seeking investors. We show that the means of the assets being compared should be included in the definition of TSD for both investor types. We also derive the conditions on the variance order of two assets with equal means for both investor types and extend the second order SD (SSD) reversal result of Levy and Levy (2002) to TSD. We apply our results to analyze the investment behaviors on traditional stocks and internet stocks for both risk averters and risk seekers. |
| Keywords: | Third order stochastic dominance, expected-utility maximization, risk aversion, risk seeking, investment behaviors. |
| JEL: | C00 G11 |
| Date: | 2016–11–10 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:75002&r=upt |
| By: | Lee Endress (Department of Economics, University of Hawaii at Manoa; UHERO); James Roumasset (Department of Economics, University of Hawaii at Manoa; UHERO); Christopher Wada (Department of Economics, University of Hawaii at Manoa; UHERO) |
| Abstract: | We consider the prospects for sustainable growth using expected utility models of optimal investment under threat from a natural disaster. Extension of a discrete, two-period model, to continuous time over an infinite time horizon permits the analysis of sustainability under uncertainty regarding adverse events, including both one-time and recurrent disasters. Natural disasters, with destruction of productive capital, disrupt the optimal consumption and utility paths, but the Arrow et al. (2004) sustainability criterion is still satisfied even without adding strong or weak sustainability constraints. We also consider a separate natural resource sector and show that, except for extreme cases, the optimal steady state level of the renewable resource is not affected by the possibility of natural disasters. In the case of catastrophic events, however, damage to the resource system may be severe enough to push the system below a critical value tipping point, undermining the prospects of long-run sustainability. |
| Keywords: | sustainable growth, natural disaster, expected utility, golden rule, Hotelling, Ramsey |
| JEL: | O4 Q2 |
| Date: | 2016–11 |
| URL: | http://d.repec.org/n?u=RePEc:hae:wpaper:2016-12&r=upt |
| By: | Wulf, David; Bertsch, Valentin |
| Abstract: | Multi-Criteria Decision Analysis (MCDA) enables decision makers (DM) and decision analysts (DA) to analyse and understand decision situations in a structured and formalised way. With the increasing complexity of decision support systems (DSSs), it becomes challenging for both expert and novice users to understand and interpret the model results. Natural language generation (NLG) techniques are used in various DSSs to cope with this challenge as they reduce the cognitive effort to achieve understanding of decision situations. However, NLG techniques in MCDA have so far mainly been developed for deterministic decision situations or one-dimensional sensitivity analyses. In this paper, a concept for the generation of textual explanations for a multi-dimensional preferential sensitivity analysis in MCDA is developed. The key contribution is a NLG approach that provides detailed explanations of the implications of preferential uncertainties in Multi-Attribute Value Theory (MAVT). It generates a report that assesses the influences of simultaneous or separate variations of inter-criteria and intra-criteria preferential parameters determined within the decision analysis. We explore the added value of the natural language report in an online survey. Our results show that the NLG approach is particularly beneficial for difficult interpretational tasks. |
| Keywords: | Decision support systems; Multiple criteria analysis; Preferential uncertainty modelling; Natural language generation; Multi-dimensional preferential sensitivity analysis |
| JEL: | C6 Q48 |
| Date: | 2016–10–27 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:75025&r=upt |
| By: | Raman Uppal (Edhec Business School); Harjoat Bhamra (Imperial College Business School) |
| Abstract: | A common criticism of behavioral economics is that it has not shown that individual investors' biases lead to aggregate long-run effects on both asset prices and macroeconomic quantities. Our objective is to address this criticism in a production economy where individual portfolio biases cancel when summed across investors, but still have an effect on aggregate quantities in the long-run. We solve in closed form a model of a stochastic general-equilibrium production economy with a large number of heterogeneous firms and investors. Investors are ambiguity averse, so they hold portfolios biased toward familiar assets. We specify this bias to be unsystematic - it cancels out when aggregated across investors. However, each investor bears more risk than necessary, which distorts the consumption of all investors in the same direction. Hence, distortions in consumption do not cancel out in aggregate and increasing the price of risk and distorting aggregate investment and growth. The increased risk from holding biased portfolios, which increases the demand for the risk-free asset, leading to a higher equity risk premium and lower risk-free rate that match empirical values. Our analysis illustrates that idiosyncratic behavioral biases can have long-run distortionary effects on both financial markets and the macroeconomy |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed016:1358&r=upt |
| By: | Somayeh Koohborfardhaghighi (College of Engineering, Seoul National University); Jorn Altmann (College of Engineering, Seoul National University) |
| Abstract: | In this study, we provide an interaction model based on complex adaptive system theory, to explain how different methods of network growth and strategic responses of existing network members towards them impact the outcome of networked individuals (i.e., utility gain at the individual level or a society’s collective utility known as social welfare). The proposed interaction model allows us to perform our experiments with dynamic utility computation, while individuals act strategically in response to what other individuals do in the network. We utilized the formulation of the co-author model, as it augments the concept of network structure for modeling individuals’ utilities. The experimental results show that different methods of a network growth lead to different networking outcome for its members. We observed that total networking outcome is the highest (with respect to the co-author model), if newly entered individuals establish their links strategically to other existing members in a way to maximize their own payoffs. We believe that reduction in the total utility due to strategic responses within the network is acceptable in exchange of having a homogenous utility distribution within the population. Our observations give us the idea that, with the help of strategic responses, central network members can be prevented from gaining very high utilities compared to others. Furthermore, network structures can be prevented, in which the utilities of network members are widely dispersed. In such a setting, individuals experience no discrimination in utility gain against other people in their community. |
| Keywords: | Co-Author Model; Social Welfare; Strategic Behavior; Utility Maximization; Network Growth Models; Complex Adaptive System Approach; Agent-based Modeling and Simulation. |
| JEL: | A13 C02 C15 C63 C73 D85 |
| Date: | 2016–08 |
| URL: | http://d.repec.org/n?u=RePEc:snv:dp2009:2016131&r=upt |
| By: | Somayeh Koohborfardhaghighi (College of Engineering, Seoul National University); Jorn Altmann (College of Engineering, Seoul National University) |
| Abstract: | Person-to-person interactions within an organization form a network of people. Changes of the structural properties of these networks are caused through a variety of dynamic processes among the people. We argue in this paper that there is a feedback loop between individual actions and the network structure. Therefore, a proper interaction model is needed to explain the emerging structural changes among networked individuals. According to our proposed interaction model, which is based on a complex adaptive system approach, changes in the network properties are consequences of four factors: (1) the initial underlying network structures; (2) the process of network growth; (3) the adoption of strategic responses to what other individuals do in the network; and (4) the network visibility. The experimental results show that all of these factors have influence. If the process of network growth triggers strategic responses of all direct neighbors, we observe a heavy drop in the average shortest path length between the individuals. The value of the average shortest path length shrinks to three, even independently of the visibility of the global network topology. We observe the same trend for the clustering coefficient. Fluctuations in the clustering coefficients are not significant, if visibility of the network topology is set to a high value. However, in the presence of only small number of strategic responses and a high network visibility, a short average shortest path length and a high clustering coefficient can be observed. |
| Keywords: | Co-Author Model; Strategic Behavior; Utility Maximization; Network Growth Models; Complex Adaptive System Approach; Agent-based Modeling and Simulation. |
| JEL: | A13 C02 C15 C63 C73 D85 |
| Date: | 2016–08 |
| URL: | http://d.repec.org/n?u=RePEc:snv:dp2009:2016130&r=upt |