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on Utility Models and Prospect Theory |
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Issue of 2017‒04‒09
nineteen papers chosen by |
| By: | Bao, Helen X. H. (Asian Development Bank Institute); Meng, Charlotte Chunming (Asian Development Bank Institute) |
| Abstract: | Loss aversion is a core concept in prospect theory that refers to people’s asymmetric attitudes with respect to gains and losses. More specifically, losses loom larger than gains. With the capability of loss aversion to explain economic phenomena, some of which are puzzling under expected utility theory, this concept has received significant attention. We develop a behavioral model of loss aversion to explain the development decisions by residential property developers in the People’s Republic of China. Under the leasehold property right system, real estate development has two stages—first to lease land from the government, and then to develop the property according to the lease terms. This presents a unique opportunity to test the presence and effect of loss aversion in real estate development decisions. More specifically, we determine when the land premium paid by a developer is substantially higher than the market value, whether and how this “paper loss” will affect the pricing of the housing products and development time of the project in future development. We use a sample of land and house transaction records from Beijing to test the hypothesis. This is the first study to use a semi-parametric model in estimating developers’ loss aversion. Results show that developers are most prone to loss aversion bias around the reference point or when facing large losses. The results also suggest that loss aversion contributes to the cyclical trading pattern in housing markets. |
| Keywords: | loss aversion; real estate; residential property; housing; housing prices; housing market; semi-parametric estimation |
| JEL: | C14 D81 R31 |
| Date: | 2017–01–18 |
| URL: | http://d.repec.org/n?u=RePEc:ris:adbiwp:0640&r=upt |
| By: | Amnon Maltz (Department of Economics, University of Haifa) |
| Abstract: | We develop a reference dependent model with an initial endowment and in a world where alternatives are grouped into categories. The model creates a link between the agent's exogenous endowment and her endogenous reference point. The actual refer- ence point is the best feasible alternative, according to the agent's preferences, which belongs to her endowment's category. This endogenous reference point induces a con- straint set from which the nal choice is made according to utility maximization. The model gives rise to category bias which generalizes the status quo bias by attracting the agent to her endowment's category but not necessarily to the endowment itself. We show that it accommodates recent experimental ndings regarding the presence and absence of status quo bias in the realm of uncertainty. We apply the model to a stylized nancial setup and show that it may lead to a risk premium even with risk neutral agents |
| Keywords: | Categories, Status Quo Bias, Reference Dependence, Risk Premium, Re- vealed Preference |
| JEL: | D03 D11 |
| URL: | http://d.repec.org/n?u=RePEc:haf:huedwp:wp201605&r=upt |
| By: | Qin, Wei-zhi; Rommeswinkel, Hendrik |
| Abstract: | Advances in behavioral economics have made decision theoretic models increasingly complex. Utility models incorporating insights from psychology often lack additive separability, a major obstacle for decision theoretic axiomatizations. We address this challenge by providing representation theorems which yield utility functions of the form u(x,y,z)=f(x,z) + g(y,z). We call these representations conditionally separable as they are additively separable only once holding fixed z. Our representation theorems have a wide range of applications. For example, extensions to finitely many dimensions yield both consumption preferences with reference points Sum_i u_i(x_i,r), as well as consumption preferences over time with dependence across time periods Sum_t u_t(x_t,x_{t-1}). |
| Keywords: | utility; representation theorem; additive; conditionally additive; ordered space |
| JEL: | D01 D03 D11 |
| Date: | 2017–04–06 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:78158&r=upt |
| By: | Amnon Maltz (University of Haifa, Department of Economics); Giorgia Romagnoli (University of Amsterdam) |
| Abstract: | Individuals' tendency to stick to the current state of a airs, known as the status quo bias, has been widely documented over the past 30 years. Yet, the determinants of this phenomenon remain elusive. Following the intuition suggested by Bewley (1986), we conduct a systematic experiment exploring the role played by di erent types of uncertainty on the emergence of the bias. We nd no bias when the status quo option and the alternative are both risky (gambles with known probabilities) or both ambiguous (gambles with unknown probabilities). The bias emerges under asymmetric presence of ambiguity, i.e., when the status quo option is risky and the alternative ambiguous, or vice versa. These ndings are not predicted by existing models based on loss aversion (Kahneman and Tversky, 1979) or incomplete preferences (Bewley, 1986) and suggest a novel determinant of the status quo bias: the dissimilarity between the status quo option and the alternative |
| Keywords: | Status Quo Bias, Risk, Ambiguity, Reference E ects, Experiment |
| JEL: | C91 D11 D81 |
| URL: | http://d.repec.org/n?u=RePEc:haf:huedwp:wp201706&r=upt |
| By: | John K. Dagsvik (Statistics Norway); Steinar Strøm |
| Abstract: | When the budget set is non-convex the application of the Hausman approach to estimate labor supply functions will in general be cumbersome because labor supply no longer depends solely on marginal criteria (first order conditions). In this paper we demonstrate that the conventional continuous labor supply model (including corner solution for non-participation) with non-convex budget sets in some cases can be estimated using only first order conditions provided the budget curve is continuously differentiable and the utility function belongs to a particular class. We subsequently discuss how the model can be specified econometrically. Finally, we discuss the application of the model to simulate the effect of counterfactual reforms. |
| Keywords: | Labor supply; non-convex budget sets; marginal criteria |
| JEL: | C51 J22 |
| Date: | 2017–03 |
| URL: | http://d.repec.org/n?u=RePEc:ssb:dispap:857&r=upt |
| By: | Anika Jansen (Federal Institute for Vocational Education and Training (BIBB), Bonn); Harald Pfeifer (Federal Institute for Vocational Education and Training (BIBB), Bonn, and Research Centre for Education and the Labour Market (ROA), Maastricht); Julia Raecke (Federal Institute for Vocational Education and Training (BIBB), Bonn) |
| Abstract: | In this paper, we study the relation between decision makers’ preferences and training investments of their firms. First, we develop a theoretical framework, which takes the possibility into account that individual preferences of decision makers may influence firm behavior with respect to training. We then develop and test the hypothesis that the willingness to take risks or the preference for future profits of decision makers is positively related and procrastination negatively related to firms’ investment in worker training. Using unique firm-level data, including both person-level preference measures and firm-level information about training costs, we find empirical support for our hypothesis. Training investment is higher in firms with risk-inclined decision makers and lower in firms with procrastinating decision makers. The preference for future profits is relevant for training participation and the number of trained workers, but not for the training investment per worker. The results imply that firms have scope to adjust their profit-maximizing strategies by taking the individual preferences of their decision makers into account. |
| Keywords: | Risk and time preferences, training investment, profit maximization |
| JEL: | J24 J31 |
| Date: | 2017–03 |
| URL: | http://d.repec.org/n?u=RePEc:iso:educat:0124&r=upt |
| By: | Groneck, Max; Ludwig, Alexander; Zimper, Alexander |
| Abstract: | On average young people "undersave" whereas old people "oversave" with respect to the rational expectations model of life-cycle consumption and savings. According to numerous studies on subjective survival beliefs, young people also "underestimate" whereas old people "overestimate" their objective survival chances on average. We take a structural behavioral economics approach to jointly address both empirical phenomena by embedding subjective survival beliefs that are consistent with these biases into a rank-dependent utility (RDU) model over life-cycle consumption. The resulting consumption behavior is dynamically inconsistent. Considering both naive and sophisticated RDU agents we show that within this framework underestimation of young age and overestimation of old age survival probabilities may (but need not) give rise to the joint occurrence of undersaving and oversaving. In contrast to this RDU model, the familiar quasi-hyperbolic discounting (QHD), which is nested as a special case, cannot generate oversaving. |
| Keywords: | saving puzzles,subjective survival beliefs,behavioral economics,prospect theory,neo-additive probability weighting,dynamic inconsistency,sophisticated versus naive behavior,quasi-hyperbolic discounting |
| JEL: | D91 D83 E21 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:safewp:169&r=upt |
| By: | Louis Raymond Eeckhoudt (Department of Economics (University of Verona)); Elisa Pagani (Department of Economics (University of Verona)); Emanuela Rosazza Gianin (Department of Statistics and Quantitative Methods, University of Milano-Bicocca, Via Bicocca degli A) |
| Abstract: | The notion of prudence was very useful in economics to analyze saving or self protection decisions. We show in this note that, following Ben-Tal and Teboulle (2007), it is also relevant to develop risk measures. |
| Keywords: | Utility Theory, Certainty Equivalent, Prudence Premium, Risk Measure. |
| JEL: | D31 D81 G11 |
| Date: | 2016–05 |
| URL: | http://d.repec.org/n?u=RePEc:ver:wpaper:07/2016&r=upt |
| By: | Marc Fleurbaey (Woodrow Wilson School and Center for Human Values - Princeton University [Pinceton]); Stéphane Zuber (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics) |
| Abstract: | Utilitarianism is a prominent approach to social justice that has played a central role in economic theory. A key issue for utilitarianism is to define how utilities should be measured and compared. This paper draws on Harsanyi's approach (Harsanyi, 1955) to derive utilities from choices in risky situations. We introduce a new normalization of utilities that ensures that: 1) a transfer from a rich to a poor is welfare enhancing, and 2) populations with more risk averse people have lower welfare. We propose normative principles that reflect these fairness requirements and characterize fair utilitarianism. We also study some implications of fair utilitarianism for risk sharing and collective risk aversion. |
| Keywords: | Fairness,utilitarianism,risk sharing,collective risk aversion |
| Date: | 2017–01 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-01441070&r=upt |
| By: | Dionne, Georges (HEC Montreal, Canada Research Chair in Risk Management); Harrington, Scott (University of Pennsylvania) |
| Abstract: | Kenneth Arrow and Karl Borch published several important articles in the early 1960s that can be viewed as the beginning of modern economic analysis of insurance activity. This chapter reviews the main theoretical and empirical contributions in insurance economics since that time. The review begins with the role of utility, risk, and risk aversion in the insurance literature and then summarizes work on the demand for insurance, insurance and resource allocation, moral hazard, and adverse selection. It then turns to financial pricing models of insurance and to analyses of price volatility and underwriting cycles; insurance price regulation; insurance company capital adequacy and capital regulation; the development of insurance securitization and insurance-linked securities; and the efficiency, distribution, organizational form, and governance of insurance organizations. |
| Keywords: | Insurance; insurance market; risk sharing; moral hazard; adverse selection; demand for insurance; financial pricing of insurance; price volatility; insurance regulation; capital regulation; securitization; insurance-linked security; organization form; governance of insurance firms. |
| JEL: | D80 D81 D82 G22 G30 |
| Date: | 2017–03–30 |
| URL: | http://d.repec.org/n?u=RePEc:ris:crcrmw:2017_002&r=upt |
| By: | Sanjit Dhami; Ali al-Nowaihi |
| Abstract: | The evidence for other-regarding preferences is extensive. How should an individual with other-regarding preferences compare two distinct distributions of income? We show that the classical concepts of first and second order stochastic dominance are inadequate to answer this question. We develop the relevant stochastic dominance concepts for the case of the popular other-regarding preferences in Fehr and Schmidt (1999) that we call FS preferences; we consider the linear and non-linear forms of FS preferences. These new dominance concepts, that we call first and second order FS dominance provide sufficient conditions for ranking income distributions. We show that our concepts can be extended to uncertainty and are applicable to some other models of other-regarding preferences. Our use of a discrete framework is empirically realistic and avoids measure theoretic issues arising under the continuous case. |
| Keywords: | Other-regarding preferences; first order FS dominance; second order FS dominance; weak FS dominance. |
| JEL: | D03 D63 D64 |
| Date: | 2017–03 |
| URL: | http://d.repec.org/n?u=RePEc:lec:leecon:17/12&r=upt |
| By: | Paul Pezanis-Christou (School of Economics, University of Adelaide); Hang Wu (Centre for Behavioural Economics, National University of Singapore) |
| Abstract: | We propose a novel approach to the modelling of bidding behavior in pay-your-bid auctions that builds on the presumption that bidders are mostly concerned with losing an auction if they happen to have the highest signal. Our models assume risk neutrality, no profit maximization and no belief about competitors' behavior. They may entail overbidding in first-price and all-pay auctions and we discuss conditions for the revenue equivalence of standard pay-your-bid auctions to hold. We fit the models to the data of first-price auction experiments and find that they do at least as well as VickreyÂ’s benchmark model for risk neutral bidders. Assuming probability misperception or impulse weighting (when relevant) improves their goodness-of-fit and leads to very similar revenue predictions. An analysis of individuals' heterogeneous behavioral traits suggests that impulse weighting is a more consistent rationale for the observed behavior than a power form of probability misperception. |
| Keywords: | first-price auctions, all-pay auctions, impulse balance equilibrium, overbidding, bounded rationality, probability distortion, regret, experiments. |
| JEL: | C44 C72 D44 L2 |
| Date: | 2017–03 |
| URL: | http://d.repec.org/n?u=RePEc:adl:wpaper:2017-03&r=upt |
| By: | Odegaard, Bernt Arne (UiS) |
| Abstract: | We characterize the equity holding periods for all equity owners in a stock market over a 15 year period. The median holding period is 0.75 years. The hazard function for equity ownership is characterized by negative aging, an equity owner is less and less likely to realize a position as time passes. There are clear differences between owner types, where private individuals have the longest holding periods, and financial owners are the least patient. Wealthier households have shorter holding periods. Using turnover to estimate holding periods severely over-estimates actual holding periods. |
| Keywords: | Equity Holding period; Duration; Failure Time; Survival |
| JEL: | D14 G11 G12 |
| Date: | 2017–03–30 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:stavef:2017_006&r=upt |
| By: | Ismaël Rafaï (Université Côte d'Azur, France; GREDEG CNRS); Mira Toumi (Université Côte d'Azur, France; GREDEG CNRS) |
| Abstract: | We investigate the impact of monetary incentives on individual attention allocation. We propose a new experimental design where the participants invest costly attention to reduce uncertainty in a two alternatives forced choice task. We compare three different incentivized environments where subjects' decisions do not impact the payoff (T0), impact their own payoff (T1) and impact other subjects' payoff (T2). Our results show that both incentives (T1) and (T2) increase the amount of allocated attention (measured by Response Time), besides the efficiency of the allocation process (measured by Error Rate) and regardless of subjects’ intrinsic motivation. Finally, we find that standard measure of social preferences (Social Value Orientation) do not explain attentional contribution in our Public Good like environment (T2). This latter result contradicts standard ones, providing new insight about social preferences. |
| Keywords: | Allocation of attention, Incentives, Public Good Game, Social Preferences, Intrinsic Motivation |
| JEL: | A13 C9 H41 D8 |
| Date: | 2017–03 |
| URL: | http://d.repec.org/n?u=RePEc:gre:wpaper:2017-11&r=upt |
| By: | Sascha Fullbrunn (Radboud University); Wolfgang J. Luhan (Portsmouth Business School); ; |
| Abstract: | Risky decisions are often taken on behalf of others rather than for oneself. Competing theoretical models predict both; higher as well as lower levels of risk aversion when taking risk for others. The experimental literature on this topic has found mixed results. In our comprehensive within-subject design, subjects in the role of money managers have substantial social responsibility by taking investment decisions for a group of six anonymous clients, with own payments either fixed or perfectly aligned with their clients payments. We find that money managers invest significantly less for others than for themselves, which is mainly driven by a less risk averse sub-sample. Digging deeper, we find money managers to act in line with what they believe their clients would invest for themselves. We derive a responsibility weighting function to show that with a perfectly aligned payment the money managers' actions are determined by a mix of egoistic and social risk preferences. |
| Keywords: | financial decision making, social responsibility, decision making for others, risk preferences, experiment |
| JEL: | C91 D03 D81 G11 |
| Date: | 2017–03–31 |
| URL: | http://d.repec.org/n?u=RePEc:pbs:ecofin:2017-02&r=upt |
| By: | Maria J. Ruiz Martos (Department of Economic Theory and Economic History, University of Granada.) |
| Abstract: | What should you do when confronting a sequence of decisions such that you make some choices and chance makes some others, i.e., a dynamic decision making problem under risk? Standard economic rationality requires you to look at the final choices, determine the preferred options, choose the sequence of decisions that lead to those and follow that sequence through to the end. That behaviour is implied by the conjunction of the principles of separability, dynamic consistency and reduction of compound lotteries. Experimental research on these dynamic choice principles has been developed within the common ratio effect theoretical framework. This paper experimentally investigates what subjects do when confronting such a problem within a new theoretical framework provided by the common consequence effect that manipulates the value of the foregone-consequence in the prior risks.Results suggest that reduction of compound lotteries holds throughout, whilst dynamic consistency and separability do not and theirfailure is related to the foregone-consequence. |
| Keywords: | reduction of compound lotteries, dynamic consistency, separability, non-expected utility and risk |
| JEL: | C91 D11 D81 |
| Date: | 2017–03–30 |
| URL: | http://d.repec.org/n?u=RePEc:gra:wpaper:17/01&r=upt |
| By: | Coimbra, Nuno; Rey, Hélène |
| Abstract: | This paper develops a dynamic macroeconomic model with heterogeneous financial intermediaries and endogenous entry. It features time-varying endogenous macroeconomic risk that arises from the risk-shifting behaviour of financial intermediaries combined with entry and exit. We show that when interest rates are high, a decrease in interest rates stimulates investment and increases financial stability. In contrast, when interest rates are low, further stimulus can increase systemic risk and induce a fall in the risk premium through increased risk-shifting. In this case, the monetary authority faces a trade-off between stimulating the economy and financial stability. |
| Keywords: | banks; cycle; leverage; risk-shifting; systemic risk |
| JEL: | E44 E58 G21 |
| Date: | 2017–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:11907&r=upt |
| By: | Nobuhiko Terui; Shohei Hasegawa; Greg M. Allenby |
| Abstract: | We develop a structural model of horizontal and temporal variety seeking using an dynamic factor model that relates attribute satiation to brand preferences. The factor model employs a threshold specification that triggers preference changes when customer satiation exceeds an admissible level but does not change otherwise. The factor model can be applied to high dimensional switching data often encountered when multiple brands are purchased across multiple time periods. The model is applied to two panel datasets, an experimental field study and a traditional scanner panel dataset, where we find large improvements in model fit that reflect distinct shifts in consumer preferences over time. The model can identify the product attributes responsible for satiation, and can be used to produce a dynamic joint space map that displays brand positions and temporal changes in consumer preferences over time. |
| Date: | 2015–10 |
| URL: | http://d.repec.org/n?u=RePEc:toh:dssraa:50&r=upt |
| By: | Ashish R. Hota; Shreyas Sundaram |
| Abstract: | We study decentralized protection strategies by human decision-makers against Susceptible-Infected-Susceptible (SIS) epidemics on networks. Specifically, we examine the impact of behavioral (mis)-perceptions of infection probabilities (captured by Prospect theory) on the Nash equilibrium strategies in two classes of games. In the first class of games, nodes choose their curing rates to minimize the steady-state infection probability under the degree-based mean-field approximation plus the cost of their selected curing rate. We establish the existence of pure Nash equilibria under both risk neutral and behavioral decision-makers. When the per-unit cost of curing rate is sufficiently high, we show that risk neutral players choose the curing rate to be zero at the equilibrium, while curing rate is nonzero under behavioral decision-making for any finite cost. In the second class of games, the nodes choose whether or not to vaccinate themselves. We establish the existence of unique threshold equilibria where nodes with degrees larger than a certain threshold vaccinate. When the vaccination cost is sufficiently high, fewer behavioral players vaccinate compared to risk neutral players, and vice versa. Finally, we provide a rigorous comparison of the equilibrium thresholds under behavioral and risk neutral players in networks with power-law degree distributions. |
| Date: | 2017–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1703.08750&r=upt |