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on Utility Models and Prospect Theory |
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Issue of 2019‒07‒22
sixteen papers chosen by |
| By: | David Meder; Finn Rabe; Tobias Morville; Kristoffer H. Madsen; Magnus T. Koudahl; Ray J. Dolan; Hartwig R. Siebner; Oliver J. Hulme |
| Abstract: | Ergodicity describes an equivalence between the expectation value and the time average of observables. Applied to human behaviour, ergodic theory reveals how individuals should tolerate risk in different environments. To optimise wealth over time, agents should adapt their utility function according to the dynamical setting they face. Linear utility is optimal for additive dynamics, whereas logarithmic utility is optimal for multiplicative dynamics. Whether humans approximate time optimal behavior across different dynamics is unknown. Here we compare the effects of additive versus multiplicative gamble dynamics on risky choice. We show that utility functions are modulated by gamble dynamics in ways not explained by prevailing economic theory. Instead, as predicted by time optimality, risk aversion increases under multiplicative dynamics, distributing close to the values that maximise the time average growth of wealth. We suggest that our findings motivate a need for explicitly grounding theories of decision-making on ergodic considerations. |
| Date: | 2019–06 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1906.04652&r=all |
| By: | Yaman, F.; Cubi-Molla, P.; Ungureanu, S. |
| Abstract: | We use an annual household panel to test which features of prospect theory can be supported by measures of life satisfaction. We also test whether recalled or expected life satisfaction is anchored at current life satisfaction and adjusted in the direction of the recall or expectation. Using a fixed effects estimator we find that life satisfaction contains features of both classic expected utility and prospect theory. Life satisfaction depends positively on levels of income, good health, and on employment. It also depends positively on income and employment improvements, however the reverse is true for health increases. Life satisfaction is concave in income gains and convex in income losses, and it exhibits loss aversion in income and employment status, but not in health. Moreover, we find that current levels of life satisfaction are better predictors of recalled (expected) life satisfaction than past (future) life satisfaction. The results support viewing life satisfaction as representing a mixture of the classic decision utility of expected utility theory, and the value function of prospect theory. Subjects seem to use an anchoring and adjustment heuristic when answering questions about past and expected life satisfaction. |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:cty:dpaper:19/12&r=all |
| By: | Hyungbin Park; Stephan Sturm |
| Abstract: | This paper discusses the sensitivity of the long-term expected utility of optimal portfolios for an investor with constant relative risk aversion. Under an incomplete market given by a factor model, we consider the utility maximization problem with long-time horizon. The main purpose is to find the long-term sensitivity, that is, the extent how much the optimal expected utility is affected in the long run for small changes of the underlying factor model. The factor model induces a specific eigenpair of an operator, and this eigenpair does not only characterize the long-term behavior of the optimal expected utility but also provides an explicit representation of the expected utility on a finite time horizon. We conclude that this eigenpair therefore determines the long-term sensitivity. As examples, explicit results for several market models such as the Kim--Omberg model for stochastic excess returns and the Heston stochastic volatility model are presented. |
| Date: | 2019–06 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1906.03690&r=all |
| By: | Levon Barseghyan; Maura Coughlin; Francesca Molinari; Joshua C. Teitelbaum |
| Abstract: | We propose a robust method of discrete choice analysis when agents' choice sets are unobserved. Our core model assumes nothing about agents' choice sets apart from their minimum size. Importantly, it leaves unrestricted the dependence, conditional on observables, between agents' choice sets and their preferences. We first establish that the model is partially identified and characterize its sharp identification region. We also show how the model can be used to assess the welfare cost of limited choice sets. We then apply our theoretical findings to learn about households' risk preferences and choice sets from data on their deductible choices in auto collision insurance. We find that the data can be explained by expected utility theory with relatively low levels of risk aversion and heterogeneous choice sets. We also find that a mixed logit model, as well as some familiar models of choice set formation, are rejected in our data. |
| Date: | 2019–07 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1907.02337&r=all |
| By: | Kreps, David M. (Stanford University); Schachermayer, Walter (?) |
| Abstract: | We examine Kreps’ (2019) conjecture that optimal expected utility in the classic Black–Scholes–Merton (BSM) economy is the limit of optimal expected utility for a sequence of discrete-time economies that “approach†the BSM economy in a natural sense: The nth discrete-time economy is generated by a scaled n-step random walk, based on an unscaled random variable zeta with mean zero, variance one, and bounded support. We confirm Kreps’ conjecture if the consumer’s utility function U has asymptotic elasticity strictly less than one, and we provide a counterexample to the conjecture for a utility function U with asymptotic elasticity equal to 1, for zeta such that E[zeta^{3}] > 0. |
| Date: | 2019–07 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:stabus:3802&r=all |
| By: | Francesca Biagini; Alessandro Doldi; Jean-Pierre Fouque; Marco Frittelli; Thilo Meyer-Brandis |
| Abstract: | We propose a novel concept of a Systemic Optimal Risk Transfer Equilibrium (SORTE), which is inspired by the B\"uhlmann's classical notion of an Equilibrium Risk Exchange. We provide sufficient general assumptions that guarantee existence, uniqueness, and Pareto optimality of such a SORTE. In both the B\"uhlmann and the SORTE definition, each agent is behaving rationally by maximizing his/her expected utility given a budget constraint. The two approaches differ by the budget constraints. In Buhlmann's definition the vector that assigns the budget constraint is given a priori. On the contrary, in the SORTE approach, the vector that assigns the budget constraint is endogenously determined by solving a systemic utility maximization. SORTE gives priority to the systemic aspects of the problem, in order to optimize the overall systemic performance, rather than to individual rationality. |
| Date: | 2019–07 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1907.04257&r=all |
| By: | Matthew Lorig; Zhou Zhou; Bin Zou |
| Abstract: | We introduce a general framework for continuous-time betting markets, in which a bookmaker can dynamically control the prices of bets on outcomes of random events. In turn, the prices set by the bookmaker affect the rate or intensity of bets placed by gamblers. The bookmaker seeks a price process that maximizes his expected (utility of) terminal wealth. We obtain explicit solutions or characterizations to the bookmaker's optimal bookmaking problem in various interesting models. |
| Date: | 2019–07 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1907.01056&r=all |
| By: | Yuki M. Asano; Jakob J. Kolb; Jobst Heitzig; J. Doyne Farmer |
| Abstract: | Standard macroeconomic models assume that households are rational in the sense that they are perfect utility maximizers, and explain economic dynamics in terms of shocks that drive the economy away from the stead-state. Here we build on a standard macroeconomic model in which a single rational representative household makes a savings decision of how much to consume or invest. In our model households are myopic boundedly rational heterogeneous agents embedded in a social network. From time to time each household updates its savings rate by copying the savings rate of its neighbor with the highest consumption. If the updating time is short, the economy is stuck in a poverty trap, but for longer updating times economic output approaches its optimal value, and we observe a critical transition to an economy with irregular endogenous oscillations in economic output, resembling a business cycle. In this regime households divide into two groups: Poor households with low savings rates and rich households with high savings rates. Thus inequality and economic dynamics both occur spontaneously as a consequence of imperfect household decision making. Our work here supports an alternative program of research that substitutes utility maximization for behaviorally grounded decision making. |
| Date: | 2019–07 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1907.02155&r=all |
| By: | Emir Hrnjic; Nikodem Tomczak |
| Abstract: | Behavioral economics changed the way we think about market participants and revolutionized policy-making by introducing the concept of choice architecture. However, even though effective on the level of a population, interventions from behavioral economics, nudges, are often characterized by weak generalisation as they struggle on the level of individuals. Recent developments in data science, artificial intelligence (AI) and machine learning (ML) have shown ability to alleviate some of the problems of weak generalisation by providing tools and methods that result in models with stronger predictive power. This paper aims to describe how ML and AI can work with behavioral economics to support and augment decision-making and inform policy decisions by designing personalized interventions, assuming that enough personalized traits and psychological variables can be sampled. |
| Date: | 2019–07 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1907.02100&r=all |
| By: | Richard Grimal (Cerema Equipe-projet ESPRIM - Centre d'Etudes et d'Expertise sur les Risques, l'Environnement, la Mobilité et l'Aménagement - Equipe-projet ESPRIM - Cerema - Centre d'Etudes et d'Expertise sur les Risques, l'Environnement, la Mobilité et l'Aménagement) |
| Abstract: | Car traffic growth has temporarily stopped during the 2000's, before coming back to growth after 2010, in relation with economic recovery and decreasing fuel prices. However, there are strong reasons to believe that car traffic growth is potentially limited, among which close completion of the diffusion process for car ownership, limited travel time budgets in relation with stable or declining travel speeds, decreasing marginal returns of additional car travel and infrastructure capacity restrictions. Representing car ownership as the result of an equilibrium between potential demand and economic constraints, and assuming additional car travel to be of decreasing marginal utility, one can implement a model to estimate saturation thresholds and describe the convergence path towards saturation. The model is disaggregated by household type and vehicle rank to account for heterogeneous choice sets and structural change in demographics and activity rates. It highlights the existence of an incomplete diffusion process for some groups and allows to break down potential demand between negotiable and non-negotiable needs. Projection results for France prove the existence of residual potential growth for car equipment among non-working adults which is nonetheless limited, while population ageing and changing cohabitation patterns will have a downwards effect on demand. By combining these results with car mileage projections, we find average car traffic per adult to increase gently until 2040, and remain almost stable afterwards. From this date, traffic trends would be essentially determined by demographic factors. |
| Keywords: | car equipment,traffic growth,potential demand,saturation |
| Date: | 2019–05–26 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-02164984&r=all |
| By: | Bauer, Michal (Charles University, Prague); Chytilová, Julie (Charles University, Prague); Miguel, Edward (University of California, Berkeley) |
| Abstract: | Can a short survey instrument reliably measure a range of fundamental economic preferences across diverse settings? We focus on survey questions that systematically predict behavior in incentivized experimental tasks among German university students (Becker et al. 2016) and were implemented among representative samples across the globe (Falk et al. 2018). This paper presents results of an experimental validation conducted among low-income individuals in Nairobi, Kenya. We find that quantitative survey measures - hypothetical versions of experimental tasks - of time preference, attitude to risk and altruism are good predictors of choices in incentivized experiments, suggesting these measures are broadly experimentally valid. At the same time, we find that qualitative questions - self-assessments - do not correlate with the experimental measures of preferences in the Kenyan sample. Thus, caution is needed before treating self-assessments as proxies of preferences in new contexts. |
| Keywords: | preference measurement, experiment, survey, validation |
| JEL: | C83 D90 |
| Date: | 2019–06 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp12450&r=all |
| By: | Anne Krupicka (CE.RE.GE - CEntre de REcherche en GEstion - ULR - Université de La Rochelle - IAE Poitiers - Institut d'Administration des Entreprises (IAE) - Poitiers - Université de Poitiers - Université de Poitiers) |
| Abstract: | Un des éléments de résistance au changement réside dans le biais de statu quo qui intervient dans la prise de décision. La théorie des perspectives développée par Kahneman et Tversky (1979) semble apporter un éclairage tant sur le poids de ce statu quo que sur les moyens d'y remédier. Après avoir décrit les facteurs explicatifs du statu quo, la présente communication explore les facteurs explicatifs du statu quo dans le basculement des préférences d'un produit A vers un produit B dans le secteur banque-assurance. Pour ce faire une observation participante, complétée par 14 entretiens individuels et deux tables rondes permettent d'identifier différents facteurs en interaction dans l'explication du statu quo observé. Mots-clés : Théorie des perspectives, biais de statu quo, approche ethnographique, facteurs explicatifs du statu quo Abstract : This paper introduces the prospect theory and presents the explanatory factors of the status quo bias. The methodology used on this research consists of a participating observation completed by 14 interviews and 2 focuses group. Through an example in the Bank Assurance sector, this paper identifies the determinants biais in interaction into the statu quo choice. |
| Keywords: | Prospect theory,statu quo bias,ethnography,explonatory factors of statu quo 1 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-02152494&r=all |
| By: | Darius N. Lakdawalla; Charles E. Phelps |
| Abstract: | Cost-effectiveness analysis (CEA) remains the de-facto method of choice to evaluate and compare medical interventions. Standard approaches to CEA use the average (mean) outcomes from clinical effectiveness studies such as randomized controlled trials. This paper generalizes standard methods to include uncertainty in clinical outcomes and proposes a generalized version of the quality-adjusted life-year (QALY), referred to as a quality- and risk-adjusted life-year (QRALY). Our approach requires new information from clinical studies – not only means and variances of health outcomes, but also skewness. With that added parameter, this paper shows how Taylor Series expansions of expected utility can account for two distinct effects of uncertainty: the “insurance value” of reducing overall risks to health, and the “value of hope” produced by the presence of positively skewed outcomes. Simulations demonstrate that stochastic terms are particularly important when baseline disease severity is high, and mean treatment effects are low. They also demonstrate that the variance-based term has the greatest importance among the stochastic terms, although skewness- and kurtosis-based terms can be significant in some situations. |
| JEL: | I1 I13 I18 |
| Date: | 2019–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:26058&r=all |
| By: | Bonjean, Isabelle |
| Keywords: | Farm Management, Research Methods/ Statistical Methods |
| Date: | 2019–07–13 |
| URL: | http://d.repec.org/n?u=RePEc:ags:kucawp:291526&r=all |
| By: | Daniel J. Benjamin (University of Southern California and NBER) |
| Abstract: | Errors in probabilistic reasoning have been the focus of much psychology research and are among the original topics of modern behavioral economics. This chapter reviews theory and evidence on this topic, with the goal of facilitating more systematic study of belief biases and their integration into economics. The chapter discusses biases in beliefs about random processes, biases in belief updating, the representativeness heuristic as a possible unifying theory, and interactions between biased belief updating and other features of the updating situation. Throughout, I aim to convey how much evidence there is for (and against) each putative bias, and I highlight when and how different biases may be related to each other. The chapter ends by drawing general lessons for when people update too much or too little, reflecting on modeling challenges, pointing to areas of economics to which the biases are relevant, and highlighting some possible directions for future work. |
| Keywords: | Gambler’s fallacy, Law of Small Numbers, hot hand, partition dependence, sample-size neglect, non-belief in the Law of Large Numbers, conservatism bias, Base-rate neglect, Representativeness heuristic, Confirmation bias |
| URL: | http://d.repec.org/n?u=RePEc:cth:wpaper:gru_2018_023&r=all |
| By: | Simina Br\^anzei; Fedor Sandomirskiy |
| Abstract: | We study the problem of allocating divisible bads (chores) among multiple agents with additive utilities, when money transfers are not allowed. The competitive rule is known to be the best mechanism for goods with additive utilities and was recently extended to chores by Bogomolnaia et al (2017). For both goods and chores, the rule produces Pareto optimal and envy-free allocations. In the case of goods, the outcome of the competitive rule can be easily computed. Competitive allocations solve the Eisenberg-Gale convex program; hence the outcome is unique and can be approximately found by standard gradient methods. An exact algorithm that runs in polynomial time in the number of agents and goods was given by Orlin. In the case of chores, the competitive rule does not solve any convex optimization problem; instead, competitive allocations correspond to local minima, local maxima, and saddle points of the Nash Social Welfare on the Pareto frontier of the set of feasible utilities. The rule becomes multivalued and none of the standard methods can be applied to compute its outcome. In this paper, we show that all the outcomes of the competitive rule for chores can be computed in strongly polynomial time if either the number of agents or the number of chores is fixed. The approach is based on a combination of three ideas: all consumption graphs of Pareto optimal allocations can be listed in polynomial time; for a given consumption graph, a candidate for a competitive allocation can be constructed via explicit formula; and a given allocation can be checked for being competitive using a maximum flow computation as in Devanur et al (2002). Our algorithm immediately gives an approximately-fair allocation of indivisible chores by the rounding technique of Barman and Krishnamurthy (2018). |
| Date: | 2019–07 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1907.01766&r=all |