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on Utility Models and Prospect Theory |
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Issue of 2020‒11‒02
thirteen papers chosen by |
| By: | Xiaosheng Mu; Luciano Pomatto; Philipp Strack; Omer Tamuz |
| Abstract: | We show that under plausible levels of background risk, no theory of choice under risk---such as expected utility theory, prospect theory, or rank dependent utility---can simultaneously satisfy the following three economic postulates: (i) Decision makers are risk-averse over small gambles, (ii) they respect stochastic dominance, and (iii) they account for background risk. |
| Date: | 2020–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2010.08033&r=all |
| By: | Franz Dietrich (Centre d'Economie de la Sorbonne, Paris School of Economics) |
| Abstract: | Can a group be a standard rational agent? This would require the group to hold aggregate preferences which maximise expected utility and change only by Bayesian updating. Group rationality is possible, but the only preference aggregation rules which support it (and are minimally Paretian and continuous) are the linear-geometric rules, which combine individual tastes linearly and individual beliefs geometrically |
| Keywords: | Bayesian aggregation; preference aggregation under uncertainty; expected-utility hypothesis for groups; Bayesian revision; rational group agents; linear versus geneometric opinion pooling |
| JEL: | D71 D81 |
| Date: | 2020–06 |
| URL: | http://d.repec.org/n?u=RePEc:mse:cesdoc:20014&r=all |
| By: | Bent Jesper Christensen (Aarhus University, CREATES and the Dale T. Mortensen Center); Juan Carlos Parra-Alvarez (Aarhus University and CREATES); Rafael Serrano (Universidad del Rosario) |
| Abstract: | A risk-averse insurance company controls its reserve, modelled as a perturbed Cramér-Lundberg process, by choice of both the premium p and the deductible K offered to potential customers. The surplus is allocated to financial investment in a riskless and a basket of risky assets potentially correlating with the insurance risks and thus serving as a partial hedge against these. Assuming customers differ in riskiness, increasing p or K reduces the number of customers n(p,K) and increases the arrival rate of claims per customer ?(p,K) through adverse selection, with a combined negative effect on the aggregate arrival rate n(p,K)?(p,K). We derive the optimal premium rate, deductible, investment strategy, and dividend payout rate (consumption by the owner-manager) maximizing expected discounted life-time utility of intermediate consumption under the assumption of constant absolute risk aversion. Closed-form solutions are provided under specific assumptions on the distributions of size and frequency claims. |
| Keywords: | Stochastic optimal control, Hamilton-Jacobi-Bellman equation, Jump-diffusion, Adverse selection, Premium control, Deductible control, Optimal investment strategy. |
| JEL: | G11 G22 C60 D82 |
| Date: | 2020–10–12 |
| URL: | http://d.repec.org/n?u=RePEc:aah:create:2020-11&r=all |
| By: | Yuhan Zhang; Cheng Chang |
| Abstract: | This paper models the US-China trade conflict and attempts to analyze the (optimal) strategic choices. In contrast to the existing literature on the topic, we employ the expected utility theory and examine the conflict mathematically. In both perfect information and incomplete information games, we show that expected net gains diminish as the utility of winning increases because of the costs incurred during the struggle. We find that the best response function exists for China but not for the US during the conflict. We argue that the less the US coerces China to change its existing trade practices, the higher the US expected net gains. China's best choice is to maintain the status quo, and any further aggression in its policy and behavior will aggravate the situation. |
| Date: | 2020–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2010.12351&r=all |
| By: | Galanis, Giorgos (Goldsmiths, University of London and Centre for Research in Economic Theory and its Applications, University of Warwick.); Veneziani, Roberto (School of Economics and Finance, Queen Mary, University of London) |
| Abstract: | What are the distributive implications of utilitarianism? Is it compatible with a concern for equality, as many utilitarians have argued? We analyse these questions in the context of a pure allocation problem. We consider an in nitely-lived economy and, drawing on the behavioural literature, assume that individuals have reference-dependent preferences: agents' utility is a function of current consumption and a reference point which captures consumption habits, or the agents' upbringing. Assuming a history of inequalities in consumption and welfare, we show that the utilitarian allocation is equalising: starting from an unequal distribution, consumption and welfare inequalities decrease over time at the utilitarian optimum. However, even though agents are in a relevant sense identical, equality does not obtain at any finite time. |
| Keywords: | utilitarianism ; inequality ; reference dependent preferences JEL Codes: D63 ; D9 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:wrk:wcreta:67&r=all |
| By: | Franz Dietrich (Centre d'Economie de la Sorbonne, Paris School of Economics); Antonios Staras (Institute of Economics - Cardiff University); Robert Sugden (School of Economics - University of East Anglia) |
| Abstract: | Leonard Savage famously contravened his own theory when first confronting the Allais Paradox, but then convinced himself that the had made an error. We examine the formal structure of Savage's ‘error-correcting’ reasoning in the light of (i) behavioural economists' claims to identify the latent preferences of individuals who violate conventional rationality requirements and (ii) John Broome's critique of arguments which presuppose that rationality requirements can be achieved through reasoning. We argue that Savage's reasoning is not vulnerable to Broome's critique, but does not provide support for the view that behavioural scientists can identify and counteract errors in people's choices |
| Keywords: | Savage; Allais Paradox; Broome; rationality; reasoning; behavioural economics |
| JEL: | B41 C18 D01 D81 D90 |
| Date: | 2020–05 |
| URL: | http://d.repec.org/n?u=RePEc:mse:cesdoc:20016&r=all |
| By: | Marcello Negrini; Arno Riedl; Matthias Wibral |
| Abstract: | Evidence from hypothetical scenarios strongly suggests the existence of a sunk cost bias, the tendency to ‘throw good money after bad money.’ However, the few studies using incentives are inconclusive. In addition, evidence on potential psychological channels underlying such a bias is scarce. We present a laboratory experiment designed to investigate the sunk cost bias and to test some prominent psychological mechanisms. Inspired by the hypothetical scenarios, we use a two-stage investment task in which an initial investment needs to be made to start a project. In the initial investment stage, the size of the investment and the responsibility of the investor are exogenously varied. In the second investment stage, participants can either decide to terminate the project or to make an additional investment to finish the project. We do not find evidence for the sunk cost bias. To the contrary, we observe a robust reverse sunk cost bias. That is, the larger the initial investment, the lower the likelihood to continue investing in a project. Moreover, whether or not subjects are responsible for the initial investment, does not affect their additional investment. More waste averse individuals also do not react more strongly to sunk cost whereas being in the loss domain decreases additional investment. Importantly, we replicate the sunk cost bias when using hypothetical scenarios. Surprisingly, the reverse sunk cost bias also holds for those participants who exhibit a strong sunk cost bias in the hypothetical scenarios. |
| Keywords: | sunk cost bias, incentivized experiment, hypothetical scenario, cognitive dissonance, loss aversion, waste aversion |
| JEL: | C91 D01 D90 D91 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_8623&r=all |
| By: | Phitawat Poonpolkul |
| Abstract: | This study revisits optimal fiscal policies in response to population ageing by introducing an age-dependent increasing risk aversion assumption into an OLG model with risk-sensitive preferences. Under this specification, the policy evaluation factors in the welfare cost of policy-induced uncertainties and suggests that, based on future generations’ welfare, financing population ageing by either reducing social security benefits or extending the retirement age may not be as strongly preferred over raising the payroll tax rate as prior studies have suggested. Varying risk aversion also emphasizes the role of precautionary savings that causes individuals to respond slightly differently to changes in demographic structures and price variables. This, in turn, influences the redistribution of life-cycle variables and transition dynamics of aggregate variables. |
| Keywords: | Overlapping generations model, Increasing risk aversion, Non-expected utility |
| JEL: | D81 E62 J11 |
| Date: | 2020–10 |
| URL: | http://d.repec.org/n?u=RePEc:een:camaaa:2020-88&r=all |
| By: | Brañas-Garza, Pablo; Jorrat, Diego; Espín, Antonio M.; Sanchez, Angel |
| Abstract: | The use of hypothetical instead of real decision-making incentives remains under debate after decades of economic experiments. Standard incentivized experiments involve substantial monetary costs due to participants’ earnings and often logistic costs as well. In time preferences experiments, which involve future payments, real payments are particularly problematic. Since immediate rewards frequently have lower transaction costs than delayed rewards in experimental tasks, among other issues, (quasi)hyperbolic functional forms cannot be accurately estimated. What if hypothetical payments provide accurate data which, moreover, avoid transaction cost problems? In this paper, we test whether the use of hypothetical - versus real - payments affects the elicitation of short-term and long-term discounting in a standard multiple price list task. One-out-of-ten participants probabilistic payment schemes are also considered. We analyze data from three studies: a lab experiment in Spain, a well-powered field experiment in Nigeria, and an online extension focused on probabilistic payments. Our results indicate that paid and hypothetical time preferences are mostly the same and, therefore, that hypothetical rewards are a good alternative to real rewards. However, our data suggest that probabilistic payments are not. |
| Keywords: | Time preferences, hypothetical vs real payoffs, lab, field, online experiments, BRIS |
| JEL: | C91 C93 |
| Date: | 2020–10–19 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:103660&r=all |
| By: | Richard S.J. Tol (Department of Economics, University of Sussex, Falmer, United Kingdom) |
| Abstract: | Video discussion of willingness to pay and willingness to accept compensation as values of the environment |
| Keywords: | environmental economics, value, stated preference, revealed preference, equivalent variation, compensating variation, undergraduate, video |
| JEL: | Q50 Q51 |
| Date: | 2020–10 |
| URL: | http://d.repec.org/n?u=RePEc:sus:susvid:2038&r=all |
| By: | Quamrul H. Ashraf; Oded Galor; Marc P. B. Klemp |
| Abstract: | This essay explores the deepest roots of comparative economic development. It underscores the significance of evolutionary processes since the Neolithic Revolution in shaping a society’s endowment of fundamental traits, such as predisposition towards child quality, time preference, loss aversion, and entrepreneurial spirit, that have contributed to differential paths of technological progress, human-capital formation, and economic development across societies. Moreover, it highlights the indelible mark of the exodus of Homo sapiens from Africa tens of thousands of years ago on the degree of interpersonal population diversity across the globe and examines the impact of this variation in diversity for comparative economic, cultural, and institutional development across countries, regions, and ethnic groups. |
| Keywords: | comparative development, human evolution, natural selection, preference for child quality, time preference, loss aversion, entrepreneurial spirit, the “out of Africa” hypothesis, interpersonal diversity |
| JEL: | O11 N10 N30 Z10 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_8624&r=all |
| By: | Quint, Ansgar F.; Rudsinske, Jonas F. |
| Abstract: | We develop an asymmetric general oligopolistic equilibrium (AGOLE) model, which extends the range of possible applications in general oligopolistic equilibrium modelling. The AGOLE allows to incorporate endogenous and asymmetric marginal utilities of income across countries.As a first exemplary application, we analyze the effects of asymmetric labor market policies. When one country increases its labor supply per capita, it is optimal for its firms to supply a part of the additional production to the other country at reduced prices to artificially inflate domestic prices. This results in a spillover effect letting consumption increase abroad due to a change in the terms of trade. In AGOLE, oligopolistic competition can induce asymmetric price reactions that shift real income and demand between the two countries. We argue that incorporating this cross-country demand channel is crucial for analyzing asymmetric countries or policies in presence of firms with market power. |
| Keywords: | general oligopolistic equilibrium,strategic trade,international trade and labor market interactions,factor income distribution |
| JEL: | F12 D51 L13 F16 D33 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cegedp:405&r=all |
| By: | Roger E. Backhouse (University of Birmingham and Erasmus University Rotterdam); Antoinette Baujard (Univ Lyon); Tamotsu Nishizawa (Teikyo University) |
| Abstract: | Our forthcoming book, Welfare Theory, Public Action and Ethical Values challenges the belief that, until modern welfare economics introduced issues such as justice, freedom and equality, economists adopted what Amartya Sen called ''welfarism.'' This is the belief that the welfare of society depends solely on the ordinal utilities of the individuals making up the society. Containing chapters on some of the leading twentieth-century economists, including Walras, Marshall, Pigou, Pareto, Samuelson, Musgrave, Hicks, Arrow, Coase and Sen, as well as lesser-known figures, including Ruskin, Hobson and contributors to the literature on capabilities, the book argues that, whatever their theoretical commitments, when economists have considered practical problems they have adopted a wider range of ethical values, attaching weight to equality, justice and freedom. Part 1 explains the concepts of welfarism and non-welfarism and explores ways in which economists have departed from welfarism when tackling practical problems and public policy. Part 2 explores the reasons for this. When moving away from abstract theories to consider practical problems it is often hard not to take an ethical position and economists have often been willing to do so. We conclude that economics needs to recognise this and to become more of a moral science. |
| Keywords: | Welfarism, non-welfarism, welfare, public policy, ethics, economics, individualism |
| JEL: | B21 B31 B41 D63 I31 |
| Date: | 2020–10 |
| URL: | http://d.repec.org/n?u=RePEc:bir:birmec:20-26&r=all |