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on Utility Models and Prospect Theory |
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Issue of 2021‒03‒01
thirteen papers chosen by |
| By: | Pawel Dziewulski (University of Sussex); Roy Allen (University of Western Ontario); John Rehbeck (Ohio State University) |
| Abstract: | We provide a microfoundation for using aggregated data (e.g. mean purchases) when evaluating consumer choice data. We present a model of statistical consumer theory where the individual maximizes their utility with respect to a distribution of bundles that is constrained by a statistic of the distribution (e.g. mean expenditure). We show that this behavior is observationally equivalent to an individual whose preferences depend only on the statistic of the distribution. This means that despite working with distributions, the empirical content of the model only depends on a finite-dimensional statistic. Statistical consumer theory neither nests nor is nested in the random utility approach. We show this approach generalizes quasilinear utility with random preferences and income, mean-variance preferences, and preferences that depend on arbitrary moments. |
| Date: | 2021–02 |
| URL: | http://d.repec.org/n?u=RePEc:sus:susewp:0221&r=all |
| By: | Marcus Roel (Beijing Normal University); Manuel Staab (Aix-Marseille University, CNRS, AMSE) |
| Abstract: | In the spirit of Blackwell (1951), we analyze how two fundamental mistakes in information processing-incorrect beliefs about the world and misperception of information-affect the expected utility ranking of information experiments. We explore their individual and combined influence on welfare and provide necessary and sufficient conditions when mistakes alter and possibly reverse the ranking of information experiments. Both mistakes by themselves reduce welfare in a model where payoff relevant actions also generate informative signals. This is true for naive decisionmakers, unaware of any errors, as well as for sophisticated decision-makers, who account for the possibility of mistakes. However, mistakes can interact in non-obvious ways and an agent might be better off suffering from both, rather than just one. We provide a characterization when such positive interactions are possible. Surprisingly, this holds true only for naive decision-makers and thus naivete can be beneficial. We discuss implications for information acquisition and avoidance, welfare-improving belief manipulation, and policy interventions in general. |
| Keywords: | ranking of experiments, information acquisition, misperception, confirmation bias, overconfidence, underconfidence |
| JEL: | D03 D81 D83 |
| Date: | 2021–02 |
| URL: | http://d.repec.org/n?u=RePEc:aim:wpaimx:2108&r=all |
| By: | Asaf Cohen; Yan Dolinsky |
| Abstract: | We consider the discretized Bachelier model where hedging is done on an equidistant set of times. Exponential utility indifference prices are studied for path-dependent European options and we compute their non-trivial scaling limit for a large number of trading times $n$ and when risk aversion is scaled like $n\ell$ for some constant $\ell>0$. Our analysis is purely probabilistic. We first use a duality argument to transform the problem into an optimal drift control problem with a penalty term. We further use martingale techniques and strong invariance principles and get that the limiting problem takes the form of a volatility control problem. |
| Date: | 2021–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2102.11968&r=all |
| By: | Pawel Dziewulski (University of Sussex); Roy Allen (University of Western Ontario); John Rehbeck (Ohio State University) |
| Abstract: | This paper re-examines research that studies economic rationality using experimental data generated by nonhuman animals (e.g. rats, pigeons, monkeys, etc.). The standard experimental methodology to elicit choices from nonhuman animals allows a researcher to test three types of economic rationality: standard deterministic utility maximization, average choice rationality, and random utility maximization. Most of the research has evaluated whether animals satisfy average choice rationality. We describe the difference between these models and check each type of rationality on capuchin monkey data from Chen et al. (2006). We reject standard deterministic utility maximization, but cannot reject either average choice rationality or random utility maximization. This paper is the first to provide a statistical test for average choice rationality. |
| Date: | 2021–02 |
| URL: | http://d.repec.org/n?u=RePEc:sus:susewp:0321&r=all |
| By: | Jivas Chakravarthy (University of Texas, Arlington); Timothy W. Shields (Argyros School of Business and Economics, Chapman University) |
| Abstract: | At present, accounting conservatism is generally viewed from a measurement or reporting perspective. In contrast, we consider whether it relates to a moral rule of conduct. Conservatism has been described as deriving from a preference for reporting errors to be in the direction of understatement rather than overstatement. We experimentally pair Reporters who provide information with Users who rely on the information. We posit that under misaligned incentives that motivate aggressive reporting, Users view an aggressive report as reflecting Reporters’ exploitative intent and expect that a social norm prohibiting aggressive reporting applies. We predict that Users use noisy reporting errors to gauge Reporters’ norm compliance. Consistent with this we find that, ceteris paribus, Users prefer not to be paired with Reporters who produce overstatement errors that are likely to reflect aggressive reporting. This preference, revealed through Users’ incentivized actions, is both inconsistent with neoclassical economic models and cannot be explained by loss aversion. Alternatively, when Reporters’ motives are aligned with Users’, we find no such preference. While our evidence is indirect, it opens the possibility that conservatism emerged from a norm that enhances trust and cooperation among economic agents. We believe this insight can open new possibilities for conservatism research. |
| Keywords: | accounting conservatism; experimental economics; intentions; moral hazard |
| JEL: | B52 D81 D82 M41 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:chu:wpaper:20-41&r=all |
| By: | Pawel Dziewulski (University of Sussex); John K.-H. Quah (John Hopkins Univeristy) |
| Abstract: | We formulate a set order on constraint sets C ? Rl which guarantee that argmin {?(x) : x ?C} increases in the product order as C increases in the set order, for all linear functions ?: Rl ?R. Using this result, we characterize the utility/production functions that lead to normal demand; we also show that this very same class of production functions have marginal costs that increase with factor prices. In the context of decision-making under uncertainty, our new set order leads to natural generalizations of first order stochastic dominance in multi-prior models. |
| Keywords: | parallelogram property, increasing differences, ambiguity, first order stochastic dominance, normal demand, marginal costs |
| JEL: | C61 D21 D24 |
| Date: | 2021–02 |
| URL: | http://d.repec.org/n?u=RePEc:sus:susewp:0121&r=all |
| By: | Tim Leung; Yang Zhou |
| Abstract: | We study the problem of dynamically trading multiple futures whose underlying asset price follows a multiscale central tendency Ornstein-Uhlenbeck (MCTOU) model. Under this model, we derive the closed-form no-arbitrage prices for the futures contracts. Applying a utility maximization approach, we solve for the optimal trading strategies under different portfolio configurations by examining the associated system of Hamilton-Jacobi-Bellman (HJB) equations. The optimal strategies depend on not only the parameters of the underlying asset price process but also the risk premia embedded in the futures prices. Numerical examples are provided to illustrate the investor's optimal positions and optimal wealth over time. |
| Date: | 2021–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2102.12601&r=all |
| By: | N'Golo Kone |
| Abstract: | This paper addresses the estimation issue that exists when estimating the traditional mean-variance portfolio. More precisely, the efficient mean-variance is estimated by a double regularization. These regularization techniques namely the ridge, the spectral cut-off, and Landweber-Fridman involve a regularization parameter or penalty term whose optimal value needs to be selected efficiently. A data-driven method has been proposed to select the tuning parameter. We show that the double regularized portfolio guarantees to investors the maximum expected return with the lowest risk. In empirical and Monte Carlo experiments, our double regularized rules are compared to several strategies, such as the traditional regularized portfolios, the new Lasso strategy of Ao et al. (2019), and the naive 1/N strategy in terms of in-sample and out-of-sample Sharpe ratio performance, and it is shown that our method yields significant Sharpe ratio improvements and a reduction in the expected utility loss. |
| Keywords: | Portfolio selection, efficient mean-variance analysis, double regularization |
| JEL: | C52 C58 G11 |
| Date: | 2021–02 |
| URL: | http://d.repec.org/n?u=RePEc:qed:wpaper:1453&r=all |
| By: | Philippe Le Coent (BRGM - Bureau de Recherches Géologiques et Minières (BRGM)); Raphaële Préget (CEE-M - Centre d'Economie de l'Environnement - Montpellier - UMR 5211 - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique - Montpellier SupAgro - Institut national d’études supérieures agronomiques de Montpellier - Institut Agro - Institut national d'enseignement supérieur pour l'agriculture, l'alimentation et l'environnement - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement); Sophie Thoyer (CEE-M - Centre d'Economie de l'Environnement - Montpellier - UMR 5211 - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique - Montpellier SupAgro - Institut national d’études supérieures agronomiques de Montpellier - Institut Agro - Institut national d'enseignement supérieur pour l'agriculture, l'alimentation et l'environnement - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement) |
| Abstract: | This article analyses the role played by social norms in farmers' decisions to enroll into an agri-environmental scheme (AES). First, it develops a simple theoretical model highlighting the interplay of descriptive and injunctive norms in farmers' utility functions. Second, an empirical valuation of the effect of social norms is provided based on the results of a stated preference survey conducted with 98 wine-growers in the South of France. Proxies are proposed to capture and measure the weight of social norms in farmers' decision to sign an agri-environmental contract. Our empirical results indicate that the injunctive norm seems to play a stronger role than the descriptive norm. |
| Keywords: | Voluntary contribution to a public good,Social norms,Behaviour,Farmers,Payments for environmental services |
| Date: | 2020–12–29 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-03124390&r=all |
| By: | Allan M Feldman (Department of Economics, Brown University); Ram Singh (Department of Economics, Delhi School of Economics) |
| Abstract: | In many accident contexts, the accident harm depends on observable as well as unobservable dimensions of the precaution exercised by the parties involved. The observable dimensions are commonly referred to as the ‘care’ levels and the unobservable aspects as the ‘activity’ levels. In a seminal contribution, Shavell (1980) extended the scope of economic analysis of liability rules by providing a model that allows for the care as well as activity level choices. Subsequent works have used and extended Shavell’s model to predict outcomes under various liability rules and also to compare their efficiency properties. These works make several claims about the existence and efficiency of equilibria under different liability rules, without providing any formal proof. In this paper, we reexamine the prevalent claims in the literature using the standard model itself. Contrary to prevalent claims, we show that the standard negligence liability rules do not induce equilibrium for all the accident contexts admissible under the model. Under the standard model, even the ‘no-fault’ rules can fail to induce a Nash equilibrium. In the absence of an equilibrium, it is not plausible to make a claim about efficiency of a rule per-se or vis-a-vis other rules. We show that even with commonly used utility functions that meet all the requirements of the standard model, the social welfare function may not have a maximum. In many other situations fully compatible with the standard models, a maximum of the social welfare function is not discoverable by the first order conditions. Under the standard models, even individually optimum choices might not exist. We analyze the underlying problems with the standard models and offer some insights for future research on this subject. Key Words: Observable and Non-observable Care, Activity Levels, Negligence Liability, No-fault Liability, Second Best, Nash equilibrium, Accident Loss, First Best. |
| Date: | 2021–02 |
| URL: | http://d.repec.org/n?u=RePEc:cde:cdewps:315&r=all |
| By: | Milan Scasny (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Opletalova 26, 110 00, Prague, Czech Republic; Environmental Centre, Charles University, Czech Republic); Matej Opatrny (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Opletalova 26, 110 00, Prague, Czech Republic; Environmental Centre, Charles University, Czech Republic) |
| Abstract: | We provide the first estimate of the elasticity of marginal utility of consumption, η, for a post-transition economy in the Central & Eastern European region, the Czech Republic, based on individual-level data. The parameter η is a crucial component of the social discount rate (SDR), which determines the inter-temporal allocations that are acceptable to society. Using the equal-sacrifice income tax approach, we obtain a central estimate of η at 1.34, which varies between 1.24 and 1.42 within the study period that covers 2005-2019. Moreover, the estimate of elasticity of marginal utility of consumption differs between various income groups and employment status. Importantly, the magnitude of η estimate depends on whether social benefits are included into gross income or social and health insurance payments are included in the definition of taxes. Our results suggest that SDR for the Czech Republic may be around 3–5 percent for a reasonable pure rate of time preference and positive forecast for per capita consumption growth. |
| Keywords: | elasticity of marginal utility of consumption; equal-sacrifice approach; income tax schedules; marginal tax rate; social discount rate |
| JEL: | D60 D61 H24 R13 |
| Date: | 2021–02 |
| URL: | http://d.repec.org/n?u=RePEc:fau:wpaper:wp2021_03&r=all |
| By: | Alberto Hidalgo (IMT School for advanced studies); Massimo Riccaboni (IMT School for advanced studies); Francisco J. Velazquez (Complutense University of Madrid) |
| Abstract: | This paper investigates how guests' preferences in peer-to-peer accommodations changed during the COVID-19 summer season. To this end, we adopt a semi- parametric hedonic pricing model and test the importance of attributes that better allow for social distancing. We take the city of Madrid as a compelling case study of an important tourist destination severely hit by the crisis. We show that guests' marginal willingness to pay for social distancing characteristics has changed from August 2019 to August 2020. In particular, we find that whereas those listings that have kitchen amenities have a premium price of around 20.4% in August 2020, which represents a 15.2 percentage point increase with respect to the previous year, the marginal willingness to pay for size-related character- istics decreased in 2.7 percentage points. Results are robust to sample and time composition. |
| Keywords: | Hedonic modelling, Peer-to-peer accommodation, COVID-19 pandemic, Generalized Additive Models |
| JEL: | C21 L83 R30 |
| Date: | 2021–02 |
| URL: | http://d.repec.org/n?u=RePEc:ial:wpaper:1/2021&r=all |
| By: | Häfner, David |
| Abstract: | This dissertation is dedicated to the analysis of three superordinate economic principles in varying market environments: market efficiency, the behavior of market participants and information asymmetry. Sustainability and social responsibility have gained importance as investment criteria in recent years. However, responsible investing can lead to conflicting goals with respect to utility-maximizing behavior and portfolio diversification in efficient markets. Conducting a meta-analysis, this thesis presents evidence that positive (non-monetary) side effects of responsible investing can overcome this burden. Next, the impact of the EU-wide regulation of investment research on the interplay between information asymmetry, idiosyncratic risk, liquidity and the role of financial analysts in stock markets is investigated. An empirical analysis of the emerging primary and secondary market for cryptocurrencies yields further insights about the effects of information asymmetry between investors, issuers and traders. The efficient allocation of resources is dependent on the market microstructure, the behavior of market participants, as well as exogenous shocks. Against this background, this thesis is dedicated to the empirical analysis of limit order books, the rationality of traders and the impact of COVID-19. Due to its young history, the market for cryptocurrencies yields a suitable research subject to test classical financial theories. This doctoral thesis reveals parallels between the microstructure of cryptocurrency and stock markets and uncovers some previously unknown statistical properties of the cryptocurrency market microstructure. An initial examination of the impact of COVID-19 further shows that cryptocurrencies with a high market capitalization seem to react to macroeconomic shocks similar to stock markets. This cumulative dissertation comprises six stand-alone papers, of which three papers have already been published. |
| Date: | 2021 |
| URL: | http://d.repec.org/n?u=RePEc:dar:wpaper:125278&r=all |