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on Utility Models and Prospect Theory |
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Issue of 2022‒04‒18
twelve papers chosen by |
| By: | Geoff Lindsell |
| Abstract: | In this paper, we extend Kreps' 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 in initially enlarged filtrations converge to the BSM economy in an initially enlarged filtration in a "strong" sense. The n-th discrete-time economy is generated by a scaled n-step random walk, based on an unscaled random variable with mean 0, variance 1, and bounded support. Moreover, the informed insider knows each functional generating the enlarged filtrations path-by-path. We confirm Kreps' conjecture in initially enlarged filtrations when the consumer's utility function U has asymptotic elasticity strictly less than one. |
| Date: | 2022–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2203.08859&r= |
| By: | Tomás Caravello; Turalay Kenc; Martín Sola |
| Abstract: | We develop and estimate a consumption-based asset pricing model that assumes recursive utility using historical US financial data, allowing for regime changes, priced regime risk, and intrinsic bubbles. We also estimate several restricted versions which include only a subset of these features. We find that switching risk is an essential component of the equity risk premium, explaining up to fifty percent of it. Furthermore, a model which does not take this into account would overestimate the degree of risk aversion of the public, mistakenly assigning the observed risk premium to highrisk aversion instead of priced regime-switching. Intrinsic bubbles are not crucial in explaining the risk premia, but they substantially improve the model’s fit at the end of the sample. |
| Keywords: | Intrinsic Bubbles; Macroeconomic Risk; Stochastic Differential Utility,Markov Chain; Equity Risk Premium. |
| JEL: | G00 G12 E44 C32 |
| Date: | 2021–12 |
| URL: | http://d.repec.org/n?u=RePEc:udt:wpecon:2021_08&r= |
| By: | Larbi Alaoui; Antonio Penta |
| Abstract: | Individuals often attach a special meaning to obtaining a certain goal, and getting past a threshold marks the difference between what they consider a success or a failure. In this paper we take a standard von Neumann-Morgenstern Expected Utility setting with an exogenous reference point that separates success from failure, and define attitudes towards success and failure as features of preferences over lotteries. The distinctive feature of our definitions is that they all concern a local reversal of the decision maker's risk attitude between riskaversion and risk-lovingness across the reference point. Our findings provide a unified view of several well-known models of reference-dependent preferences in economics, finance and psychology, and also include novel representations. Moreover, we introduce orderings over the primitive space of preferences to define different attitudes with which each attitudes can be displayed, and characterize them in terms of the representation, with indices analogous to the well-known Arrow-Pratt index of risk aversion. Our findings shed new light on frequently used notions of reference-dependent preferences, and suggest that new comparative statics analyses be conducted in these settings. Finally, we argue that our framework may prove useful to incorporate, within a standard economic model, behavioral manifestations of personality traits that have received increasing attention within the empirical economics literature. |
| Keywords: | Expected utility; loss aversion; aspirations; risk aversion; reference-dependence |
| JEL: | D01 D81 |
| Date: | 2022–03 |
| URL: | http://d.repec.org/n?u=RePEc:upf:upfgen:1831&r= |
| By: | Hamed Hamze Bajgiran; Federico Echenique |
| Abstract: | We study the complexity of closure operators, with applications to machine learning and decision theory. In machine learning, closure operators emerge naturally in data classification and clustering. In decision theory, they can model equivalence of choice menus, and therefore situations with a preference for flexibility. Our contribution is to formulate a notion of complexity of closure operators, which translate into the complexity of a classifier in ML, or of a utility function in decision theory. |
| Date: | 2022–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2202.05339&r= |
| By: | Ivan Moscati |
| Abstract: | I examine some behavioral and heuristic-based models of individual decision making, and argue that the diverse psychological mechanisms these models posit are cognitively too demanding to be implemented, consciously or unconsciously, by actual decision makers. Accordingly, and contrary to what their advocates typically claim, behavioral and heuristic models are best understood as “as-if models†that account for the observable choices that individuals make, but do not pretend to capture the actual psychological mechanisms that generate those choices. In this respect, behavioral and heuristic models are just like neoclassical models, whose as-if status is generally acknowledged. I then sketch a local version of scientific antirealism that justifies the practice of as-if modelling in the theory of decision making. The antirealism on offer emphasizes the role that mechanistic explanations play in decision analysis, and therefore goes beyond traditional instrumentalism. |
| Keywords: | Decision theory; Expected Utility theory; Cumulative Prospect Theory; Priority Heuristic model; Scientific antirealism; Mechanistic explanation |
| Date: | 2022 |
| URL: | http://d.repec.org/n?u=RePEc:baf:cbafwp:cbafwp22177&r= |
| By: | Weber, Matthias (University of St. Gallen) |
| Abstract: | It is a great honor for me to have received the University Latsis Prize from the Fondation Latsis Internationale. In this text, I describe the research for which the prize has been awarded and the research agenda to which these works belong. In a nutshell, my work analyzes how individuals make economic and financial decisions, when outcomes are uncertain and when the laws governing economic behavior are unknown. These individual decisions usually differ from the rational utility maximization assumed in traditional models. My work then tries to understand to what aggregate outcomes and policy implications such boundedly rational behavior leads in financial markets, in the macroeconomy, and in public finance and public economics. |
| Date: | 2022–02–20 |
| URL: | http://d.repec.org/n?u=RePEc:osf:socarx:5ju7z&r= |
| By: | Elias Tsakas |
| Abstract: | It is well known that individual beliefs cannot be identified using traditional choice data, unless we impose the practically restrictive and conceptually awkward assumption that utilities are state-independent. In this paper, we propose a novel methodology that solves this long-standing identification problem in a simple way. Our method relies on the concept of influential actions. These are actions that are controlled by the analyst and lead the agent to change her beliefs. Notably, the analyst does not need to have any idea on how the agent's beliefs will change in response to an influential action. Then, instead of eliciting directly the agent's beliefs about the state space, we elicit her subjective probabilities about the influential action having been undertaken conditional on each state realization. The latter can be easily done with existing elicitation tools. It turns out that this is enough to uniquely identify her beliefs about the state space irrespective of her utility function, thus solving the identification problem. We discuss that this method can be used in most applications of interest. As an example, we show how it can provide a new useful tool for identifying motivated beliefs on an individual level. |
| Date: | 2022–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2203.10505&r= |
| By: | andhyozt, Andi |
| Abstract: | Ilmu ekonomi(economics) adalah bagian ilmu social yang mempelajari bagaimana manusia menentukan pillihan dalam menggunakan sumber daya (resources) untuk menghasilkan benda (commodity) yang mereka butuhkan dalam hidup mereka agar memperoleh guna/manfaat (utility) yang sebesar-besarnya. Lahir pada tahun 1776 yaitu pada waktu ditulisnya buku “ The Wealt Of Nations” oelh Adam Smith seorang ilmuwan Skotlandia. |
| Date: | 2022–03–24 |
| URL: | http://d.repec.org/n?u=RePEc:osf:osfxxx:xbtpu&r= |
| By: | Nahed Eddai (GAEL - Laboratoire d'Economie Appliquée de Grenoble - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement - UGA - Université Grenoble Alpes - Grenoble INP - Institut polytechnique de Grenoble - Grenoble Institute of Technology - UGA - Université Grenoble Alpes); Ani Guerdjikova (GAEL - Laboratoire d'Economie Appliquée de Grenoble - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement - UGA - Université Grenoble Alpes - Grenoble INP - Institut polytechnique de Grenoble - Grenoble Institute of Technology - UGA - Université Grenoble Alpes) |
| Abstract: | We analyze the effect of strategic ambiguity and heterogeneous attitudes towards such ambiguity on optimal mitigation and adaptation. Pessimistic players tend to invest more in mitigation, while optimists favor adaptation. When adaptation is more expensive than mitigation, three types of equilibria can obtain depending on the level and distribution of ambiguity aversion: (i) a mitigation equilibrium, (ii) an adaptation equilibrium and (iii) a mixed equilibrium with both adaptation and mitigation. The interaction between ambiguity attitudes and wealth distribution plays a crucial role for the aggregate environmental policy: a wealth transfer from pessimistic to optimistic agents increases total mitigation. A similar result applies to the choice of an optimal tax on consumption, which is shown to increase in optimism, but decrease following a transfer of income towards the more optimistic players. Finally, we show that under strategic ambiguity, the introduction of a non-binding standard can impact agents' beliefs about their opponents' behavior and as a result lower total equilibrium mitigation. Our results highlight the necessity to consider attitudes towards strategic ambiguity in the design of economic policies targeting climate change. They might also shed some light on the slow rate of convergence of environmental policies across countries. |
| Keywords: | Climate policy,Ambiguity,Heterogeneity,Choquet expected utility |
| Date: | 2021–06–01 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-03590990&r= |
| By: | Hubert Janos Kiss (KRTK KTI and Corvinus University of Budapest); Ismael Rodriguez-Lara (Department of Economics, Universidad de Granada and Economic Science Institute, Chapman University); Alfonso Rosa-Garcia (Department of Economics, Universidad de Murcia) |
| Abstract: | We study how lines form in front of banks. In our model, depositors choose first the level of effort to arrive early at the bank and then whether or not to withdraw their deposit. We argue that the informational environment (i.e., the possibility of observing the action of others) a ects the emergence of bank runs and should, therefore, influence the line formation. We test this prediction experimentally. While the informational environment has no e ect on the line formation when we look at the average level of e ort, our rindings suggest that the reasons to arrive early at the bank varies across informational environment. Thus, expectations on the occurrence of bank run are key to explain the level of effort when depositors cannot observe the action of others. In this setting, depositors who expect a run arrive early at the bank to withdraw their funds. If actions can be observed, however, those who expect a run arrive early at the bank to keep their funds deposited. Depending on the informational environment, there are other factors (e.g., irrationality of depositors or loss aversion) that also explain the behavior of depositors. |
| Keywords: | bank run, beliefs, experimental economics, line formation, loss aversion, observability |
| JEL: | C91 D90 G21 G40 J16 |
| Date: | 2022 |
| URL: | http://d.repec.org/n?u=RePEc:chu:wpaper:22-04&r= |
| By: | Georgia Michailidou; Hande Erkut (Division of Social Science) |
| Abstract: | In lying utility models, benefits and costs typically occur presently and simultaneously. However, lying and its products often develop asynchronously. To evaluate how these asynchronies affect the psychological costs of lying, we develop an experiment in which lying decisions occur presently, while externalities (external costs) and observability (internal costs) occur in future temporal brackets. To assess if lying costs or social preferences drive our findings, we compare against a baseline in which lying opportunities become simple distributive choices. We report significant behavioral differences when outcomes occur as products of lying rather than distributive choices which suggests that lying, per se, begets distinct psychological costs. Further, the results from exponential and quasi-hyperbolic discounting estimations suggest that temporally distancing antisocial decision-making from its consequences dilutes the associated psychological costs. External psychological costs caused by lying are discounted less and are subject to milder present-bias compared to those produced by distributive choices while manipulating internal psychological costs via observability attenuates discounting and present-bias in both cases. |
| Date: | 2022–04 |
| URL: | http://d.repec.org/n?u=RePEc:nad:wpaper:20220076&r= |
| By: | Glötzl, Erhard |
| Abstract: | In economics balance identities as e.g. C+K'-Y(L,K) = 0 must always apply. Therefore, they are called constraints. This means that variables C,K,L cannot change independently of each other. In General Equilibrium Theory (GE), the solution for equilibrium is obtained as optimisation under the above or similar constraints. The standard method for modelling dynamics in macroeconomics are Dynamic Stochastic General Equilibrium (DSGE) models. Dynamics in DSGE models result from the maximisation of an intertemporal utility function that results in the Euler-Lagrange equations. The Euler-Lagrange equations are differential equations that determine the dynamics of the system. In Glötzl, Glötzl, und Richters (2019) we have introduced an alternative method to model dynamics, which is constitutes a natural extension of GE theory. It is based on the standard method for modelling dynamics under constraints in physics. We therefore call models of this type "General Constrained Dynamic (GCD)" models. GCD models can be seen as an alternative to DSGE models to model the dynamics of economic processes. DSGE models are used in particular to analyse economic shocks. For this reason, the aim of this article is to show how GCD models are formulated and how they can be used to model economic shocks such as demand, supply, and price shocks. Since the goal of this paper is to lay out the fundamental principles to the formulation of such GCD models, very simple macroeconomic models are used for illustrative purposes. All calculations can easily be carried out with the open-source program GCDconfigurator, which also allows for the integration of shocks. |
| Keywords: | macroeconomic models, demand shock, supply shock, price shock, constraint dynamics, GCD, DSGE, out-of-equilibrium dynamics, Lagrangian mechanics, stock flow consistent, SFC |
| JEL: | A12 B13 B41 B59 C02 C30 C54 C60 E10 |
| Date: | 2022–03–15 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:112386&r= |