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on Utility Models and Prospect Theory |
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Issue of 2023‒01‒02
fourteen papers chosen by |
| By: | Hans-Martin von Gaudecker; Axel Wogrolly; Christian Zimpelmann |
| Abstract: | This paper analyzes the stability and distribution of ambiguity attitudes using a broad population sample. Using high-powered incentives, we collected six waves of data on ambiguity attitudes about financial markets—our main application—and climate change. Estimating a structural stochastic choice model, we obtain three individual-level parameters: Ambiguity aversion, likelihood insensitivity, and the magnitude of decision errors. These parameters are very heterogeneous in the population. At the same time, they are stable over time and largely stable across domains. We summarize heterogeneity in these three dimensions using a discrete classification approach with four types. Each group makes up 20-30% of the sample. One group comes close to the behavior of expected utility maximizers. Two types are characterized by high likelihood insensitivity; one of them is ambiguity averse and the other ambiguity seeking. Members of the final group have large error parameters; robust conclusions about their ambiguity attitudes are difficult. Observed characteristics vary between groups in plausible ways. Ambiguity types predict risky asset holdings in the expected fashion, even after controlling for many covariates. |
| Keywords: | ambiguity attitudes, temporal stability, domain specificity, sociodemographic factors, cluster analysis, household portfolio choice |
| JEL: | D81 G41 C38 D14 |
| Date: | 2022 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10079&r=upt |
| By: | Milan Scasny (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic); Matej Opatrny (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic) |
| Abstract: | We provide the first estimate of the elasticity of marginal utility of consumption, µ, for Europe and for thirty individual European countries, using the income-tax individual-level data. Specifically, we rely on the absolute equal-sacrifice approach and CRRA utility function to elicit the revealed preferences of income tax payers on their acceptance of the tax schedule. Our central estimate of µ equals to 1.42. With few exceptional cases, µ´s for European countries exceed unity, ranging between 1.2 and 1.90. We further discuss the implications of our estimate of µ for the social discount rate and Social Cost of Carbon. We conclude that the social discount rate might be slightly higher than traditionally assumed, implying lower magnitude of Social Cost of Carbon, at least for Europe. |
| 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: | 2022–12 |
| URL: | http://d.repec.org/n?u=RePEc:fau:wpaper:wp2022_29&r=upt |
| By: | Broughel, James (Mercury Publication) |
| Abstract: | Economists discount future benefit and cost flows for a variety of reasons, including time preference, diminishing marginal utility of consumption, opportunity cost of capital, and risk aversion. Many of these rationales for discounting can be explained u |
| URL: | http://d.repec.org/n?u=RePEc:ajw:wpaper:06956&r=upt |
| By: | Kilponen, Juha; Vilmunen, Jouko; Vähämaa, Oskari |
| Abstract: | Macroeconomic models typically assume additively separable preferences where consumption enters the utility function in a logarithmic form. This restriction implies that consumption growth is highly sensitive to movements in real interest rates, which in turn implies an unrealistically steep demand curve and intertemporal trade-off. We re-estimate the stylized New Keynesian Model with US data using King-Plosser-Rebelo (1988) preferences with and without habits and show that the equilibrium real interest rate elasticity of output is in the range of 0.05 - 0.20 in the US. Such low real interest rate elasticity is better in line with the empirical consumption Euler equation literature and implies relatively weak transmission of monetary policy to output and inflation. |
| Keywords: | Monetary policy,Bayesian estimation,Non-separable utility |
| JEL: | E32 E52 E21 |
| Date: | 2021 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bofrdp:rdp2021_009&r=upt |
| By: | Bodnar, Taras (Stockholm University); Mazur, Stepan (Örebro University School of Business); Nguyen, Hoang (Örebro University School of Business) |
| Abstract: | In the paper we consider the optimal portfolio choice problem under parameter uncertainty when the covariance matrix of asset returns is singular. Very useful stochastic representations are deduced for the characteristics of the expected utility optimal portfolio. Using these stochastic representations, we derive the moments of higher order of the estimated expected return and the estimated variance of the expected utility optimal portfolio. Another line of applications leads to their asymptotic distributions obtained in the high-dimensional setting. Via a simulation study, it is shown that the derived high-dimensional asymptotic distributions provide good approximations of the exact ones even for moderate sample sizes. |
| Keywords: | singular Wishart distribution; mean-variance portfolio; Moore-Penrose inverse |
| JEL: | G11 |
| Date: | 2022–12–06 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:oruesi:2022_015&r=upt |
| By: | Distefano, Rosaria |
| Abstract: | In a simple agency model of the labor market, we examine how fairness concerns affect the structure of optimal contracts when workers have different and unobservable abilities. In the framework, we assume that low-ability workers are envious and incur a utility cost whenever the more talented earn a surplus from their contracts. We focus on the equilibrium payoff of the envied and show that, when the ability gap is relatively small, it is first increasing and then decreasing in the level of envy cost borne by the envious. In contrast, when the gap is large, the payoff is monotonically decreasing. We also find that the utility loss of the envious is higher the lower the skill heterogeneity between types. Finally, we validate our theoretical results through GSOEP data. |
| Keywords: | asymmetric information; envy; fairness; other-regarding preferences; principal-agent model. |
| JEL: | D03 D82 M54 |
| Date: | 2022–06–18 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:115396&r=upt |
| By: | Fortin, Ines (Macroeconomics and Business Cycles, Institute for Advanced Studies, Vienna, Austria); Hlouskova, Jaroslava (Macroeconomics and Business Cycles, Institute for Advanced Studies, Vienna, Austria and Department of Economics, Faculty of National Economy, University of Economics in Bratislava, Slovak Republic) |
| Abstract: | We study the asset allocation of an investor with prospect theory (PT) preferences. First, we solve analytically the two-asset problem of the PT investor for one risk-free and one risky asset and find that loss aversion and the reference return affect differently less ambitious investors and more ambitious investors. Second, we empirically investigate the performance of a PT portfolio when diversifying among a stock market index, a government bond and gold, in Europe and the US. We focus on investors with PT preferences under different scenarios regarding the reference return and the degree of loss aversion and compare their portfolio performance with the performance of investors under CVaR, risk neutral, linear loss averse and in particular mean-variance (MV) preferences. We find that, in the US, PT portfolios signiffcantly outperform (in terms of returns) mean-variance portfolios in the majority of cases. Also with respect to riskadjusted performance, PT investment outperforms MV investment in the US. Similar results, however, can not be observed in Europe. Finally, we analyze asymmetric effects along economic uncertainty and observe that PT investment leads to higher returns than MV investment in times of larger economic uncertainty, especially in the US. |
| Keywords: | prospect theory, loss aversion, portfolio allocation, mean-variance portfolios, investment strategy |
| JEL: | D81 G02 G11 G15 |
| Date: | 2022–12 |
| URL: | http://d.repec.org/n?u=RePEc:ihs:ihswps:42&r=upt |
| By: | Bnaya Dreyfuss; Ofer Glicksohn; Ori Heffetz; Assaf Romm |
| Abstract: | Can incorporating expectations-based-reference-dependence (EBRD) considerations reduce seemingly dominated choices in the Deferred Acceptance (DA) mechanism? We run two experiments (total N = 500) where participants are randomly assigned into one of four DA variants—{static, dynamic} × {student proposing, student receiving}—and play ten simulated large-market school-assignment problems. While a standard, reference-independent model predicts the same straightforward behavior across all problems and variants, a news-utility EBRD model predicts stark differences across variants and problems. As the EBRD model predicts, we find that (i) across variants, dynamic student receiving leads to significantly fewer deviations from straightforward behavior, (ii) across problems, deviations increase with competitiveness, and (iii) within specific problems, the specific deviations predicted by the EBRD model are indeed those commonly observed in the data. |
| JEL: | D47 D82 D84 D91 |
| Date: | 2022–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:30635&r=upt |
| By: | Dyrland, Kjetil; Lundervold, Alexander Selvikvåg (Western Norway University of Applied Sciences); Porta Mana, PierGianLuca (HVL Western Norway University of Applied Sciences) |
| Abstract: | In a classification task from a set of features, one would ideally like to have the probability of the class conditional on the features. Such probability is computationally almost impossible to find in many important cases. The primary idea of the present work is to calculate the probability of a class conditional not on the features, but on a trained classifying algorithm's output. Such probability is easily calculated and provides an output-to-probability ’transducer’ that can be applied to the algorithm's future outputs. In conjunction with problem-dependent utilities, the probabilities of the transducer allows one to make the optimal choice among the classes or among a set of more general decisions, by means of expected-utility maximization. The combined procedure is a computationally cheap yet powerful ‘augmentation’ of the original classifier. This idea is demonstrated in a simplified drug-discovery problem with a highly imbalanced dataset. The augmentation leads to improved results, sometimes close to theoretical maximum, for any set of problem-dependent utilities. The calculation of the transducer also provides, automatically: (i) a quantification of the uncertainty about the transducer itself; (ii) the expected utility of the augmented algorithm (including its uncertainty), which can be used for algorithm selection; (iii) the possibility of using the algorithm in a ‘generative mode’, useful if the training dataset is biased. It is argued that the optimality, flexibility, and uncertainty assessment provided by the transducer & augmentation are dearly needed for classification problems in fields such as medicine and drug discovery. |
| Date: | 2022–06–01 |
| URL: | http://d.repec.org/n?u=RePEc:osf:osfxxx:vct9y&r=upt |
| By: | Andreasen, Martin Møller; Caggiano, Giovanni; Castelnuovo, Efrem; Pellegrino, Giovanni |
| Abstract: | This paper uses a nonlinear vector autoregression and a non-recursive identiÖcation strategy to show that an equal-sized uncertainty shock generates a larger contraction in real activity when growth is low (as in recessions) than when growth is high (as in expansions). An estimated New Keynesian model with recursive preferences and approximated to third order around its risky steady state replicates these state-dependent responses. The key mechanism behind this result is that Örms display a stronger upward nominal pricing bias in recessions than in expansions, because recessions imply higher ináation volatility and higher marginal utility of consumption than expansions. |
| Keywords: | New Keynesian Model,Nonlinear SVAR,Non-recursive identiÖcation,State-dependent uncertainty shock,Risky steady state |
| Date: | 2021 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bofrdp:rdp2021_013&r=upt |
| By: | Giuseppe Travaglini (Department of Economics, Society & Politics, Università di Urbino Carlo Bo) |
| Abstract: | Political Economy, as an autonomous discipline, has a relatively recent history. From its origins, it appears to be divided into two fields, the “classical†one based on the labor- value theory, and the “neoclassical†one at the center of which is the utility-value theory. Our aim in this paper is to identify some relevant philosopher strands in economic thought that can help to disentangle the reciprocal relationships between the different economic theories, and to understand their relations with philosophy, and particularly with Moral philosophy. This can make it easier to study political economy, its social and political implications, and the not always simple relationship of the economic theory with social disciplines. |
| Keywords: | political economy; moral philosophy; welfare economics; social justice |
| JEL: | B00 B10 B40 |
| Date: | 2022 |
| URL: | http://d.repec.org/n?u=RePEc:urb:wpaper:22_04&r=upt |
| By: | Ciccia, Diego; Distefano, Rosaria; Reito, Francesco |
| Abstract: | We present a simple model of bureaucracy under imperfect information, with a public manager and many public officials, some of whom may have the incentive to shirk. We show that the level of shirking in the bureaucracy may be non-monotone in the initial proportion of potential shirkers in the population. Namely, provided the utility from leisure is not too large, the equilibrium level of shirking can be first increasing and then decreasing in the proportion of potential shirkers. A corollary result is that the equilibrium can be efficient only when potential shirkers are particularly numerous. |
| Keywords: | bureaucracy; asymmetric information; shirking. |
| JEL: | D82 J31 J45 |
| Date: | 2022–09–07 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:115452&r=upt |
| By: | Borges da Silva, Eduardo; Emanuel M. Oliveira, Vitor |
| Abstract: | The significant growth in discussions on the relationship between finance and sustainability has as its central point the wondering whether it is possible to have synergy between the generation of alpha in the return and profitability of an asset that has a sustainable identity and composition. In this context, this paper looks forward to analyze the theme of sustainability, represented by the ESG assumptions - Environmental, Social and Governance, under the theoretical bias of behavioral finance. Just as the heuristics and the Prospect Theory represented a counterpoint to the premise of strict rationality of economic agents, provided for by the Modern Theory of Finance, the ESG, based on this new perspective for decision-making, seeks to assert that it is possible to generate value with adoption and filters of sustainable assumptions. The emphasis of the work is to verify, through optimization at the Markowitz Efficient Frontier, whether a sustainable portfolio, represented by the Índice de Sustentabilidade Empresarial - ISE, can present a better risk-adjusted return performance, compared to the benchmark of the market portfolio, represented by the Índice Ibovespa – IBOV. |
| Keywords: | ESG; Behavioral Finance; Portfolio Management |
| JEL: | G00 G02 G21 G3 G30 |
| Date: | 2022–11–15 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:115510&r=upt |
| By: | Juselius, Mikael; Tarashev, Nikola A. |
| Abstract: | A parsimonious extension of a well-known portfolio credit-risk model allows us to study a salient stylized fact - abrupt switches between high- and low-loss phases - from a risk-management perspective. As uncertainty about phase switches increases, expected losses decouple from unexpected losses, which reflect a high percentile of the loss distribution. Banks that ignore this decoupling have shortfalls of loss-absorbing resources, which is more detrimental if the portfolio is more diversified within a phase. Likewise, the risk-management benefits of improving phase-switch forecasts increase with diversification. The analysis of these findings leads us to an empirical method for comparing the degree of within-phase default clustering across portfolios. |
| Keywords: | Expected loss provisioning,Bank capital,Unexpected losses,Credit cycles,Portfolio credit risk |
| JEL: | G21 G28 G32 |
| Date: | 2022 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bofrdp:rdp2022_004&r=upt |