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on Utility Models and Prospect Theory |
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Issue of 2023‒02‒20
sixteen papers chosen by |
| By: | Christopher P. Chambers; Federico Echenique; Nicolas S. Lambert |
| Abstract: | We provide sufficient conditions under which a utility function may be recovered from a finite choice experiment. Identification, as is commonly understood in decision theory, is not enough. We provide a general recoverability result that is widely applicable to modern theories of choice under uncertainty. Key is to allow for a monetary environment, in which an objective notion of monotonicity is meaningful. In such environments, we show that subjective expected utility, as well as variational preferences, and other parametrizations of utilities over uncertain acts are recoverable. We also consider utility recovery in a statistical model with noise and random deviations from utility maximization. |
| Date: | 2023–01 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2301.11492&r=upt |
| By: | Miller, Anne |
| Abstract: | This paper extends demand theory into the neglected area of increasing marginal utility, representing ‘deprivation’. Proposition 1 suggests that an individual’s consumption of a commodity could be represented by a bounded cardinal, S-shaped utility function. Proposition 2 indicates when to add and when to multiply utilities. Added S-shaped utilities lead to both convex- and concave-to-the-origin indifference curves, the latter space defining dysfunctional poverty. An absolute poverty line can be identified. A given commodity could potentially provide all of superior, inferior or Giffen experiences within the convex-to-the-indifference curve space. The derived structural forms, including labour supply, reveal discontinuities, envelope curves and high elasticities associated with deprivation. The two propositions together yield the familiar results of traditional neoclassical theory and provide an integrating framework for analysing utility and demand. A functional form for additive S-shaped utilities with meaningful, estimable parameters is derived in the appendix, and is used to create the diagrams. |
| Keywords: | increasing marginal utility, additive utilities, absolute poverty line, Giffen good |
| JEL: | D11 J22 |
| Date: | 2022–12 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:116144&r=upt |
| By: | Sanjit Dhami; Narges Hajimoladarvish; Pavan Mamidi |
| Abstract: | We consider income-source-dependent tax evasion and show that this is a generalization of the well-known endowment effect. We show that loss aversion, moral costs, mental accounting, and risk preferences play a key role in explaining key features of source-dependent tax evasion. We provide evidence of the first direct link between subject-specific loss aversion and tax evasion, which is central to most successful modern theoretical accounts of tax evasion. We provide some evidence that risk aversion strengthens the cautionary effect of loss aversion and risk loving behavior attenuates, or reverses, it. However, the underlying effect is also influenced by the source of income. Evasion is increasing in the tax rate and decreasing in the audit penalty, as predicted. Our paper provides novel theoretical insights; proposes new methods in the estimation of the underlying behavioral parameters; and confirms the central predictions of the theory, while pointing out challenges for further developments that existing theory is unable to account for. |
| Keywords: | tax evasion, endowment effect, loss aversion, morality, mental accounting, prospect theory, risk aversion |
| JEL: | C91 C92 D82 D91 G21 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10224&r=upt |
| By: | Jeanne Hagenbach (ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique); Frédéric Koessler (PSE - Paris School of Economics - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement) |
| Abstract: | We consider a single psychological agent whose utility depends on his action, the state of the world, and the belief he holds about that state. The agent is initially informed about the state and decides whether to memorize it, otherwise he has no recall. We model the memorization process by a multi-self game in which the privately-informed first self voluntarily discloses information to the second self, who has identical preferences and acts upon the disclosed information. We show that, for broad categories of psychological utility functions, there exists an equilibrium in which every state is voluntarily memorized. In contrast, if there are exogenous failures in the memorization process, the agent always memorizes states selectively. In this case, we characterize the partially informative equilibria for common classes of psychological utilities. |
| Keywords: | Multi-self games, Disclosure games, Imperfect recall, Selective memory, Motivated beliefs, Psychological games, Anticipatory utility |
| Date: | 2022–02 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-03672216&r=upt |
| By: | Bruno Bouchard (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - Université Paris Dauphine-PSL - PSL - Université Paris sciences et lettres - CNRS - Centre National de la Recherche Scientifique, PSL - Université Paris sciences et lettres); Johannes Muhle-Karbe (University of Michigan [Ann Arbor] - University of Michigan System) |
| Abstract: | Using elementary arguments, we derive Lp-error bounds for the approximation of frictionless wealth process in markets with proportional transaction costs. For utilities with bounded risk aversion, these estimates yield lower bounds for the frictional value function, which paves the way for its asymptotic analysis using stability results for viscosity solutions. Using tools from Malliavin calculus, we also derive simple sufficient conditions for the regularity of frictionless optimal trading strategies, the second main ingredient for the asymptotic analysis of small transaction costs. |
| Keywords: | Transaction costs, Utility maximization, Asymptotic analysis |
| Date: | 2022–04 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-01711371&r=upt |
| By: | Abdelali Gabih; Hakam Kondakji; Ralf Wunderlich |
| Abstract: | In this paper we study optimal trading strategies in a financial market in which stock returns depend on a hidden Gaussian mean reverting drift process. Investors obtain information on that drift by observing stock returns. Moreover, expert opinions in the form of signals about the current state of the drift arriving at fixed and known dates are included in the analysis. Drift estimates are based on Kalman filter techniques. They are used to transform a power utility maximization problem under partial information into an optimization problem under full information where the state variable is the filter of the drift. The dynamic programming equation for this problem is studied and closed-form solutions for the value function and the optimal trading strategy of an investor are derived. They allow to quantify the monetary value of information delivered by the expert opinions. We illustrate our theoretical findings by results of extensive numerical experiments. |
| Date: | 2023–01 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2301.06847&r=upt |
| By: | Lorenzo Esposito (Dipartimento di Politica Economica, DISCE, Università Cattolica del Sacro Cuore, Milano, Italy – Banca d'Italia, Milano, Italy); Letizia Malara (DISCE, Università Cattolica del Sacro Cuore, Milano, Italy) |
| Abstract: | Mainstream theory of finance is based on the assumptions that markets are efficient and economic agents are rational, in the sense that they use optimally the information they have in order to maximize their utility. At least since the “Allais paradox”, countless experiments have shown that this is not the case and investors’ decisions are often inconsistent. In particular, the researches by Kahneman and Tversky have highlighted that investor behaviors are not rational and sometimes are inconsistent with the logic of the traditional finance theory, due to numerous cognitive biases, which interfere with the choice process of investors. In this paper we investigate some of the most well-known cognitive biases: framing effect, loss aversion, endowment effect, decoy effect and disposition effect. In addition, the availability and representativeness heuristics and their associated biases (confirmation bias, accessibility bias, and conjunction fallacy) are examined. Our experimental methodology is based on a questionnaire consisting of 23 questions and organized into 6 sections, each referring to the various biases examined. The answers obtained differ somewhat from the huge literature on cognitive biases. We understand these differences as mainly connected to the unheard situation created by the Covid-19 pandemic, showing that personal experiences do have an effect on risk preferences. |
| Keywords: | cognitive biases, behavioral economics, prospect theory, pandemic |
| JEL: | G41 |
| Date: | 2023–01 |
| URL: | http://d.repec.org/n?u=RePEc:ctc:serie5:dipe0029&r=upt |
| By: | Jerg Gutmann; Léa Marchal; Betül Simsek |
| Abstract: | This is the first global study of how institutionally entrenched gender discrimination affects the gender migration gap (GMG) using data on 158 origin and 37 destination countries over the period 1961-2019. We estimate a gravity equation derived from a random utility maximization model of migration that accounts for migrants’ gender. Instrumental variable estimates indicate that increasing gender equality in economic or political rights generally deepens the GMG, i.e., it reduces female emigration relative to that of men. In line with our theoretical model, this average effect is driven by higher-income countries. In contrast, increased gender equality in rights reduces the GMG in lower-income countries by facilitating female emigration. |
| Keywords: | discrimination, gender equality, individual rights, migration, RUM model |
| JEL: | F22 J16 J71 K38 O15 P48 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10222&r=upt |
| By: | Alfred Galichon (NYU - New York University [New York] - NYU - NYU System, ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique); Bernard Salanié (Columbia University [New York]) |
| Abstract: | In this paper we propose two simple methods to estimate models of matching with transferable and separable utility introduced in Galichon and Salanié (2022). The first method is a minimum distance estimator that relies on the generalized entropy of matching. The second relies on a reformulation of the more special but popular Choo and Siow (2006) model; it uses generalized linear models (GLMs) with two-way fixed effects. |
| Keywords: | Matching, Marriage, Assignment, Estimations comparison |
| Date: | 2022–04–04 |
| URL: | http://d.repec.org/n?u=RePEc:hal:spmain:hal-03936122&r=upt |
| By: | Zhengyang Jiang |
| Abstract: | I develop a general characterization of the effect that market incompleteness has on exchange rate dynamics. On the one hand, it weakens the pass-through from a country's marginal utility shocks to its own exchange rate movements; on the other hand, it gives rise to additional variations in exchange rates and propagates one country's marginal utility shocks to other countries' exchange rate movements. This novel international spill-over effect gives rise to both exchange rate disconnect from local fundamentals and exchange rate comovements in the cross-section of currencies, offering a novel channel for understanding these salient features of exchange rate behaviors. |
| JEL: | F31 G15 |
| Date: | 2023–01 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:30856&r=upt |
| By: | Bernard, Sabine Esther; Weber, Martin; Loos, Benjamin |
| Abstract: | Using German and US brokerage data we find that investors are more likely to sell speculative stocks trading at a gain. Investors' gain realizations are monotonically increasing in a stock's speculativeness. This translates into a high disposition effect for speculative and a much lower disposition effect for non-speculative stocks. Our findings hold across asset classes (stocks, passive, and active funds) and explain cross-sectional differences in investor selling behavior which previous literature attributed primarily to investor demographics. Our results are robust to rank or attention effects and can be linked to realization utility and rolling mental account. |
| Keywords: | Selling Behavior, Disposition Effect, Retail Investor, Speculation, Higher Moments of Return, Realization Utility |
| JEL: | D14 D81 D9 G11 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:safewp:378&r=upt |
| By: | Bohmann, Sandra; Kalleitner, Fabian |
| Abstract: | This paper argues that `inequity aversion' can be understood as an emotional reaction to perceived injustice that arises from individuals’ comparisons of their own and others’ outcomes to a subjective fairness ideal. In particular, we assume that subjective perceptions of inequity and not objective deviations from equality are crucial to understanding how individuals react to inequality. The paper formalizes these insights by adapting the Fehr and Schmidt (1999) model of inequity aversion replacing the fairness frame of objective equality with subjectively perceived equity. We test this model using data from the European Social Survey 2018 analyzing the association between respondents' perceived fairness of own, top, and bottom incomes with subjective well-being and preferences for redistribution. Results from spline regressions with country-fixed effects indicate that perceived injustice of own and top incomes is positively related to individuals' subjective well-being. For the perceived injustice of bottom incomes, we find no substantive relationships with subjective well-being. Further analyses indicate a positive link between the perceived injustice of bottom and top incomes and preferences for redistribution. In sum, our results suggest that injustice perceived for oneself is connected to utility while perceived injustice of others is related to increased willingness to back redistributive policy proposals even if they are not in line with material self-interest. |
| Date: | 2023–01–23 |
| URL: | http://d.repec.org/n?u=RePEc:osf:socarx:g8arw&r=upt |
| By: | Moshe Buchinsky (UCLA - University of California [Los Angeles] - UC - University of California, NBER - National Bureau of Economic Research [New York] - NBER - The National Bureau of Economic Research, ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique); Chemi Gotlibovski (MTA - The Academic College of Tel Aviv-Yaffo); Osnat Lifshitz (Reichman University [Herzliya]) |
| Abstract: | We estimated two dynamic programing models, one for men and one for women, on a sample of immigrants who arrived in Israel from the Former Soviet Union (FSU) between 1989 and 1995. Following the literature, we assume that the household maximizes its expected utility based only on the husband's human capital. Therefore, the family's residential location decision is based on the husband's labor market opportunities. We study the potential effect of this assumed behavior on the labor market's gender gaps. In the model estimated for men, we endogenize the decisions regarding residential location, employment location, and occupational choices. In contrast, in the model estimated for women the family's residential location is taken as given. Using the estimated parameters from the two models and a number of counterfactual simulations, we are able to decompose the observed gender wage gap into two parts–one based on behavioral differences and the other based on the lower labor market returns for women. The simulations indicate that if women had the same labor market returns and the same preferences as men, their outcomes would have been similar to those of men. Moreover, the simulations show that even without any changes in their labor market conditions, women would have gained in terms of both job quality and wages if the family's residential location was based on their human capital. |
| Keywords: | Family migration, Gender wage gap, Household Labor Supply, Residential Location |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:hal:spmain:hal-03925781&r=upt |
| By: | Cetin, Sefane (Université catholique de Louvain, LIDAM/CORE, Belgium); Jousten, Alain (Université de Liège) |
| Abstract: | This paper investigates the retirement patterns of married couples in Belgium. To forecast retirement behavior, we use administrative Social Security data from 2003 to 2017 and a discrete choice random utility model. In particular, we concentrate on the spousal bonus of pension payments to comprehend how financial incentives resulting from the social security system’s structural design affect both partners’ retirement decisions. We simulate the effect of the elimination of the spousal bonus and find that a small portion of women delay their retirement whereas the rest substitute into alternative social security benefits. Our results not only highlight the significance of cross-program spillovers between various Social Security benefits, but also the heterogeneity in preferences for retirement and asymmetry of retirement behavior between husbands and wives. |
| Keywords: | Old-Age Labor Supply ; Retirement Incentives ; Spousal Bonus ; Pension Reforms |
| JEL: | D10 H55 J26 |
| Date: | 2022–11–16 |
| URL: | http://d.repec.org/n?u=RePEc:cor:louvco:2022024&r=upt |
| By: | Luís Sá (NIPE/Center for Research in Economics and Management, University of Minho, Portugal); Odd Rune Straume (NIPE/Center for Research in Economics and Management, University of Minho, Portugal; and Department of Economics, University of Bergen, Norway) |
| Abstract: | We study competing hospitals' incentives for quality provision in a dynamic setting where healthcare is an experience good. In our model, the utility a patient derives from choosing a particular provider depends on a subjective component specifi c to the match between the patient and the provider, which can only be learned through experience. We find that the experience-good nature of healthcare can either reinforce or dampen the demand responsiveness to quality and the hospitals' incentives for quality provision, depending on two key factors: (i) the shape of the distribution of match-specific utilities, and (ii) the cost relationship between quality provision and treatment volume. Our analysis helps identify and understand the conditions required for the market-based provision of healthcare to deliver improved quality. |
| Keywords: | Hospital competition; experience goods; forward-looking consumers; expectations; quality. |
| JEL: | I11 I18 L13 L51 |
| Date: | 2022 |
| URL: | http://d.repec.org/n?u=RePEc:nip:nipewp:12/2022&r=upt |
| By: | Stéphane Gauthier (PSE - Paris School of Economics - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, UP1 - Université Paris 1 Panthéon-Sorbonne, IFS - Laboratory of the Institute for Fiscal Studies - Institute for Fiscal Studies); Guy Laroque (ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique, UCL - University College of London [London], IFS - Laboratory of the Institute for Fiscal Studies - Institute for Fiscal Studies) |
| Abstract: | We assess the usefulness of stochastic redistribution among a continuum of riskaverse agents with quasilinear utilities in labor. Agents differ according to their consumption tastes, which remain private information. We identify circumstances where stochastic redistribution is socially dominated by the deterministic policy where aftertax income lotteries are replaced with their certainty equivalent. We also provide a parametric example where feasible and incentive compatible lotteries locally dominate the optimal deterministic menu. In this example the downward pattern of incentives prevailing in the deterministic case is reversed to an upward pattern in the stochastic case. |
| Keywords: | Redistribution, Asymmetric information, Random taxes, Certainty equivalent |
| Date: | 2022–09–01 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-03915336&r=upt |