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on Utility Models and Prospect Theory |
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Issue of 2023‒04‒10
fifteen papers chosen by |
| By: | Gabriel Montes Rojas; Luciano De Castro; Antonio Galvao; José Olmo; Kim Jeong Yeol |
| Keywords: | Optimal Asset Allocation, Quantile Preferences, Portfolio Theory, Risk Attitude, Predictive Ability Tests |
| JEL: | D81 G11 |
| Date: | 2021–11 |
| URL: | http://d.repec.org/n?u=RePEc:aep:anales:4494&r=upt |
| By: | Naudé, Wim (RWTH Aachen University) |
| Abstract: | Artificial Intelligence (AI) scientists are challenged to create intelligent, autonomous agents that can make rational decisions. In this challenge, they confront two questions: what decision theory to follow and how to implement it in AI systems. This paper provides answers to these questions and makes three contributions. The first is to discuss how economic decision theory – Expected Utility Theory (EUT) – can help AI systems with utility functions to deal with the problem of instrumental goals, the possibility of utility function instability, and coordination challenges in multi-actor and human-agent collectives settings. The second contribution is to show that using EUT restricts AI systems to narrow applications, which are "small worlds" where concerns about AI alignment may lose urgency and be better labelled as safety issues. This papers third contribution points to several areas where economists may learn from AI scientists as they implement EUT. These include consideration of procedural rationality, overcoming computational difficulties, and understanding decision-making in disequilibrium situations. |
| Keywords: | economics, artificial intelligence, expected utility theory, decision-theory |
| JEL: | D01 C60 C45 O33 |
| Date: | 2023–03 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp16000&r=upt |
| By: | Alex Gershkov; Benny Moldovanu; Philipp Strack; Mengxi Zhang |
| Abstract: | We study a generalization of the classical monopoly insurance problem under adverse selection (see Stiglitz [1977]) where we allow for a random distribution of losses, possibly correlated with the agent’s risk parameter that is private information. Our model explains patterns of observed customer behavior and predicts insurance contracts most often observed in practice: these consist of menus of several deductible-premium pairs, or menus of insurance with coverage limits-premium pairs. The main departure from the classical insurance literature is obtained here by endowing the agents with risk-averse preferences that can be represented by a dual utility functional (Yaari [1987]). |
| Keywords: | digital platforms, Big Tech, market definition, multi-markets approach, German Competition Act, 19a designations, competition law |
| JEL: | K21 |
| Date: | 2023–03 |
| URL: | http://d.repec.org/n?u=RePEc:bon:boncrc:crctr224_2023_399&r=upt |
| By: | Ramírez, H; Serrano, R |
| Abstract: | We study investment and insurance demand decisions for an agent in a theoretical continuoustime expected utility maximization model that combines risky assets with an (exogenous) insurable background risk. This risk takes the form of a jump-diffusion process with negative jumps in the return rate of the (self-financed) wealth. The main distinctive feature of our model is that the agent’s decision on portfolio choice and insurance demand causes nonlinear friction in the dynamics of the wealth process. We use the dynamic programming approach to find optimality conditions under which the agent assumes the insurable risk entirely, or partially, or purchases total insurance against it. In particular, we consider differential and piece-wise linear portfolio allocation frictions, with differential borrowing and lending rates as our most emblematic example. Finally, we present a mutual-fund separation result and illustrate our results with several numerical examples when the adverse jump risk has Beta distribution. |
| Keywords: | Portfolio allocation, Insurance demand, CRRA utility, Background risk, Jump-diffusions, Dynamic programming, Differential rates, Fund separation Theorem |
| Date: | 2023–03–10 |
| URL: | http://d.repec.org/n?u=RePEc:col:000092:020658&r=upt |
| By: | Thomas Dohmen (University of Bonn, Lennestrasse 43, 53113 Bonn, Germany; IZA Instituteo f Labor Economics; Maastricht University); Simone Quercia (University of Verona, Via Cantarane 24, 37129 Verona, Italy); Jana Willrodt (Duesseldorf Institute for Competition Economics (DICE), Universitaetsstrasse 1, 40225 Duesseldorf, Germany) |
| Abstract: | In this paper, we provide an explanation for why risk taking is related to optimism. Using a laboratory experiment, we show that the degree of optimism predicts whether people tend to focus on the positive or negative outcomes of risky decisions. While optimists tend to focus on the good outcomes, pessimists focus on the bad outcomes of risk. The tendency to focus on good or bad outcomes of risk in turn affects both the self-reported willingness to take risk and actual risk taking behavior. This suggests that dispositional optimism may affect risk taking mainly by shifting attention to specific outcomes rather than causing misperception of probabilities. In line with this, in a second studywe find evidence that dispositional optimism is related to elicited parameters of rank dependent utility theory suggesting that focusing may be among the psychological determinants of decision weights. Finally, we corroborate our findings with process data related to focusing showing that optimists tend to remember more and attend more to good outcomes and this in turn affects their risk taking. |
| Keywords: | Risk taking behavior, optimism, preference measure |
| JEL: | D91 C91 D81 D01 |
| Date: | 2023–03 |
| URL: | http://d.repec.org/n?u=RePEc:ajk:ajkdps:223&r=upt |
| By: | Koji Yokote; Isa E. Hafalir; Fuhito Kojima; M. Bumin Yenmez |
| Abstract: | Path independence is arguably one of the most important choice rule properties in economic theory. We show that a choice rule is path independent if and only if it is rationalizable by a utility function satisfying ordinal concavity, a concept closely related to concavity notions in discrete mathematics. We also provide a representation result for choice rules that satisfy path independence and the law of aggregate demand. |
| Date: | 2023–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2303.00892&r=upt |
| By: | Kenneth W Clements (Business School, The University of Western Australia) |
| Abstract: | This paper deals with the microeconomic theory of the consumer concentrating on the implications of tastes in the form of the utility function. The paper is selective in the treatment of the literature and highlights what I regard as important and derivations are omitted. There are a number of excellent sources that provide details of the approach, such as Deaton and Muellbauer (1980a), Theil (1980) and Wohlgenant (2021). |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:uwa:wpaper:23-01&r=upt |
| By: | Antoinette Baujard (Université Jean Monnet, 42 023 Saint-Etienne, France. GATE Lyon Saint-Etienne (UMR CNRS 5824)) |
| Abstract: | Under welfarism, assertions such as “this social state is better than an alternative” or “this policy should be enacted” are based on the assumption that social welfare ultimately depends only on the well-being of individuals. A normative analysis of welfarism seeks to provide a transparent description of the basis upon which welfarism makes its value judgements, which is equivalent to an investigation into its choice of a preferred notion of well-being. Such an investigation, this paper claims, can take two forms, which we should distinguish: the ethical analysis of welfarism is concerned with the appeal to a given ethical theory of well-being; and the technical analysis of welfarism concerns the specific measure of individual utility that in practice is used to measure social welfare. Reviewing a series of claims which bear on how these two versions of welfarism are articulated (the standard, proxy, evidential and tension claims), the paper explores the differences between the ethical and technical approaches in the normative interpretation of welfarist assertions. |
| Keywords: | Welfare Economics, Welfarism, Ethics, Practice, Ethical welfarism, Technical welfarism, Demarcation, Neutrality, Non-Neutrality, Axiological transparency, Value judgements |
| JEL: | B4 D6 I31 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:gat:wpaper:2306&r=upt |
| By: | Marcos Escobar-Anel; Michel Kschonnek; Rudi Zagst |
| Abstract: | We study the expected utility portfolio optimization problem in an incomplete financial market where the risky asset dynamics depend on stochastic factors and the portfolio allocation is constrained to lie within a given convex set. We employ fundamental duality results from real constrained optimization to formally derive a dual representation of the associated HJB PDE. Using this representation, we provide a condition on the market dynamics and the allocation constraints, which ensures that the solution to the HJB PDE is exponentially affine and separable. This condition is used to derive an explicit expression for the optimal allocation-constrained portfolio up to a deterministic minimizer and the solution to a system of Riccati ODEs in a market with CIR volatility and in a market with multi-factor OU short rate. |
| Date: | 2023–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2303.09835&r=upt |
| By: | Anna Bogomolnaia (HSE St Petersburg - Higher School of Economics - St Petersburg, University of Glasgow, CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Hervé Moulin (University of Glasgow, HSE St Petersburg - Higher School of Economics - St Petersburg, CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique) |
| Abstract: | When dividing a "manna" Ω of private items (commodities, workloads, land, time slots) between n agents, the individual guarantee is the welfare each agent can secure in the worst case of other agents' preferences and actions. If the manna is nonatomic and utilities are continuous (not necessarily monotone or convex) the minmax utility, that of our agent's best share in the agent's worst partition of the manna, is guaranteed by Kuhn's generalization of divide and choose. The larger maxmin utility—of the agent's worst share in the agent's best partition—cannot be guaranteed even for two agents. If, for all agents, more manna is better than less (or less is better than more), the new bid and choose rules offer guarantees between minmax and maxmin by letting agents bid for the smallest (or largest) size of a share they find acceptable. |
| Keywords: | fair division, divide and choose, guarantees, nonatomic utilities |
| Date: | 2022–04–08 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-03886828&r=upt |
| By: | Sebastiaan Maes; Raghav Malhotra |
| Abstract: | Measuring the welfare impact of price changes on consumers is pivotal in economic analyses. Researchers often measure these impacts with cross sectional data, where every consumer is observed only once. The representative agent (RA) approach, which assumes all observations stem from a single agent, may lead to biased estimates when agents preferences are heterogeneous. We show how to use the higher moments of demand to improve these estimates. In fact, the variance alone captures much of the bias in the RA approach. Our approach also enables inference on the distribution of welfare changes. We then leverage our approach to obtain conditions moments of demand must satisfy to arise from a population of utility maximizers and deliver a characterization of rationality for the two good case. Using the UK Household Budget Survey, we apply our methodology to estimate the welfare impact of a 10 percent transport price increase and find that the RA approach understates the welfare impact by 27 percent. |
| Date: | 2023–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2303.01231&r=upt |
| By: | André de Palma; Zhi-Chun Li; De-Ping Yu (Université de Cergy-Pontoise, THEMA) |
| Abstract: | We propose an analytically solvable model for the residential location choices of heterogeneous households in a linear monocentric city corridor with bottleneck congestion. Residents have heterogeneous income, and make a joint choice of residential location and departure time. There is a bottleneck with a fixed or with a stochastic location between central downtown and adjacent suburb of the city. The urban system equilibrium and the effects of bottleneck capacity expansion on the city system are analytically investigated, together with the design of the bottleneck capacity. We show that the residents spatially sort themselves along the city corridor from CBD outward in a descending order of their values of time. Expanding bottleneck capacity leads to an increase in the commuting costs of the downtown residents but a decrease in the commuting costs of the suburban residents. All residents of the city benefit from the bottleneck capacity expansion, with the highest benefit for the relatively mid-income residents, and the lowest benefit for the lowest-income or the highest-income residents, depending on the status quo of the bottleneck capacity. Expanding the bottleneck capacity leads to urban sprawl, and a decrease in total net land rent. Ignoring the effects of the bottleneck capacity expansion on the urban spatial structure overestimates the social surplus. The bottleneck location's stochasticity smoothes the residential distribution, increases the system's transportation cost, and decreases household utility and social surplus. |
| Keywords: | Residential location choice, linear monocentric city, heterogeneous residents, stochastic bottleneck, bottleneck capacity expansion |
| JEL: | R13 R14 R41 R42 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ema:worpap:2023-01&r=upt |
| By: | Tonami, Shun (University of Warwick) |
| Abstract: | This paper gives a fresh perspective on the New Keynesian Philips Curve (NKPC) when combining the rational inattention hypothesis, which will give a new insight into backward-looking evidence. A further contribution of this paper is to give a unique application method of the development of the rational inattention hypothesis in other economic fields. This study provides the viewpoint that OLS (ordinary least squares) estimators have an imperfect information bias under the noise information model where economic agents optimize their behaviors through the rational inattention hypothesis. Specifically, the information flow constraint is redefined as the regression coefficient constraint by information theory extension. As a result, if the rational inattention hypothesis is expected to hold in economic fields, the Ridge regression can provide optimal estimations for economists in their fields by allowing them to consider the imperfect information bias through penalizing the coefficients. In empirical wook, the rational inattention model complements the NKPC by including the imperfect information bias error in the regression analysis. The estimation reveals that the imperfect information bias error can play a backward-looking role. The rational inattention NKPC introduces the backward-looking element theoretically and demonstrates inflation inertia well. |
| Keywords: | Rational Inattention ; Ridge Regression ; Information Flow ; Constraint ; New Keynesian Philips Curve JEL classifications: C51 ; D8 ; E31 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:wrk:wrkesp:53&r=upt |
| By: | Faten Saliba; Giorgio Maarraoui; Walid Marrouch; Ada Wossink |
| Abstract: | This paper uses life satisfaction data to help the design of climate mitigation policies in the United Kingdom. We assess the effects of the exposure to ambient pollutants on long-term life satisfaction and short-term mental health in the UK. We estimate augmented Cobb-Douglas utility functions using pooled and random effects ordinal logit models. Results show that increases in NO2, PM10 and PM2.5 significantly decrease the odds of longterm happiness and short-term mental health in the UK. The willingness to pay for clean air is also significant and increases with level of education. These measurements derived can be used as benchmarks for pollution abatement subsidies or pollution taxes and can help in projecting a more comprehensive assessment of costs and benefits. |
| Keywords: | Air Pollution; Happiness; Policy Valuation; Climate Change; Environmental Policies; Pollution Taxes; Pollution Abatement Subsidies; life satisfaction data; dataset description; air pollutant; pollutants' correlation; household data; ordinal Logit; Income; Europe; Global |
| Date: | 2023–02–17 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:2023/035&r=upt |
| By: | Jean-Gabriel Lauzier; Liyuan Lin; Ruodu Wang |
| Abstract: | We systemically study pairwise counter-monotonicity, an extremal notion of negative dependence. A stochastic representation and an invariance property are established for this dependence structure. We show that pairwise counter-monotonicity implies negative association, and it is equivalent to joint mix dependence if both are possible for the same marginal distributions. We find an intimate connection between pairwise counter-monotonicity and risk sharing problems for quantile agents. This result highlights the importance of this extremal negative dependence structure in optimal allocations for agents who are not risk averse in the classic sense. |
| Date: | 2023–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2302.11701&r=upt |