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on Utility Models and Prospect Theory |
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Issue of 2024‒01‒08
twenty-one papers chosen by |
| By: | Gérard Mondello (Université Côte d'Azur, France; GREDEG CNRS) |
| Abstract: | This article studies the influence of the quality of information sources on the decisions of agents faced with radical uncertainty. It compares the decision-making process of expected utility maximizers and neo-additive Choquet utility maximizers. It shows that the first type of decision-maker will always prefer information provided by an unreliable source, even if its credibility is very low. The second type conditions its choice on its level of aversion to ambiguity, its degree of optimism and its level of confidence in the information source itself. Furthermore, the preferences may also be influenced by the information content. |
| Keywords: | Uncertainty theory, decision theory, ambiguity aversion, information |
| JEL: | I10 I18 I19 D80 D81 D83 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:gre:wpaper:2023-18&r=upt |
| By: | Kausik, B.N. |
| Abstract: | Equity premium, the surplus returns of stocks over bonds, has been an enduring puzzle. While numerous prior works approach the problem assuming the utility of money is invariant across contexts, our approach implies that in efficient markets the utility of money is polymorphic, with risk aversion dependent on the information available in each context, i.e. the discount on each future cash flow depends on all information available on that cash flow. Specifically, we prove that in efficient markets, informed investors maximize return on volatility by being risk-neutral with riskless bonds, and risk-averse with equities, thereby resolving the puzzle. We validate our results on historical data with surprising consistency. |
| Keywords: | Equity premium, efficient markets |
| JEL: | C58 G12 G17 |
| Date: | 2023–11–19 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:119278&r=upt |
| By: | Avner Seror (Aix-Marseille Univ., CNRS, AMSE, Marseille, France) |
| Abstract: | In this paper, I introduce a novel methodology to conduct surveys. The priced survey methodology (PSM). Like standard surveys, priced surveys are easy to implement, and measure social preferences on numerical scales. The PSM's design draws inspiration from consumption choice experiments, as respondents fill out the same survey several times under different choice sets. I extend Afriat's theorem and show that the Generalized Axiom of Revealed Preferences is necessary and sufficient for the existence of a concave, continuous, and single-peaked utility function rationalizing answers to the PSM. I apply the PSM to a sample of online participants and show that most respondents are rational when answering the PSM. I estimate respondents' single-peaked utility functions and draw several implications on their social preferences. |
| Keywords: | Decision Theory, revealed preference, Social Preferences, Behavioral Economics, survey |
| JEL: | C9 D91 C44 |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:aim:wpaimx:2330&r=upt |
| By: | Fedor Sandomirskiy; Omer Tamuz |
| Abstract: | We investigate inherent stochasticity in individual choice behavior across diverse decisions. Each decision is modeled as a menu of actions with outcomes, and a stochastic choice rule assigns probabilities to actions based on the outcome profile. Outcomes can be monetary values, lotteries, or elements of an abstract outcome space. We characterize decomposable rules: those that predict independent choices across decisions not affecting each other. For monetary outcomes, such rules form the one-parametric family of multinomial logit rules. For general outcomes, there exists a universal utility function on the set of outcomes, such that choice follows multinomial logit with respect to this utility. The conclusions are robust to replacing strict decomposability with an approximate version or allowing minor dependencies on the actions' labels. Applications include choice over time, under risk, and with ambiguity. |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2312.04827&r=upt |
| By: | Yan Dolinsky |
| Abstract: | In this work we study the continuous time exponential utility maximization problem in the framework of semi-static hedging. |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2311.17270&r=upt |
| By: | Deirdre Haskell; Jeremiah Hurley; Junying Zhao |
| Abstract: | This paper concerns the aggregation of individual preferences into a social ordering. Working in a higher-dimensional economic environment where an indifference hypersurface is the level set of a utility function representing a preference relation, we give axiomatic conditions under which a function on the indifference hypersurfaces can be used to define a rational anonymous social ordering function. We show that the curvature of the indifference hypersurfaces can potentially be used as such a function, and discuss a possible economic interpretation of the curvature. The minmax-like definition of our social ordering function coincides with the Rawlsian difference principle under certain circumstances. |
| Keywords: | Preference aggregation; Social ordering function; Independence of irrelevant alternatives; Indifference hypersurface; Curvature; Information |
| JEL: | D63 D70 D71 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:mcm:deptwp:2023-06&r=upt |
| By: | Ernst Fehr (Department of Economics, Zurich University. Blümlisalpstrasse 10, 8006 Zurich, Switzerland); Thomas Epper (IESEG School of Management, Univ. Lille, CNRS, UMR 9221 - LEM - Lille Economie Management, F-59000 Lille, France; iRisk Center on Risk and Uncertainty); Julien Senn (Department of Economics, Zurich University. Blümlisalpstrasse 10, 8006 Zurich, Switzerland) |
| Abstract: | Parsimony is a desirable feature of economic models but almost all human behaviors are characterized by vast individual variation that appears to defy parsimony. How much parsimony do we need to give up to capture the fundamental aspects of a population’s distributional preferences and to maintain high predictive ability? Using a Bayesian nonparametric clustering method that makes the trade-off between parsimony and descriptive accuracy explicit, we show that three preference types—an inequality averse, an altruistic and a predominantly selfish type—capture the essence of behavioral heterogeneity. These types independently emerge in four different data sets and are strikingly stable over time. They predict out-of-sample behavior equally well as a model that permits all individuals to differ and substantially better than a representative agent model and a state-of-the-art machine learning algorithm. Thus, a parsimonious model with three stable types captures key characteristics of distributional preferences and has excellent predictive power. |
| Keywords: | Distributional Preferences, Altruism, Inequality Aversion, Preference Heterogeneity, Stability, Out-of-Sample Prediction, Parsimony, Bayesian Nonparametrics. |
| JEL: | D31 D63 C49 C90 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:ies:wpaper:e202310&r=upt |
| By: | Alexander Bertermann; Daniel A. Kamhöfer; Hannah Schildberg-Hörisch |
| Abstract: | This paper investigates the causal effect of education on life satisfaction, exploring effect heterogeneity along employment status. We use exogenous variation in compulsory schooling requirements and the build-up of new, academically more demanding schools, shifting educational attainment along the entire distribution of schooling. Leveraging plant closures and longitudinal information, we also address the endogeneity of employment status. We find a positive effect of education on life satisfaction for employed individuals, but a negative one for those without a job. We propose an aspiration-augmented utility function as a unifying explanation for the asymmetric effect of education on life satisfaction. |
| Keywords: | Education, Life satisfaction, Employment status, Compulsory schooling reforms, School openings, Instrumental variable estimation |
| JEL: | I26 I31 C26 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:diw:diwsop:diw_sp1192&r=upt |
| By: | Kettlewell, Nathan (University of Technology, Sydney); Tymula, Agnieszka (University of Sydney); Yoo, Hong Il (Loughborough University) |
| Abstract: | We study the heritability of risk, uncertainty, and time preferences using a field experiment with a large sample of adult twins. We also offer a meta-analysis of existing findings. Our field study introduces a novel empirical approach that marries behavioral genetics with structural econometrics. This allows us to, for the first time, quantify the heritability of economic preference parameters directly without employing proxy measures. Our incentive-compatible experiment is the first twin study to elicit all three types of preferences for the same individual. Compared to previous studies, we find a greater role of genes in explaining risk and uncertainty preferences, and of the shared familial environment in explaining time preferences. Time preferences appear more important from policy and parenting perspectives since they exhibit limited genetic variation and are more than twice as sensitive to the familial environment as risk and uncertainty preferences. |
| Keywords: | risk preferences, ambiguity aversion, time preferences, twin study, genetics |
| JEL: | C93 D15 D81 D91 Z13 |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp16633&r=upt |
| By: | Keegan Harris; Nicole Immorlica; Brendan Lucier; Aleksandrs Slivkins |
| Abstract: | How can an informed sender persuade a receiver, having only limited information about the receiver's beliefs? Motivated by research showing generative AI can simulate economic agents, we initiate the study of information design with an oracle. We assume the sender can learn more about the receiver by querying this oracle, e.g., by simulating the receiver's behavior. Aside from AI motivations such as general-purpose Large Language Models (LLMs) and problem-specific machine learning models, alternate motivations include customer surveys and querying a small pool of live users. Specifically, we study Bayesian Persuasion where the sender has a second-order prior over the receiver's beliefs. After a fixed number of queries to an oracle to refine this prior, the sender commits to an information structure. Upon receiving the message, the receiver takes a payoff-relevant action maximizing her expected utility given her posterior beliefs. We design polynomial-time querying algorithms that optimize the sender's expected utility in this Bayesian Persuasion game. As a technical contribution, we show that queries form partitions of the space of receiver beliefs that can be used to quantify the sender's knowledge. |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2311.18138&r=upt |
| By: | Frédéric Dufourt (Aix-Marseille Univ., CNRS, AMSE, Marseille, France); Kazuo Nishimura (RIEB, Kobe University, Kobe, Japan); Alain Venditti (Aix-Marseille Univ., CNRS, AMSE, Marseille, France) |
| Abstract: | When can exogenous changes in beliefs generate endogenous fluctuations in rational expectation models? We analyze this question in the canonical one-sector and two-sector models of the business cycle with increasing returns to scale. A key feature of our analysis is that we express the uniqueness/multiplicity condition of equilibirum paths in terms of restrictions on five critical and economically interpretable parameters: the Frisch elasticities of the labor supply curve with respect to the real wage and to the marginal utility of wealth, the intertemporal elasticity of substitution in consumption, the elasticity of substitution between capital and labor, and the degree of increasing returns to scale. We obtain two clear-cut conclusions: belief-driven fluctuations cannot exist in the one-sector version of the model for empirically consistent values for these five parameters. By contrast, belief-driven fluctuations are a robust property of the twosector version of the model-with differentiated consumption and investment goods-, as they now emerge for a wide range of parameter values consistent with available empirical estimates. The key ingredients explaining these different outcomes are factor reallocation between sectors and the implied variations in the relative price of investment, affecting the expected return on capital accumulation. |
| Keywords: | belief-driven business cycles, endogenous fluctuations, expectations, income effect |
| JEL: | C62 E32 O41 |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:aim:wpaimx:2327&r=upt |
| By: | Marc Fleurbaey (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, CNRS - Centre National de la Recherche Scientifique, ENS-PSL - École normale supérieure - Paris - PSL - Université Paris sciences et lettres); Stéphane Zuber (CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, CNRS - Centre National de la Recherche Scientifique, 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) |
| Abstract: | Suppose that, for whatever reason, it is decided that inequalities within countries are more offensive than inequalities between countries, and that inequalities between populations living together are more offensive than inequalities between generations living in different times. Can a social welfare function express that preference? We show that it is actually difficult to incorporate such a localist preference into a social welfare function, except in a limited way (i.e., from a situation of specific similarity between countries). We also show that in order to obtain such preferences, the relative size of inequality aversion within and between countries may be counter-intuitive in some relevant cases, in the sense that a greater inequality aversion may happen to be required across countries than within countries. This research highlights new social welfare functions that aggregate the outcomes of evaluations over pairs of agents. |
| Keywords: | inequality aversion, transfer principle, within-country preference |
| Date: | 2023–10 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-04270021&r=upt |
| By: | Sommervoll, Dag Einar (Centre for Land Tenure Studies, Norwegian University of Life Sciences); Holden, Stein T. (Centre for Land Tenure Studies, Norwegian University of Life Sciences); Tilahun, Mesfin (Centre for Land Tenure Studies, Norwegian University of Life Sciences) |
| Abstract: | The experiments designed to estimate real-life discount rates in intertemporal choice often rely on ordered choice lists, where the list by design aims to capture a switch point between near- and far-future alternatives. Structural models like a Samuelson discounted utility model are often fitted to the model using maximal likelihood estimation. We show that dominated tasks, that is, choices that do not define the switch point, may bias ML estimates profoundly and predictably. More (less) dominated near future tasks give higher (lower) discount rates. Simulation analysis indicates estimates may remain largely unbiased using switch point-defining tasks only. |
| Keywords: | Choice lists; time discounting; maximal likelihood estimation |
| JEL: | C13 C81 C93 D91 |
| Date: | 2023–12–19 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:nlsclt:2023_009&r=upt |
| By: | Yves Breitmoser; Justin Valasek; Justin Mattias Valasek |
| Abstract: | We report on the results of an experiment designed to disentangle behavioral biases in information aggregation of committees. Subjects get private signals about the state of world, send binary messages, and finally vote under either majority or unanimity rules. Committee decisions are significantly more efficient than predicted by Bayesian equilibrium even with lying aversion. Messages are truthful, subjects correctly anticipate the truthfulness (contradicting limited depth of reasoning), but strikingly overestimate their pivotality when voting (contradicting plain lying aversion). That is, committees are efficient because members message truthfully and vote non-strategically. We show that all facets of behavior are predicted by overreaction, subjects overshooting in Bayesian updating, which implies that subjects exaggerate the importance of truthful messages and sincere voting. A simple one-parameteric generalization of quantal response equilibrium capturing overreaction covers 87 percent of observed noise. |
| Keywords: | committees, incomplete information, cheap talk, information aggregation, laboratory experiment, Bayesian updating, lying aversion, limited depth of reasoning |
| JEL: | D71 D72 C90 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10800&r=upt |
| By: | Kerry Back; Bruce I. Carlin; Seyed Mohammad Kazempour; Chloe L. Xie |
| Abstract: | We study strategic disclosure timing by correlated firms in the presence of risk-averse investors. Firms delay disclosures in the hope that positively correlated firms will announce especially good news and lift their own price. Risk premia rise before disclosures, drop when disclosures occur, and then rise again. Conditional risk premia can be much larger than unconditional risk premia. Disclosures are always good news, but disclosures that are only moderately good news induce clustering of disclosures by other positively correlated firms. We present evidence of strategic behavior in earnings announcement timing as predicted by the model. |
| JEL: | D83 G12 G14 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:31935&r=upt |
| By: | Takanori Adachi |
| Abstract: | The experience of unknown events such as financial crises and infectious disease crises, which are black swans that appear suddenly, has revealed the limitations of measuring risk under a fixed probability measure. In order to solve this problem, the importance of so-called ambiguity, which allows the probability measure itself to change, has long been recognized in the financial world. On the other hand, there have been many studies on subjective probability measures in the field of economics, including Savage's work. But even in those cases, the studies are based on the two levels of uncertainty: risk when a conventional probability measure (probability distribution) is known, and ambiguity due to the fact that the subjective probability measure (prior) can be taken arbitrarily in a certain space. In this study, we express n-layer uncertainty, which we call hierarchical uncertainty by introducing a new concept called uncertainty spaces which is an extended concept of probability spaces. We use uncertainty spaces for providing examples that illustrate Ellsberg's paradox. Next, we construct an endofunctor S of Mble, the category formed by measurable spaces and measurable functions between them, in order to embed a given set of uncertainty spaces into it. The endofunctor S maps a measurable space to a set of capacities defined on the space, where a capacity is a non-additive probability measure introduced by Choquet. After developing n-layer uncertainty analysis through uncertainty spaces, we construct the universal uncertainty space as a limit of the sequence of measurable spaces representing multi-layer uncertainty. This universal uncertainty space can serve as a basis for multi-layer uncertainty theory because it has as its projections the uncertainty spaces of all levels. |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2311.14219&r=upt |
| By: | Yvonne Jie Chen; Deniz Dutz; Li Li; Sarah Moon; Edward J. Vytlacil; Songfa Zhong |
| Abstract: | This paper develops a partial-identification methodology for analyzing self-selection into alternative compensation schemes in a laboratory environment. We formulate a model of self-selection in which individuals select the compensation scheme with the largest expected valuation, which depends on individual- and scheme-specific beliefs and non-monetary preferences. We characterize the resulting sharp identified sets for individual-specific willingness-to-pay, subjective beliefs, and preferences, and develop conditions on the experimental design under which these identified sets are informative. We apply our methods to examine gender differences in preference for winner-take-all compensation schemes. We find that what has commonly been attributed to a gender difference in preference for performing in a competition is instead explained by men being more confident than women in their probability of winning a future (though not necessarily a past) competition. |
| JEL: | C25 C91 J16 J31 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:31930&r=upt |
| By: | Alicia Martin-Navarro; Maria Paula Lechuga Sancho; Jose Aurelio Medina-Garrido |
| Abstract: | BPMS (Business Process Management System) represents a type of software that automates the organizational processes looking for efficiency. Since the knowledge of organizations lies in their processes, it seems probable that a BPMS can be used to manage the knowledge applied in these processes. Through the BPMS-KM Support Model, this study aims to determine the reliability and validity of a 65-item instrument to measure the utility and the use of a BPMS for knowledge management (KM). A questionnaire was sent to 242 BPMS users and to determine its validity, a factorial analysis was conducted. The results showed that the measuring instrument is trustworthy and valid. It represents implications for research, since it provides an instrument validated for research on the success of a BPMS for KM. There would also be practical implications, since managers can evaluate the use of BPMS, in addition to automating processes to manage knowledge. |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2311.14348&r=upt |
| By: | Phoebe Koundouri; Nikitas Pittis (University of Piraeus, Greece); Panagiotis Samartzis |
| Abstract: | Economic rationality puts constraints on the preferences and/or degrees of belief (subjective probabilities or credences) of a decision maker (DM). This paper focuses on a belief-based definition of rationality (referred to as BEL): BEL requires DM's credences to be precise, unique, ascertainable, coherent and asymptotically accurate. We distinguish two types of DMs, the "expert"(DMs) and the "naive"(DMo) ones, and ask whether and how BEL may be achieved by either of them. To answer this we define two sets of cognitive/epistemic properties, Ys and Yo for DMs and DMo, respectively and show that Ys and Yo form the basis of the corresponding processes (referred to as Bayesian Confirmation (BC) and "trial and error, frequency-based (TEFB), respectively) by which DMs and DMo reach BEL. This means that on the assumption that Ys and Yo are empirically valid, the naive decision maker thinks probabilistically "as-if" she were the expert. An important difference between this paper and the related literature concerns the obscurity" of the "as-if" process. In our approach, this is a concrete process, namely TEFB, instead of an unspecified, "black box" one. We also argue that some of the assumptions in Yo (on which standard arguments of rationality - such as the Dutch Book and Arbitrage arguments - are based) are empirically questionable. Finally, we suggest that although BEL is the normative standard against which beliefs must be measured and judged, the actual rationality of decision makers comes in degrees (graded rationality). The smooth functioning of the economic system requires decision makers who are "sufficiently" rather than "perfectly" rational. |
| JEL: | C44 D81 D83 D89 |
| Date: | 2023–12–22 |
| URL: | http://d.repec.org/n?u=RePEc:aue:wpaper:2322&r=upt |
| By: | Hengjie Ai; Ravi Bansal; Hongye Guo |
| Abstract: | The paper reviews the evidence on the macroeconomic announcement premium and its implications on equilibrium asset pricing models. Empirically, a large fraction of the equity market risk premium is realized on a small number of trading days with significant macroeconomic announcements. We review the literature that demonstrates that the existence of the macroeconomic announcement premium implies that investors' preferences must satisfy generalized risk sensitivity. We show how this conclusion generalizes to environments with heterogeneous investors and demonstrate how incorporating generalized risk sensitivity affects economic analysis in dynamic setups with uncertainty. |
| JEL: | A0 E0 E37 E40 |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:31923&r=upt |
| By: | Kwabena Donkor (Stanford GSB); Lorenz Goette (National University of Singapore); Maximilian Müller (Toulouse School of Economics); Eugen Dimant (University of Pennsylvania); Michael Kurschilgen (Uni Distance Suisse) |
| Abstract: | This paper examines how beliefs and preferences drive identity-conforming consumption or investments. We introduce a theory that explains how identity distorts individuals' beliefs about potential outcomes and imposes psychic costs on benefiting from identity-incongruent sources. We substantiate our theoretical foundation through two lab-in-field experiments on soccer betting in Kenya and the UK, where participants either had established affiliations with the teams involved or assumed a neutral stance. The results indicate that soccer fans have overoptimistic beliefs about match outcomes that align with their identity and bet significantly higher amounts on those than on outcomes of comparable games where they are neutral. After accounting for individuals' beliefs and risk preferences, our structural estimates reveal that participants undervalue gains from identity-incongruent assets by 9% to 27%. Our counterfactual simulations imply that identity-specific beliefs account for 30% to 44% of the investment differences between neutral observers and supporters, with the remainder being due to identity preferences. |
| Keywords: | Identity, Experiment, Structural Analysis |
| JEL: | D91 G41 Z10 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:ajk:ajkdps:269&r=upt |