A simple preference foundation of cumulative prospect theory with power utility

Most empirical studies of rank-dependent utility and cumulative prospect theory have assumed power utility functions, both for gains and for losses. As it turns out, a remarkably simple preference foundation is possible for such models: Tail independence (a weakening of comonotonic independence which underlies all rank-dependent models) together with constant proportional risk aversion suffice, in the presence of common assumptions (weak ordering, continuity, and first stochastic dominance), to imply these models. Thus, sign dependence, the different treatment of gains and losses, and the separation of decision weights and utility are obtained free of charge.     

Exploitation and time

This paper analyses exploitation and class formation in a dynamic context. An intertemporal model of a subsistence economy is set up and, among other results, it is proved that, in an interior equilibrium, Differential Ownership of (Scarce) Productive Assets is an inherent feature of a capitalist economy, while exploitation tends to disappear in the long run. Asset inequality is therefore proved to be a normatively secondary (though causally primary) wrong. It is also argued that these results raise several doubts about the possibility of providing robust micro-foundations to Marxian concepts by means of Walrasian general equilibrium models.     

Context effects: A representation of choices from categories

This paper studies a model of reference-dependent choice from sets of options grouped into categories. The proposed model is consistent with experimental evidence documenting context effects in a variety of choice situations. In our model, the reference point for any given category is subjective, and corresponds to the least preferred element in the category under consideration. Every object in a category is evaluated relative to the corresponding reference point; this may distort the objective ranking of options across different categories, and thus possibly give rise to a context-effects bias. The resulting representation is essentially unique. We also provide an economic application of the preferences that we axiomatize to principal-agent models. We show how sellers facing consumers exhibiting the context-effects bias can increase their profits by exploiting their bounded rationality.     

Quasitransitive social preference: why some very large coalitions have very little power

Summary. If only the strict part of social preference is required to be transitive then Independence of Irrelevant Alternatives implies that there is a coalition containing all but one individual that cannot force x to be socially ranked above y for at least half of the pairs of alternatives (x,y). Received: August 29, 1996; revised version: March 24, 1997     

A note on small income effects

This note provides an alternative sufficient condition for the small income effect result that is first shown by Vives [Small income effects: a Marshallian theory of consumer surplus and downward sloping demand, Rev. Econ. Stud. 54(1) (1987) 87-103]. The condition is stated by ordinal terms only, whereas Vives assumes cardinal properties of utility representation. Second, as its application, we provide a sufficient condition for the preference being asymptotically quasi-linear, in a two good economy where the second good is a composition of a large number of goods.     

A simple explanation of the relative performance evaluation puzzle

We study a simple moral hazard model in which two risk-neutral owners establish incentives for their risk-averse managers to exert effort. Because the probability distributions over output realizations depend on a common aggregate shock, optimal contracts make the compensation of each manager contingent on own performance but also on a performance benchmark—the performance of the other firm. If the marginal return of effort depends on the aggregate state, optimal contracts are not monotonically decreasing in the performance benchmark. This provides a simple explanation of the Relative Performance Evaluation (RPE) Puzzle—the documented lack of a negative relationship between CEO compensation and comparative performance measures, such as industry or market performance. Our simple model can also explain one-sided RPE—the documented tendency to insulate a CEO's rewards from bad luck, but not from good luck. We clarify that our results are robust in several dimensions and we discuss other applications of our findings.     

A theory of (relative) discounting

We derive a representation theorem for time preferences (on the prize-time space) which identifies a novel notion of relative discounting as the key ingredient. This representation covers a variety of time preference models, including the standard exponential and hyperbolic discounting models and certain non-transitive time preferences, such as the similarity-based and subadditive discounting models. Our axiomatic work thus unifies a number of seemingly disparate time preference structures, thereby providing a tractable mathematical format that allows for investigating certain economic environments without subscribing to a particular time preference model. This point is illustrated by means of an application to sequential bargaining theory.     

A class of incomplete and ambiguity averse preferences

This paper characterizes models of ambiguous beliefs in the absence of the completeness axiom. We axiomatize multiple-selves versions of some of the most important examples of complete and ambiguity averse preferences, and characterize when those incomplete preferences are ambiguity averse.     

A systematic analysis of the links amongst the Marshallian,Hicksian, and Frischian demand functions: A note

Three types of demand functions are central to contemporary consumer theory: the Marshallian, the Hicksian, and the Frischian demand functions. This paper presents a systematic definition of the analytical relationships amongst these demand functions under the maintained hypothesis that the decision maker is a profit maximizer.     

A subjective model of experimentation

Typically an experiment is defined by a set of possible signals and a likelihood function, and both are specified exogenously—they are taken to be observable by the analyst. This paper renders them subjective by showing that they may be derived from suitable choice behavior. This is done in the context of an axiomatic representation theorem for preference on a suitable domain.     

Countercyclical pricing: A consumer heterogeneity explanation

We show that a seasonal good could be priced countercyclically due to the heterogeneous seasonal shifts in consumer valuations. We provide empirical support for our explanation based on two product categories (canned soup and tuna) studied in the literature.     

Multiplicative habit formation and consumption: A note

A multiplicative form of the habit term in the utility function has some undesirable properties if the habit function is itself still additive (Wendner, 2003). A geometric form for the way the stock of habit accumulates can resolve these shortcomings.     

Gross substitutes and complements: A simple generalization

We extend the gross substitutes and complements framework (Sun and Yang, 2006). Competitive equilibrium with indivisible goods exists under significantly weaker, intuitive and interpretable conditions. A generalized dynamic double-track procedure (Sun and Yang, 2008, 2009) finds the competitive equilibrium outcome.     

A procedural condition necessary and sufficient for cyclic social preference

Several variations and generalizations of the Voting Paradox show that social-preference cycles are not peculiar to majority rule. I offer a new generalization that is demonstrably as general as possible: a relaxation of majority rule is necessary for a cycle of any sort and sufficient for a dominant one—given certain background assumptions, few and familiar. In its “Latin square” proof as well as its assumptions, the sufficiency theorem directly generalizes both the Voting Paradox and Sen's Liberal Paradox.     

The existence, uniqueness, and optimality of the terminal wealth depletion time in life-cycle models of saving under uncertain lifetime and borrowing constraint

In life-cycle models of saving under uncertain lifetime and borrowing constraint, the consumer's wealth must be depleted before the maximum lifetime. This paper investigates the existence, uniqueness, and optimality of the terminal wealth depletion time. It is proved that the optimal terminal wealth depletion time, if such exists, must be unique. If the equation that determines the optimal terminal wealth depletion has multiple solutions, then the location of the optimal solution will depend on the configuration of the solutions. An optimality test is developed to verify whether a candidate solution for the terminal wealth depletion time is indeed optimal. The paper introduces a method new to economics, the Dubovitskii-Milyutin adjoint equation, to analyze the properties of the optimal control problem.     

A ONE-SECTOR NEOCLASSICAL GROWTH MODEL WITH ENDOGENOUS RETIREMENT

This paper extends Diamond's overlapping generations model by allowing the agents to make the retirement decision. Earning a higher wage income when young not only enables the agents to save more. It also induces more agents to retire early and gives an additional incentive to save more for retirement. This leads to a higher capital–labour ratio in the following period and hence the next generation of agents earns a higher wage income when young. Due to this positive feedback mechanism, endogenous retirement magnifies the persistence of growth dynamics and even generates multiple steady-states for empirically plausible parameter values.     

A simple model of herd behavior, a comment

In this paper we analyze the role played by the tie-breaking assumptions in Banerjee’s model of herd behavior. Changing one assumption we obtain three important results: players’ strategies are parameter dependent; an incorrect herd could be reversed; a correct herd is irreversible.     

A simple impossibility result in behavioral contract theory

This paper studies a contract between an optimistic agent and a realistic principal, both risk-neutral. Even with complete contracts and ex-ante symmetric information, it may be impossible to achieve the first-best unless the weight on emotions is sufficiently low.     

Indirect addilog translation of indirect utility functions

Abstract .  The difficulty of specifying a set of consumer demand equations that can simultaneously display compatibility with rational economic behaviour (regularity) and have the capacity to represent a comprehensive spectrum of consumer behaviour (flexibility) is well known. A variety of approaches have been investigated in the literature, but scope for substantial improvement remains. The approach of this paper is to start from indirect utility functions producing globally regular, if inflexible, systems and to improve flexibility by adding parameters through a device termed 'indirect addilog translation.'     

Errors of aggregation and errors of specification in a consumer demand model: a theoretical note

Abstract .  Consumer demand models based on the concept of a representative or average consumer suffer from aggregation error. Misspecification of the underlying micro utility-maximizing model, which is virtually inevitable, also results in error. This note provides a theoretical investigation of the relationship between the two types of error. Misspecified expenditure support functions for demand systems at the micro level induce the same misspecified structure in the corresponding expenditure functions at the macro level, and the errors at the two levels are shown to be of similar order.