For decades, discrete choice modelling was practically dominated by only two models: multinomial probit and logit. This paper presents a novel alternative—harmonic choice model. It is qualitatively similar to multinomial probit and logit: if one choice alternative greatly exceeds all (falls below at least one of) other alternatives in terms of utility then it is chosen with probability close to one (zero). Compared to probit and logit, the new model has relatively flat tails and it is steeper in the neighborhood (...) of zero (when all alternatives yield the same utility and the decision maker chooses among them at random). (shrink)

Empirical research often requires a method how to convert a deterministic economic theory into an econometric model. A popular method is to add a random error term on the utility scale. This method, however, ignores stochastic dominance. A modification of this method is proposed to account for stochastic dominance. The modified model compares favorably to other existing models in terms of goodness of fit to experimental data. The modified model can rationalize the preference reversal phenomenon. An intuitive axiomatic characterization of (...) the modified model is provided. Important microeconomic concept of risk aversion is well defined in the modified model. (shrink)

In binary choice between discrete outcome lotteries, an individual may prefer lottery L1 to lottery L2 when the probability that L1 delivers a better outcome than L2 is higher than the probability that L2 delivers a better outcome than L1. Such a preference can be rationalized by three standard axioms (solvability, convexity and symmetry) and one less standard axiom (a fanning-in). A preference for the most probable winner can be represented by a skew-symmetric bilinear utility function. Such a utility function (...) has the structure of a regret theory when lottery outcomes are perceived as ordinal and the assumption of regret aversion is replaced with a preference for a win. The empirical evidence supporting the proposed system of axioms is discussed. (shrink)

Discounted utility theory and its generalizations use discount functions for weighting utilities of outcomes received in different time periods. We propose a new simple test of convexity–concavity of discount function. This test can be used with any utility function and any preferences over risky lotteries. The data from a controlled laboratory experiment show that about one third of experimental subjects reveal a concave discount function and another one third of subjects reveal a convex discount function.

Debreu (American Economic Review 50:186–188, 1960) famously criticized Luce (Individual choice behavior, Wiley, New York, 1959) choice model with what became known as the red-bus blue-bus example: if a choice set contains two distinct alternatives C (car) and B (blue bus) then adding a third alternative A (red bus) that is essentially identical to B does not affect the choice probability of C but reduces the choice probability of B by half. Debreu’s critique highlights the existence of substitution effects violating (...) the principle of independence from irrelevant alternatives—the cornerstone of Luce (Individual choice behavior, Wiley, New York, 1959) choice model. This paper weakens this principle to construct a model of probabilistic choice satisfying Debreu’s critique. (shrink)

The problem of intertemporal choice arises when outcomes are received in different moments of time. This paper presents an axiomatic model of intertemporal choice when consumption in the previous moment of time contributes to utility evaluation of consumption in the current moment. This model generalizes classic discounted utility theory (also known as constant or exponential discounting) in two ways. First, in every moment of time, a decision maker derives utility not only from current consumption but also from “residual” consumption in (...) the previous moment of time. Second, these utilities are discounted with weights that are essentially a quasi-hyperbolic discounting function. The paper presents an application of the proposed model to the problem of optimal consumption and savings given a fixed income (wealth). When a decision maker derives satisfaction from both instantaneous consumption as well as a share of consumption in the previous moment of time, optimal consumption path is cyclic—periods of relatively high consumption are interchanged with periods of relatively low consumption. These cycles decay over time. Asymptotically, the consumption path exhibits conventional properties (constant, increasing or decreasing over time when a gross interest rate multiplied by discount factor is correspondingly equal to, greater than, or less than one). (shrink)

This article investigates how subjects determine minimum selling prices for lotteries. We design an experiment where subjects have at every moment an incentive to state their minimum selling price and to adjust the price, if they believe that the price that they stated initially was not optimal. We observe frequent and sizeable price adjustments. We find that random pricing models cannot explain the observed price patterns. We show that earlier prices contain information about future price adjustments. We propose a model (...) of Stochastic Pricing that offers an intuitive explanation for these price adjustment patterns. (shrink)

Risk preferences of Australian academics are elicited by analyzing the aggregate distribution of their retirement funds across available investment options. Not more than 10 % of retirement funds are invested as if their owners maximize expected utility under the assumption of constant relative risk aversion with an empirically plausible level of risk aversion. An implausibly high level of risk aversion is required to rationalize any investment into bonds when stocks are available. Not more than 36.54 % of all investments can (...) be rationalized by a model of loss averse preferences. Moreover, the levels of loss aversion typically reported in the experimental studies imply overinvestment in bonds, which is not observed in the data. Up to 67.18 % of all investments can be rationalized by rank-dependent utility or Yaari’s dual model with empirically plausible parameters. A median Australian academic behaves as if maximizing rank-dependent utility with parameter γ∈[0.76,0.79]\documentclass[12pt]{minimal} \usepackage{amsmath} \usepackage{wasysym} \usepackage{amsfonts} \usepackage{amssymb} \usepackage{amsbsy} \usepackage{mathrsfs} \usepackage{upgreek} \setlength{\oddsidemargin}{-69pt} \begin{document}$$\gamma \in [0.76, 0.79]$$\end{document} in a Tversky and Kahneman probability weighting function. (shrink)

In decision theory, the betweenness axiom postulates that a decision maker who chooses an alternative A over another alternative B must also choose any probability mixture of A and B over B itself and can never choose a probability mixture of A and B over A itself. The betweenness axiom is a weaker version of the independence axiom of expected utility theory. Numerous empirical studies documented systematic violations of the betweenness axiom in revealed individual choice under uncertainty. This paper shows (...) that these systematic violations can be linked to another behavioral regularity—choice shifts in a group decision making. Choice shifts are observed if an individual faces the same decision problem but makes a different choice when deciding alone and in a group. (shrink)

Investors who are more willing to accept risks when evaluating their investments less frequently are said to exhibit myopic loss aversion (MLA). Several recent experimental studies found that, on average, subjects bet significantly higher amounts on a risky lottery when they observe only a cumulative outcome of several realizations of the lottery (long evaluation period). In this article, we reexamine these empirical findings by analyzing individual rather than aggregate choice patterns. The behavior of the majority of subjects is inconsistent with (...) the hypothesis of MLA: they bet an intermediate fraction of their initial endowment and these bets, on average, are not significantly different across two treatments with short and long evaluation period. We discuss several alternative explanations of this finding, including the Fechner model of random errors and the financial asset pricing model. (shrink)