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Accounting for optimism and pessimism in expected utility

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  • Webb, Craig S.
  • Zank, Horst

Abstract

We provide a preference foundation for decision under risk resulting in a model where probability weighting is linear as long as the corresponding probabilities are not extreme (i.e., 0 or 1). This way, most of the elegance and mathematical tractability of expected utility is maintained and also much of its normative foundation. Yet, the new model can accommodate the extreme sensitivity towards changes from 0 to almost impossible and from almost certain to 1 that has widely been documented in the experimental literature. The model can be viewed as “expected utility with the best and worst in mind” as suggested by Chateauneuf, Eichberger and Grant (Chateauneuf, Alain, Eichberger, Jürgen, Grant, Simon, 2007. Choice under uncertainty with the best and worst in mind: NEO-Additive capacities. Journal of Economic Theory 137, 538–567) or, following our preference foundation, interpreted as “expected utility with consistent optimism and pessimism”.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Mathematical Economics.

Volume (Year): 47 (2011)
Issue (Month): 6 ()
Pages: 706-717

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Handle: RePEc:eee:mateco:v:47:y:2011:i:6:p:706-717

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Web page: http://www.elsevier.com/locate/jmateco

Related research

Keywords: Expected utility; Optimism and pessimism; Probability weighting function; Preference foundation; Prospect theory; Rank-dependent utility;

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References

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Cited by:
  1. Ulrich Schmidt & Zank Horst, 2013. "Chance Theory: A Separation of Riskless and Risky Utility," Kiel Working Papers 1874, Kiel Institute for the World Economy.

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