Expected Utility and the Truncated Normal Distribution
AbstractThis article demonstrates that: (1) When a normally distributed decision variable is combined with an analytic utility function (one with derivatives of all orders and a power series expansion involving those derivatives), the expected utility can be expressed in powers of \mu and \sigma 2 . (2) In the case of the normal model, when the tails of the distribution do not reflect reality in the mind of a decision-maker, a truncated normal model is a possible alternative. (3) If the appropriate model is the truncated normal distribution, then the expected utility is approximately a linear function of \mu and \sigma for several important classes of risk averse utility functions. (4) The negative exponential is an especially useful utility function since it has a simple closed form for both the truncated and nontruncated models, and since it gives an ordering similar to those of the log, arctangent or power utility functions.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoArticle provided by INFORMS in its journal Management Science.
Volume (Year): 26 (1980)
Issue (Month): 9 (September)
finance: capital budgeting; utility/preference: applications;
You can help add them by filling out this form.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Mirko Janc).
If references are entirely missing, you can add them using this form.