Stochastic expected utility theory
AbstractThis paper proposes a new decision theory of how individuals make random errors when they compute the expected utility of risky lotteries. When distorted by errors, the expected utility of a lottery never exceeds (falls below) the utility of the highest (lowest) outcome. This assumption implies that errors are likely to overvalue (undervalue) lotteries with expected utility close to the utility of the lowest (highest) outcome. Proposed theory explains many stylized empirical facts such as the fourfold pattern of risk attitudes, common consequence effect (Allais paradox), common ratio effect and violations of betweenness. Theory fits the data from ten well-known experimental studies at least as well as cumulative prospect theory. Copyright Springer Science+Business Media, LLC 2007
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Bibliographic InfoArticle provided by Springer in its journal Journal of Risk and Uncertainty.
Volume (Year): 34 (2007)
Issue (Month): 3 (June)
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Web page: http://www.springerlink.com/link.asp?id=100299
Decision theory; Stochastic utility; Expected utility theory; Cumulative prospect theory; C91; D81;
Find related papers by JEL classification:
- C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
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