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Optimal allocations with α-MaxMin utilities, Choquet expected utilities, and Prospect Theory

Author

Listed:
  • Beissner, Patrick

    (Research School of Economics, ANU)

  • Werner, Jan

    (Department of Economics, University of Minnesota)

Abstract

The analysis of optimal risk sharing has been thus far largely restricted to non-expected utility models with concave utility functions, where concavity is an expression of ambiguity aversion and/or risk aversion. This paper extends the analysis to α-maxmin expected utility, Choquet expected utility, and Cumulative Prospect Theory, which accommodate ambiguity seeking and risk seeking attitudes. We introduce a novel methodology of quasidifferential calculus of Demyanov and Rubinov (1986, 1992) and argue that it is particularly well-suited for the analysis of these three classes of utility functions which are neither concave nor differentiable. We provide characterizations of quasidifferentials of these utility functions, derive first-order conditions for Pareto optimal allocations under uncertainty, and analyze implications of these conditions for risk sharing with and without aggregate risk.

Suggested Citation

  • Beissner, Patrick & Werner, Jan, 2023. "Optimal allocations with α-MaxMin utilities, Choquet expected utilities, and Prospect Theory," Theoretical Economics, Econometric Society, vol. 18(3), July.
    • Handle: RePEc:the:publsh:5060
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    References listed on IDEAS

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    More about this item

    Keywords

    Ambiguity; risk sharing; non-convex preferences; Pareto optimality; quasidifferential; Clarke subdifferential; α-MaxMin expected utility; Choquet expected utility; rank-dependent expected utility; Cumulative Prospect Theory;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
    • D60 - Microeconomics - - Welfare Economics - - - General
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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