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Principle of uncertain future and utility

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  • Harin, Alexander

Abstract

The principle of uncertain future: the probability of a future event contains a degree of (hidden) uncertainty. As a result, this uncertainty (in a sense, similar to vibrations, fluctuations) pushes the probability value back from the bounds to the middle of its range (from ~100% and ~0% to the middle probability values). In other words, the real values of high probabilities are lower than the preliminarily determined ones. Conversely, the real values of low probabilities are higher than the preliminarily determined ones. This result provides the uniform solution of a number of fundamental problems: the underweighting of high and the overweighting of low probabilities, the Allais paradox, risk aversion, loss aversion, the Ellsberg paradox, the equity premium puzzle, etc. The principle and its consequences can be applied in the fields of banking, investment, insurance, trade, industry, planning and forecasting. Explanations of the principle and examples of solution of three types of basic utility problems are provided.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 1959.

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Date of creation: 28 Feb 2007
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Handle: RePEc:pra:mprapa:1959

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Keywords: risk; market; banking; industry; development; investments; insurance; hidden causes;

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  1. Schoemaker, Paul J H, 1982. "The Expected Utility Model: Its Variants, Purposes, Evidence and Limitations," Journal of Economic Literature, American Economic Association, vol. 20(2), pages 529-63, June.
  2. John Quiggin & Robert G. Chambers, 2005. "Economists and uncertainty," Risk & Uncertainty Working Papers WP2R05, Risk and Sustainable Management Group, University of Queensland.
  3. Kenneth Chay & Patrick J. McEwan & Miguel Urquiola, 2003. "The Central Role of Noise in Evaluating Interventions that Use Test Scores to Rank Schools," Discussion Papers 0304-10, Columbia University, Department of Economics.
  4. Tversky, Amos & Wakker, Peter, 1995. "Risk Attitudes and Decision Weights," Econometrica, Econometric Society, vol. 63(6), pages 1255-80, November.
  5. John Quiggin, 2005. "The precautionary principle in environmental policy and the theory of choice under uncertainty," Murray-Darling Program Working Papers WPM05_3, Risk and Sustainable Management Group, University of Queensland.
  6. Capuano, Christian, 2006. "Strategic noise traders and liquidity pressure with a physically deliverable futures contract," International Review of Economics & Finance, Elsevier, vol. 15(1), pages 1-14.
  7. Helga Fehr-Duda & Marc Schürer & Renate Schubert, 2006. "What Determines the Shape of the Probability Weighting Function?," CER-ETH Economics working paper series 06/54, CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich.
  8. Carmela Di Mauro & Anna Maffioletti, 2004. "Attitudes to risk and attitudes to uncertainty: experimental evidence," Applied Economics, Taylor & Francis Journals, vol. 36(4), pages 357-372.
  9. Hey, John D & Orme, Chris, 1994. "Investigating Generalizations of Expected Utility Theory Using Experimental Data," Econometrica, Econometric Society, vol. 62(6), pages 1291-1326, November.
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Cited by:
  1. Harin, Alexander, 2014. "Is data interpretation in utility and prospect theories unquestionably correct?," MPRA Paper 53880, University Library of Munich, Germany.
  2. Harin, Alexander, 2014. "General correcting formulae for forecasts," MPRA Paper 55283, University Library of Munich, Germany.
  3. Harin, Alexander, 2011. "Теоремы О Существовании Разрывов На Числовых Отрезках И В Шкале Вероятностей И Некоторые Возможности Их При�," EconStor Open Access Articles, ZBW - German National Library of Economics, pages 5-7.

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