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Comparison of Mean-Variance theory and Expected-Utility theory through a Laboratory Experiment

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  • Andrea Morone

Abstract

In the 40’s and early 50’ two decision theories were proposed and have since dominated the scene of the fascinating field of decision-making. In 1944 – when von Neumann and Morgenstern showed that if preferences are consistent with a set of axioms then it is possible to represent these preference by the expectation of some utility function – Expected Utility theory provide a natural way to establish “measurable utility”. In the early 50’s Markowitz introduced the Mean-Variance theory that is the basis of modern portfolio selection theory. Even if both models were analyzed from virtually all possible point of view; although they were tested against several generalizations; even though they seams to be the most attractive theories of decision making, they were never testes gains each other. This paper will try to fill this gap. It investigates, using experimental data, which of these two models represent a better approximation of subjects’ preferences.

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File URL: http://128.118.178.162/eps/exp/papers/0402/0402001.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Experimental with number 0402001.

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Length: 16 pages
Date of creation: 04 Feb 2004
Date of revision:
Handle: RePEc:wpa:wuwpex:0402001

Note: Type of Document - pdf; prepared on WinXP; pages: 16
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Web page: http://128.118.178.162

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Keywords: Expected utility; Mean variance; preference functional; pair wise choice; experiments;

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  1. John Hey & Enrica Carbone, . "Which Error Theory is Best?," Discussion Papers 99/31, Department of Economics, University of York.
  2. Vuong, Quang H, 1989. "Likelihood Ratio Tests for Model Selection and Non-nested Hypotheses," Econometrica, Econometric Society, vol. 57(2), pages 307-33, March.
  3. John Hey, . "Does Repetition Improve Consistency?," Discussion Papers 99/28, Department of Economics, University of York.
  4. Loomes, G. & Moffatt, P.G. & Sugden, R., 1998. "A Microeconometric Test of Alternative Stochastic Theories of Risky Choice," University of East Anglia Discussion Papers in Economics 9806, School of Economics, University of East Anglia, Norwich, UK..
  5. Levy, H & Markowtiz, H M, 1979. "Approximating Expected Utility by a Function of Mean and Variance," American Economic Review, American Economic Association, vol. 69(3), pages 308-17, June.
  6. Carbone, Enrica, 1997. "Investigation of stochastic preference theory using experimental data," Economics Letters, Elsevier, vol. 57(3), pages 305-311, December.
  7. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
  8. Carbone, Enrica, 1997. "Discriminating between Preference Functionals: A Monte Carlo Study," Journal of Risk and Uncertainty, Springer, vol. 15(1), pages 29-54, October.
  9. Kroll, Yoram & Levy, Haim & Markowitz, Harry M, 1984. " Mean-Variance versus Direct Utility Maximization," Journal of Finance, American Finance Association, vol. 39(1), pages 47-61, March.
  10. Harless, David W & Camerer, Colin F, 1994. "The Predictive Utility of Generalized Expected Utility Theories," Econometrica, Econometric Society, vol. 62(6), pages 1251-89, November.
  11. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, 09.
  12. 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.
  13. Hey, John D., 1995. "Experimental investigations of errors in decision making under risk," European Economic Review, Elsevier, vol. 39(3-4), pages 633-640, April.
  14. Holt, Charles A, 1986. "Preference Reversals and the Independence Axiom," American Economic Review, American Economic Association, vol. 76(3), pages 508-15, June.
  15. Hey, John D. & Carbone, Enrica, 1995. "Stochastic choice with deterministic preferences: An experimental investigation," Economics Letters, Elsevier, vol. 47(2), pages 161-167, February.
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Cited by:
  1. Andrea Morone & Ulrich Schmidt, 2005. "An Experimental Investigation of Alternatives to Expected Utility Using Pricing Data," Papers on Strategic Interaction 2005-28, Max Planck Institute of Economics, Strategic Interaction Group.
  2. Morone, Andrea & Ozdemir, Ozlem, 2012. "Black swan protection: an experimental investigation," MPRA Paper 38842, University Library of Munich, Germany.
  3. Morone, Andrea, 2009. "On Price Data Elicitation: a Laboratory Investigation," MPRA Paper 18358, University Library of Munich, Germany.
  4. Andrea Morone & Piergiuseppe Morone, 2012. "Are small groups Expected Utility?," Working Papers 2012/08, Economics Department, Universitat Jaume I, Castellón (Spain).

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