Advanced Search
MyIDEAS: Login to save this paper or follow this series

A Stochastic Expected Utility Theory

Contents:

Author Info

  • Pavlo R. Blavatskyy
Registered author(s):

    Abstract

    This paper proposes a new model that explains the violations of expected utility theory through the role of random errors. The paper analyzes decision making under risk when individuals make random errors when they compute expected utilities. Errors are drawn from the normal distribution, which is truncated so that the stochastic utility of a lottery cannot be greater (lower) than the utility of the highest (lowest) possible outcome. The standard deviation of random errors is higher for lotteries with a wider range of possible outcomes. It converges to zero for lotteries converging to a degenerate lottery. The model explains all major stylized empirical facts such as the Allais paradox and the fourfold pattern of risk attitudes. The model fits the data from ten well-known experimental studies at least as good as cumulative prospect theory.

    Download Info

    If 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.
    File URL: http://www.iew.uzh.ch/wp/iewwp231.pdf
    Download Restriction: no

    Bibliographic Info

    Paper provided by Institute for Empirical Research in Economics - University of Zurich in its series IEW - Working Papers with number 231.

    as in new window
    Length:
    Date of creation:
    Date of revision:
    Handle: RePEc:zur:iewwpx:231

    Contact details of provider:
    Postal: Bl├╝mlisalpstrasse 10, CH-8006 Z├╝rich
    Phone: +41-1-634 22 05
    Fax: +41-1-634 49 07
    Email:
    Web page: http://www.econ.uzh.ch/
    More information through EDIRC

    Related research

    Keywords: decision theory; stochastic utility; expected utility theory; cumulative prospect theory;

    Find related papers by JEL classification:

    This paper has been announced in the following NEP Reports:

    References

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
    as in new window
    1. Gul, Faruk, 1991. "A Theory of Disappointment Aversion," Econometrica, Econometric Society, vol. 59(3), pages 667-86, May.
    2. 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.
    3. Uri Gneezy & John A List & George Wu, 2006. "The Uncertainty Effect: When a Risky Prospect Is Valued Less Than Its Worst Possible Outcome," The Quarterly Journal of Economics, MIT Press, vol. 121(4), pages 1283-1309, November.
    4. Milton Friedman & L. J. Savage, 1948. "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, University of Chicago Press, vol. 56, pages 279.
    5. Prelec, Drazen, 1990. " A "Pseudo-Endowment" Effect, and Its Implications for Some Recent Nonexpected Utility Models," Journal of Risk and Uncertainty, Springer, vol. 3(3), pages 247-59, September.
    6. Mark J Machina, 1982. ""Expected Utility" Analysis without the Independence Axiom," Levine's Working Paper Archive 7650, David K. Levine.
    7. Benartzi, Shlomo & Thaler, Richard H, 1995. "Myopic Loss Aversion and the Equity Premium Puzzle," The Quarterly Journal of Economics, MIT Press, vol. 110(1), pages 73-92, February.
    8. Bernasconi, Michele, 1994. "Nonlinear Preferences and Two-Stage Lotteries: Theories and Evidence," Economic Journal, Royal Economic Society, vol. 104(422), pages 54-70, January.
    9. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
    10. Neilson, William S & Stowe, Jill, 2002. " A Further Examination of Cumulative Prospect Theory Parameterizations," Journal of Risk and Uncertainty, Springer, vol. 24(1), pages 31-46, January.
    11. Starmer, Chris, 1992. "Testing New Theories of Choice under Uncertainty Using the Common Consequence Effect," Review of Economic Studies, Wiley Blackwell, vol. 59(4), pages 813-30, October.
    12. Starmer, Chris & Sugden, Robert, 1989. " Probability and Juxtaposition Effects: An Experimental Investigation of the Common Ratio Effect," Journal of Risk and Uncertainty, Springer, vol. 2(2), pages 159-78, June.
    13. Chris Starmer, 2000. "Developments in Non-expected Utility Theory: The Hunt for a Descriptive Theory of Choice under Risk," Journal of Economic Literature, American Economic Association, vol. 38(2), pages 332-382, June.
    14. Smith, Vernon L & Walker, James M, 1993. "Monetary Rewards and Decision Cost in Experimental Economics," Economic Inquiry, Western Economic Association International, vol. 31(2), pages 245-61, April.
    15. Camerer, Colin F, 1989. " An Experimental Test of Several Generalized Utility Theories," Journal of Risk and Uncertainty, Springer, vol. 2(1), pages 61-104, April.
    16. Chew, Soo Hong, 1983. "A Generalization of the Quasilinear Mean with Applications to the Measurement of Income Inequality and Decision Theory Resolving the Allais Paradox," Econometrica, Econometric Society, vol. 51(4), pages 1065-92, July.
    17. Conlisk, John, 1989. "Three Variants on the Allais Example," American Economic Review, American Economic Association, vol. 79(3), pages 392-407, June.
    18. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
    19. Wu, George, 1994. "An Empirical Test of Ordinal Independence," Journal of Risk and Uncertainty, Springer, vol. 9(1), pages 39-60, July.
    20. Battalio, Raymond C & Kagel, John H & Jiranyakul, Komain, 1990. " Testing between Alternative Models of Choice under Uncertainty: Some Initial Results," Journal of Risk and Uncertainty, Springer, vol. 3(1), pages 25-50, March.
    21. Loomes, Graham & Sugden, Robert, 1998. "Testing Different Stochastic Specifications of Risky Choice," Economica, London School of Economics and Political Science, vol. 65(260), pages 581-98, November.
    22. Harry Markowitz, 1952. "The Utility of Wealth," Journal of Political Economy, University of Chicago Press, vol. 60, pages 151.
    23. 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.
    24. George Wu & Richard Gonzalez, 1996. "Curvature of the Probability Weighting Function," Management Science, INFORMS, vol. 42(12), pages 1676-1690, December.
    25. Camerer, Colin F & Ho, Teck-Hua, 1994. "Violations of the Betweenness Axiom and Nonlinearity in Probability," Journal of Risk and Uncertainty, Springer, vol. 8(2), pages 167-96, March.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as in new window

    Cited by:
    1. Fehr, Ernst & Fischbacher, Urs & Kosfeld, Michael, 2005. "Neuroeconomic Foundation of Trust and Social Preferences," CEPR Discussion Papers 5127, C.E.P.R. Discussion Papers.
    2. Tania Singer & Ernst Fehr, 2005. "The Neuroeconomics of Mind Reading and Empathy," American Economic Review, American Economic Association, vol. 95(2), pages 340-345, May.
    3. Falk, Armin & Fehr, Ernst & Zehnder, Christian, 2005. "The Behavioural Effects of Minimum Wages," CEPR Discussion Papers 5115, C.E.P.R. Discussion Papers.

    Lists

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    Statistics

    Access and download statistics

    Corrections

    When requesting a correction, please mention this item's handle: RePEc:zur:iewwpx:231. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Marita Kieser).

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.