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The Simplest Non-Expected Utility Model for Lottery and Portfolio Choices

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  • Butler Richard

    (Department of Economics, Brigham Young University, Provo, USA)

  • Lambson Val

    (Brigham Young University, Provo, USA)

Abstract

This paper explores a particularly simple model of choice under risk, based on geometric means and entropy. Despite its simplicity, it satisfies various prudence and risk aversion conditions, is consistent with the Allais paradox, and generates various insurance-related results. Within a portfolio framework with compounded reinvestments, our index fits the risks/rewards data from post-war US stock market returns and recent international markets, at least as well as does the standard deviation measures more typically used. It also generates returns that are consistent with the equity premium puzzle.

Suggested Citation

  • Butler Richard & Lambson Val, 2018. "The Simplest Non-Expected Utility Model for Lottery and Portfolio Choices," Asia-Pacific Journal of Risk and Insurance, De Gruyter, vol. 12(1), pages 1-36, January.
    • Handle: RePEc:bpj:apjrin:v:12:y:2018:i:1:p:36:n:3
    DOI: 10.1515/apjri-2017-0006
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    References listed on IDEAS

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    4. Yang, Jiping & Qiu, Wanhua, 2005. "A measure of risk and a decision-making model based on expected utility and entropy," European Journal of Operational Research, Elsevier, vol. 164(3), pages 792-799, August.
    5. 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.
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