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Is Expected Utility Theory Applicable? A Revealed Preference Test

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  • David R. Just
  • Hikaru Hanawa Peterson

Abstract

We proffer a method to assess the adequacy of expected utility theory (EUT) in empirical studies involving discrete and continuous choices. The method calibrates a utility function to revealed choices and rejects EUT for absurd degrees of implied concavity over the wealth at risk. We find EUT rejections in cases where risk-averse choices are made between gambles with similar stakes, regardless of their absolute sizes. EUT is shown to be applicable only when expected payoffs of gambles are similar, or when more than half of wealth is at risk. We illustrate our method with an application to agricultural production. Copyright 2010, Oxford University Press.

Suggested Citation

  • David R. Just & Hikaru Hanawa Peterson, 2010. "Is Expected Utility Theory Applicable? A Revealed Preference Test," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 92(1), pages 16-27.
  • Handle: RePEc:oup:ajagec:v:92:y:2010:i:1:p:16-27
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    File URL: http://hdl.handle.net/10.1093/ajae/aap015
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    Citations

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    Cited by:

    1. Franken, Jason R.V. & Pennings, Joost M.E. & Garcia, Philip, 2012. "Measuring Risk Attitude and Relation to Marketing Behavior," 2012 Annual Meeting, August 12-14, 2012, Seattle, Washington 124471, Agricultural and Applied Economics Association.
    2. Gómez-Limón, José A. & Gutiérrez-Martín, Carlos & Riesgo, Laura, 2016. "Modeling at farm level: Positive Multi-Attribute Utility Programming," Omega, Elsevier, vol. 65(C), pages 17-27.
    3. Viaggi, Davide & Raggi, Meri & Gomez y Paloma, Sergio, 2011. "Farm-household investment behaviour and the CAP decoupling: Methodological issues in assessing policy impacts," Journal of Policy Modeling, Elsevier, vol. 33(1), pages 127-145, January.
    4. Annemie Maertens & A. V. Chari & David R. Just, 2014. "Why Farmers Sometimes Love Risks: Evidence from India," Economic Development and Cultural Change, University of Chicago Press, vol. 62(2), pages 239-274.
    5. Petsakos, Athanasios & Rozakis, Stelios, 2015. "Calibration of agricultural risk programming models," European Journal of Operational Research, Elsevier, vol. 242(2), pages 536-545.
    6. Heiman, Amir & Just, David R. & McWilliams, Bruce P. & Zilberman, David, 2015. "A prospect theory approach to assessing changes in parameters of insurance contracts with an application to money-back guarantees," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 54(C), pages 105-117.
    7. Moro, Daniele & Sckokai, Paolo, 2013. "The impact of decoupled payments on farm choices: Conceptual and methodological challenges," Food Policy, Elsevier, vol. 41(C), pages 28-38.
    8. Jason R.V. Franken & Joost M.E. Pennings & Philip Garcia, 2014. "Measuring the effect of risk attitude on marketing behavior," Agricultural Economics, International Association of Agricultural Economists, vol. 45(5), pages 525-535, September.
    9. Peterson, Hikaru H. & Bernard, John C. & Fox, John A. (Sean) & Peterson, Jeffrey M., 2013. "Japanese Consumers' Valuation of Rice and Pork from Domestic, U.S., and Other Origins," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 38(1), April.
    10. Dolores Rey & Alberto Garrido & Javier Calatrava, 2016. "Comparison of Different Water Supply Risk Management Tools for Irrigators: Option Contracts and Insurance," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 65(2), pages 415-439, October.

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