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What's in a u?

Author

Listed:
  • Larbi Alaoui
  • Antonio Penta

Abstract

We revisit the long-lasting debate about the meaning of the utility function used in the standard Expected Utility (EU) model. Despite the common view that EU forces risk aversion and diminishing marginal utility of wealth to be pegged to one another, here we show that this is not the case. Marginal utility for money is an input into risk attitude, but it is not its sole determinant. The attitude towards 'pure risk' is also a contributing factor, and it is independent from the former. We discuss several theoretical implications of this result, for the following topics: (i) non- neutral risk attitudes for profit maximizing firms; (ii) risk aversion over time lotteries in the presence of discounting, and convex time budget decisions; (iii) the equity premium puzzle. We also discuss matters of identification: (i) for firms; (ii) via proxies ; (iii) via standard MLE methods under parametric restrictions; (iv) in intertemporal choice problems; and (v) cross-context elicitation in multi-dimensional settings, and its relationship with the methods and results from the psychology literature.

Suggested Citation

  • Larbi Alaoui & Antonio Penta, 2025. "What's in a u?," Working Papers 1494, Barcelona School of Economics.
    • Handle: RePEc:bge:wpaper:1494
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    References listed on IDEAS

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    1. Garance Genicot & Debraj Ray, 2017. "Aspirations and Inequality," Econometrica, Econometric Society, vol. 85, pages 489-519, March.
    2. David Gill & Victoria Prowse, 2012. "A Structural Analysis of Disappointment Aversion in a Real Effort Competition," American Economic Review, American Economic Association, vol. 102(1), pages 469-503, February.
    3. Ferdinand M. Vieider & Mathieu Lefebvre & Ranoua Bouchouicha & Thorsten Chmura & Rustamdjan Hakimov & Michal Krawczyk & Peter Martinsson, 2015. "Common Components Of Risk And Uncertainty Attitudes Across Contexts And Domains: Evidence From 30 Countries," Journal of the European Economic Association, European Economic Association, vol. 13(3), pages 421-452, June.
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    Keywords

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    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

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