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Expected Utility Without Linearity: Distinguishing Between Prospect Theory and Cumulative Prospect Theory

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  • Mononen, Lasse

    (Center for Mathematical Economics, Bielefeld University)

Abstract

We reconsider the foundations of expected utility without assuming the linearity of the independence axiom. We consider a decision-maker who cancels out common outcomes when comparing a pair of lotteries with the same probability tree. We show that if the decision-maker is consistent with first-order stochastic dominance or topological continuity in weak convergence, then the decision-maker is an expected utility maximizer. This offers a simple method to differentiate behavior between prospect theory, canceling out common outcomes in pairwise comparisons, and cumulative prospect theory, satisfying first-order stochastic dominance. Additionally, this offers a novel method to test technical continuity assumptions based on their behavioral content that rules out, e.g., prospect theory.

Suggested Citation

  • Mononen, Lasse, 2025. "Expected Utility Without Linearity: Distinguishing Between Prospect Theory and Cumulative Prospect Theory," Center for Mathematical Economics Working Papers 728, Center for Mathematical Economics, Bielefeld University.
    • Handle: RePEc:bie:wpaper:728
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    File URL: https://pub.uni-bielefeld.de/download/3006148/3006149
    File Function: First Version, 2023
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