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Subjective Expected Utility Theory with “Small Worlds”

Author

Listed:
  • Jacob Gyntelberg

    (Bank for International Settlements)

  • Frank Hansen

    (Department of Economics, University of Copenhagen)

Abstract

We model the notion of a "small world" as a context dependent state space embedded into the "grand world". For each situation the decision maker creates a "small world" reflecting the events perceived to be relevant for the act under consideration. The "grand world" is represented by an event space which is a more general construction than a state space. We retain preference axioms similar in spirit to the Savage axioms and obtain, without abandoning linearity of expectations, a subjective expected utility theory which allows for an intuitive distinction between risk and uncertainty. We also obtain separation of subjective probability and utility as in the state space models.

Suggested Citation

  • Jacob Gyntelberg & Frank Hansen, 2004. "Subjective Expected Utility Theory with “Small Worlds”," Discussion Papers 09-26, University of Copenhagen. Department of Economics, revised Dec 2009.
    • Handle: RePEc:kud:kuiedp:0926
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    File URL: http://www.econ.ku.dk/english/research/publications/wp/dp_2009/0926.pdf/
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    More about this item

    Keywords

    subjective expected utility; decision making under uncertainty; uncertainty aversion; Ellsberg paradox;
    All these keywords.

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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