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Optimism and Pessimism with Expected Utility, Third Version

Listed author(s):
  • David Dillenberger

    ()

    (Department of Economics, University of Pennsylvania)

  • Andrew Postlewaite

    ()

    (Department of Economics, University of Pennsylvania)

  • Kareen Rozen

    ()

    (Department of Economics, Yale University)

Savage (1954) provides axioms on preferences over acts that are equivalent to the existence of a subjective expected utility representation. We show that there is a continuum of other \expected utility" representations in which for any act, the probability distribution over states depends on the corresponding outcomes and is first-order stochastically dominated by (dominates) the Savage distribution. We suggest that pessimism (optimism) can be captured by the stake-dependent probabilities in these alternate representations. We then extend the DM's preferences to be defined over both subjective acts and objective lotteries. Our result permits modeling ambiguity aversion in Ellsberg's two-urn experiment using pessimistic probability assessments, the same utility over prizes for lotteries and acts, and without relaxing Savage's axioms. An implication of our results is that the large body of existing research based on expected utility can, with a simple reinterpretation, be understood as modeling the behavior of optimistic or pessimistic decision makers.

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File URL: http://economics.sas.upenn.edu/system/files/13-001.pdf
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Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 13-001.

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Length: 19 pages
Date of creation: 01 Aug 2011
Date of revision: 26 Dec 2012
Handle: RePEc:pen:papers:13-001
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