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Principle of uncertain future and utility

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  • Harin, Alexander

Abstract

The principle of uncertain future: the probability of a future event contains a degree of (hidden) uncertainty. As a result, this uncertainty (in a sense, similar to vibrations, fluctuations) pushes the probability value back from the bounds to the middle of its range (from ~100% and ~0% to the middle probability values). In other words, the real values of high probabilities are lower than the preliminarily determined ones. Conversely, the real values of low probabilities are higher than the preliminarily determined ones. This result provides the uniform solution of a number of fundamental problems: the underweighting of high and the overweighting of low probabilities, the Allais paradox, risk aversion, loss aversion, the Ellsberg paradox, the equity premium puzzle, etc. The principle and its consequences can be applied in the fields of banking, investment, insurance, trade, industry, planning and forecasting. Explanations of the principle and examples of solution of three types of basic utility problems are provided.

Suggested Citation

  • Harin, Alexander, 2007. "Principle of uncertain future and utility," MPRA Paper 1959, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:1959
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    File URL: https://mpra.ub.uni-muenchen.de/1959/1/MPRA_paper_1959.pdf
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    References listed on IDEAS

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    1. Carmela Di Mauro & Anna Maffioletti, 2004. "Attitudes to risk and attitudes to uncertainty: experimental evidence," Applied Economics, Taylor & Francis Journals, vol. 36(4), pages 357-372.
    2. Helga Fehr-Duda & Marc Schürer & Renate Schubert, 2006. "What Determines the Shape of the Probability Weighting Function?," CER-ETH Economics working paper series 06/54, CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich.
    3. Quiggin, John, 2005. "Economists and Uncertainty," Risk and Sustainable Management Group Working Papers 151169, University of Queensland, School of Economics.
    4. Hey, John D & Orme, Chris, 1994. "Investigating Generalizations of Expected Utility Theory Using Experimental Data," Econometrica, Econometric Society, vol. 62(6), pages 1291-1326, November.
    5. Kenneth Y. Chay & Patrick J. McEwan & Miguel Urquiola, 2005. "The Central Role of Noise in Evaluating Interventions That Use Test Scores to Rank Schools," American Economic Review, American Economic Association, vol. 95(4), pages 1237-1258, September.
    6. Capuano, Christian, 2006. "Strategic noise traders and liquidity pressure with a physically deliverable futures contract," International Review of Economics & Finance, Elsevier, vol. 15(1), pages 1-14.
    7. Schoemaker, Paul J H, 1982. "The Expected Utility Model: Its Variants, Purposes, Evidence and Limitations," Journal of Economic Literature, American Economic Association, vol. 20(2), pages 529-563, June.
    8. Quiggin, John, 2005. "The Precautionary Principle in Environmental Policy and the Theory of Choice under Uncertainty," Risk and Sustainable Management Group Working Papers 149847, University of Queensland, School of Economics.
    9. Tversky, Amos & Wakker, Peter, 1995. "Risk Attitudes and Decision Weights," Econometrica, Econometric Society, vol. 63(6), pages 1255-1280, November.
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    Citations

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    Cited by:

    1. Harin, Alexander, 2015. "“Luce problem” and discontinuity of Prelec’s function at p = 1," MPRA Paper 63672, University Library of Munich, Germany.
    2. Harin, Alexander, 2014. "Is data interpretation in utility and prospect theories unquestionably correct?," MPRA Paper 53880, University Library of Munich, Germany.
    3. Harin, Alexander, 2011. "Теоремы О Существовании Разрывов На Числовых Отрезках И В Шкале Вероятностей И Некоторые Возможности Их Применения
      [Theorems of existence of the ruptures in numerical segments and in the probabilit
      ," EconStor Open Access Articles, ZBW - German National Library of Economics, pages 5-7.
    4. Harin, Alexander, 2014. "General correcting formulae for forecasts," MPRA Paper 55283, University Library of Munich, Germany.

    More about this item

    Keywords

    risk; market; banking; industry; development; investments; insurance; hidden causes;

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • A1 - General Economics and Teaching - - General Economics
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory

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