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Iterated Expectations Under Rank-dependent Expected Utility And Model Consistency


  • Alex Stomper

    (Humboldt University)

  • Marie-Louise Vierø

    () (Queen's University)


Under expected utility theory, compound lotteries can be valued by "iterating" expectations: the expected utility of a compound lottery is the expected value of a simple lottery over prizes that are certainty equivalents to follow-up lotteries. We derive necessary and sufficient conditions for a similar valuation technique in the framework of rank-dependent expected utility (RDU) when a decision maker has to choose between prospects that belong to a comonotonic class and his preferences satisfy consequentialism. The conditions are so restrictive that they can be viewed as an impossibility result. Our contribution thus identifies a challenge for future research. If we accept RDU as the model of behavior, we either need to find alternative valuation algorithms, or we need to relax the assumption of preference exogeneity.

Suggested Citation

  • Alex Stomper & Marie-Louise Vierø, 2015. "Iterated Expectations Under Rank-dependent Expected Utility And Model Consistency," Working Paper 1228, Economics Department, Queen's University.
  • Handle: RePEc:qed:wpaper:1228

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    References listed on IDEAS

    1. Gilboa Itzhak & Schmeidler David, 1993. "Updating Ambiguous Beliefs," Journal of Economic Theory, Elsevier, vol. 59(1), pages 33-49, February.
    2. Tversky, Amos & Kahneman, Daniel, 1992. "Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
    3. Sarin, Rakesh & Wakker, Peter P, 1998. "Revealed Likelihood and Knightian Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 16(3), pages 223-250, July-Aug..
    4. Drazen Prelec, 1998. "The Probability Weighting Function," Econometrica, Econometric Society, vol. 66(3), pages 497-528, May.
    5. Wakker, Peter & Tversky, Amos, 1993. "An Axiomatization of Cumulative Prospect Theory," Journal of Risk and Uncertainty, Springer, vol. 7(2), pages 147-175, October.
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    More about this item


    model consistency; Iterated expectations; rank-dependent expected utility; valuation methods; conditioning; dynamic consistency; consequentialism; probability weighting function; updating;

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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