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Range-Dependent Utility

Author

Listed:
  • Krzysztof Kontek

    (Artal Investments)

  • Michal Lewandowski

    (Warsaw School of Economics)

Abstract

This paper introduces the concept of range-dependent utility. Instead of reference dependence which evaluates outcomes relative to some reference point, we postulate dependence on a given lottery (set of lotteries) outcomes range. In this way the decision maker is a fully rational expected utility maximizer only within a certain range. Range-dependent utility enables experimental results to be explained without recourse to the probability weighting function. Experimental data show that range-dependent utilities can be normalized to obtain decision utility - a single utility function able to describe decisions involving lotteries defned over diferent ranges. Both the data analysis as well as theoretical considerations concerning monotonicity indicate that the decision utility should be of S-shape

Suggested Citation

  • Krzysztof Kontek & Michal Lewandowski, 2013. "Range-Dependent Utility," Working Papers 69, Department of Applied Econometrics, Warsaw School of Economics.
    • Handle: RePEc:wse:wpaper:69
    as

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    References listed on IDEAS

    as
    1. Yaari, Menahem E, 1987. "The Dual Theory of Choice under Risk," Econometrica, Econometric Society, vol. 55(1), pages 95-115, January.
    2. Cox, James C. & Sadiraj, Vjollca, 2006. "Small- and large-stakes risk aversion: Implications of concavity calibration for decision theory," Games and Economic Behavior, Elsevier, vol. 56(1), pages 45-60, July.
    3. Michał Lewandowski, 2013. "Risk Attitudes, Buying and Selling Price for a Lottery and Simple Strategies," Central European Journal of Economic Modelling and Econometrics, Central European Journal of Economic Modelling and Econometrics, vol. 5(1), pages 1-34, March.
    4. 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.
    5. Palacios-Huerta, Ignacio & Serrano, Roberto, 2006. "Rejecting small gambles under expected utility," Economics Letters, Elsevier, vol. 91(2), pages 250-259, May.
    6. Ariel Rubinstein, 2006. "Lecture Notes in Microeconomic Theory," Online economics textbooks, SUNY-Oswego, Department of Economics, number gradmicro1.
    7. Harry Markowitz, 1952. "The Utility of Wealth," Journal of Political Economy, University of Chicago Press, vol. 60, pages 151-151.
    8. Kontek, Krzysztof, 2009. "On Mental Transformations," MPRA Paper 16516, University Library of Munich, Germany.
    9. Daniel Kahneman & Amos Tversky, 2013. "Prospect Theory: An Analysis of Decision Under Risk," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 6, pages 99-127, World Scientific Publishing Co. Pte. Ltd..
    10. Michal Lewandowski, 2014. "Buying and selling price for risky lotteries and expected utility theory with gambling wealth," Journal of Risk and Uncertainty, Springer, vol. 48(3), pages 253-283, June.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Krzysztof Kontek, 2018. "Boundary effects in the Marschak-Machina triangle," Judgment and Decision Making, Society for Judgment and Decision Making, vol. 13(6), pages 587-606, November.
    2. Michał Lewandowski & Łukasz Woźny, 2020. "On complementary symmetry and reference dependence," KAE Working Papers 2020-059, Warsaw School of Economics, Collegium of Economic Analysis.
    3. Michał Lewandowski, 2017. "Prospect Theory Versus Expected Utility Theory: Assumptions, Predictions, Intuition and Modelling of Risk Attitudes," Central European Journal of Economic Modelling and Econometrics, Central European Journal of Economic Modelling and Econometrics, vol. 9(4), pages 275-321, December.
    4. Emilia Tomczyk, 2013. "End of sample vs. real time data: perspectives for analysis of expectations," Working Papers 68, Department of Applied Econometrics, Warsaw School of Economics.
    5. repec:cup:judgdm:v:13:y:2018:i:6:p:587-606 is not listed on IDEAS
    6. Raman Kachurka & Michał Krawczyk & Joanna Rachubik, 2021. "State lottery in the lab: an experiment in external validity," Experimental Economics, Springer;Economic Science Association, vol. 24(4), pages 1242-1266, December.
    7. Kontek, Krzysztof, 2015. "Fanning-Out or Fanning-In? Continuous or Discontinuous? Estimating Indifference Curves Inside the Marschak-Machina Triangle using Certainty Equivalents," MPRA Paper 63965, University Library of Munich, Germany.
    8. Kontek, Krzysztof & Birnbaum, Michael H., 2019. "The impact of middle outcomes on lottery valuations," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 78(C), pages 30-44.

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    More about this item

    Keywords

    range-dependent utility; decision utility; Certainty Equivalent; quasilinear mean; Expected Utility Theory; Prospect Theory; Allais paradox; insurance and gambling;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior

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