Issues in utility measurement (original) (raw)
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Management …, 2007
T his paper explores inconsistencies that occur in utility measurement under risk when expected utility theory is assumed and the contribution that prospect theory and some other generalizations of expected utility can make to the resolution of these inconsistencies. We used five methods to measure utilities under risk and found clear violations of expected utility. Of the theories studied, prospect theory was the most consistent with our data. The main improvement of prospect theory over expected utility was in comparisons between a riskless and a risky prospect (riskless-risk methods). We observed no improvement over expected utility in comparisons between two risky prospects (risk-risk methods). An explanation for the latter observation may be that there was less distortion in probability weighting in the interval 0 10 0 20 than has commonly been observed.
Preferences, prices, and ratings in risky decision making
Journal of Experimental Psychology: Human Perception and Performance, 1992
Systematically different preference orders are obtained when different procedures are used to elicit preferences for gambles. Three new experiments found different preference orders with attractiveness ratings, risk ratings, buying prices, selling prices, avoidance prices, and strength-ofpreference judgments. Preference reversals persisted even when Ss were given financial incentives to motivate them to rank the gambles identically. Results were consistent with a change-ofprocess theory in which Ss are assumed to use different strategies in different tasks with the same scales. Attractiveness and risk ratings could be described by an additive combination of probability and amount, and prices could be predicted by a multiplicative combination of the same scales. Strength-of-preference judgments were consistent with a contrast-weighting model in which the weight of a dimension (either probability or amount) depends on the contrast between the 2 gambles along that dimension.
Unexpected Utility: Experimental Tests of Five Key Questions about Preferences over Risk
2009
Experimental work on preferences over risk has typically considered choices over a small number of discrete options, some of which involve no risk. Such experiments often demonstrate contradictions of standard expected utility theory. We reconsider this literature with a new preference elicitation device that allows a continuous choice space over only risky options. Our analysis assumes only that preferences depend on the probability p and prize x; U = u(p; x): We then allow subjects to choose p and x continuously on a linear budget constraint, r 1 p + r 2 x = m, so that all prospects with a nonzero expected value are risky. We test …ve of the most importantly debated questions about risk preferences: rationality, prospect theory asymmetry, the independence axiom, probability weighting, and constant relative risk aversion. Overall, we …nd that the expected utility model does unexpectedly well.
Testing risk aversion and nonexpected utility theories
Journal of Economic Behavior & Organization, 1998
This paper tests risk aversion and compares several nonexpected utility theories using paired comparisons. Economic hypotheses associated with risk aversion are found not to hold in preference data. Expected utility with rank dependent probability is found to provide a smooth representation of preference for a wide range of preference types. Published by Elsevier Science B.V.
Risk-aversion concepts in expected- and non-expected-utility models
Insurance: Mathematics and Economics, 1996
The non-expected-utility tbeories of decision under risk have fovond the appearance of new notions of incieasing risk like ntonotone increasing risk (based on the notion of comonotonic random vahablcs) or new notions of risk aversion like averaion to monotone increasing risk, in better agreement witb tbese new theories. After a survey of atl tbc possible notions of increasing risk and of risk aversion and tbeir intrinsic de^nitions, we show tbat cODtivy to expected-utility tbeory where all the notions of risk avenion bave the same characterization (u concave), in the ftunework of rank-dependent expected utility (one of the most well known of the non-expectedutility models), tbe characterizations of all these notions of risk aversion are different. Moreover, we sbow tbat, even in tbe expected-utility framcworic, the new notion of monotone increasing risk can give better answers to some pn^lems of comparative sutics sucb as in ponfoUo cboice or in partial insurance. This new notion also can suggest more intuitive approaches to inequalities measurement.
Certain and Uncertain Utility: The Allais Paradox and Five Decision Theory Phenomena
2010
In the study of decision making under risk, preferences are assumed to be continuous. We present a model of discontinuous preferences over certain and uncertain outcomes. Using existing parameter estimates for certain and uncertain utility, five important decision theory phenomena are discussed: the certainty effect, experimentally observed probability weighting, the uncertainty effect, extreme experimental risk aversion and quasi-hyperbolic discounting. All five phenomena can be resolved.
Prospect theory and utility theory: Temporary versus permanent attitude toward risk
Journal of Economics and Business, 2013
Prospect Theory (PT), which relies on subjects' behavior as observed in laboratory experiments contradicts the behavior predicted by the Expected Utility (EU) paradigm. In this study, we introduce the concept of Temporary Attitude Towards Risk (TATR) and Permanent Attitude Towards Risk (PATR). Using these concepts, we build a model that merges both the PT and the EU paradigms. The TATR and PATR concepts explain recent experimental findings and the observed stock price overreaction. We relate the properties of PT to some well-known financial and economic results. We show that a positive risk premium with decreasing absolute risk aversion (DARA) can be consistent with the S-shaped value function used in PT. Finally, we introduce the Prospect Stochastic Dominance (PSD) rule for partial ordering of uncertain prospects for all S-shaped value functions.
The hunt for a descriptive theory of choice under risk—A view from the road not taken
The Journal of Socio-Economics, 2010
In this paper I propose that the development of descriptive theories of choice in economics has been profoundly influenced by an arbitrary and seemly innocuous decision as to how to present risky choices to experimental subjects. This decision to represent lotteries as prospects has lead to a preoccupation with the question of whether preferences conform to what is known as the "independence axiom." Had the profession chosen to represent lotteries in the action-by-state matrices favored by Savage, the independence axiom would have appeared uncontroversial but we would have questioned whether preferences obeyed arguably more fundamental tenets of rationality like transitivity. That different ways of representing lotteries lead to different conclusions regarding which axioms preferences do and don't obey suggests that the choices people make aren't necessarily reflecting properties of their preferences at all. Instead the choices reveal properties of the decision rule individuals use to try to satisfy their preferences-a rule that involves judgments regarding the similarity or dissimilarity of prizes and their associated payoffs across alternatives. The paper discusses how such judgments explain observed behaviors given both prospect and matrix representations of lottery choices as well as explaining anomalies in other choice domains.