Non-Expected Utility and Stochastic Dominance

  • Haim Levy
Part of the Studies in Risk and Uncertainty book series (SIRU, volume 12)

Abstract

Most of the economic and finance models that deal with investment decision making under uncertainty are based on the expected utility paradigm. However, experimental studies have shown that subjects often behave in a manner that runs counter to expected utility maximization. Such inconsistencies have been shown to be mainly due to violation of the independent axiom (called also the interchangeability axiom, see Chapter 2). In this chapter, we discuss some of the violations of the expected utility model (for a fuller account, see Machina, [1982 and 1983]1), and review the modified of the expected utility theory, the generalized expected utility or non-expected utility theory, as well as the competing models that have been developed in order to avoid these violations.

Keywords

Utility Function Utility Theory Prospect Theory Stochastic Dominance Expect Utility Theory 
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

Preview

Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.

Notes

  1. 1.
    Machina, Mark A., “‘Expected Utility’ Analysis Without Independent Axiom,” Econometrica, 50, 1982, pp. 270–323.Google Scholar
  2. Machina, M.A., “Generalized Expected Utility Analysis and the Nature of Observed Violations of the Independence Axiom, in Stigum, B., and Wenstøph, F. (eds.) Foundation of Utility and Risk with Applications, Reidel, Dordrecht, Holland, 1983.Google Scholar
  3. 2.
    Fishburn, P.C., “Nontransitive Measureable Utility,” Journal of Math. Psychology, 26, 1982, pp. 31–67.CrossRefGoogle Scholar
  4. 3.
    Mosteller, F., and Nogee, P., “An Experimental Measurement of Utility,” Journal of Political Economy, 59, October 1951, pp. 371–404.CrossRefGoogle Scholar
  5. 4.
    Edwards, W., “Probability Preferences in Gambling,” American Journal of Psychology, 66, 1953, pp. 349–364.CrossRefGoogle Scholar
  6. Edwards W., “Probability Preferences Among Bets with Differing Expected Values,” American Journal of Psychology, 67, 1954, pp. 56–67.CrossRefGoogle Scholar
  7. 6.
    Yaari, M, “The Dual Theory of Choice Under Risk,” Econometrica, 55, 1987, pp. 95–115.CrossRefGoogle Scholar
  8. 7.
    Teversky, A. and D. Kahaneman, “Advances in Prospect Theory: Cumulative Representation of Uncertainty,” Journal of Risk and Uncertainty, 5, 1992, pp. 297–323.CrossRefGoogle Scholar
  9. 8.
    Quiggin, J., Generalized Expected Utility Theory, The Rank Dependent Model, Kluwer Academic Publishers, Boston, 1993.CrossRefGoogle Scholar
  10. 10.
    Kahneman, D. and Tversky, A., “Prospect Theory: An Analysis of Decision Under Risk,” Econometrica, 47, 1979, pp. 263–291.CrossRefGoogle Scholar
  11. 13.
    Thaler, R.H., and E.J. Johnson, “Gambling with the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choices,” Management Science, 36, 1990, pp. 643–660.CrossRefGoogle Scholar
  12. 16.
    The proof, as the proofs of the SD criteria, holds also for the unbounded case (see Hanoch and Levy, Review of Economic Studies, 36, 1969, pp. 335–346).CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media New York 1998

Authors and Affiliations

  • Haim Levy
    • 1
  1. 1.The Hebrew University of JerusalemIsrael

Personalised recommendations