The expected utility model developed by
John von NeumannJohn von Neumann was a Hungarian American mathematician who made major contributions to a vast range of fields, including set theory, functional analysis, quantum mechanics, ergodic theory, continuous geometry, economics and game theory, computer science, numerical analysis, hydrodynamics John...
and
Oskar MorgensternOskar Morgenstern was a German-born Austrian economist. He, along with John von Neumann, helped found the mathematical field of game theory .Morgenstern was born in Görlitz, Germany...
dominated decision theory from its formulation in 1944 until the late 1970s, not only as a prescriptive, but also as a descriptive model, despite powerful criticism from
Maurice AllaisMaurice Félix Charles Allais is a French economist, and was the 1988 winner of the Nobel Memorial Prize in Economics "for his pioneering contributions to the theory of markets and efficient utilization of resources."-The economist:...
and
Daniel EllsbergDaniel Ellsberg is a former US military analyst employed by the RAND Corporation who precipitated a national political controversy in 1971 when he released the Pentagon Papers, a top-secret Pentagon study of US government decision-making about the Vietnam War, to The New York Times and other...
who showed that, in certain choice problems, decisions were usually inconsistent with the axioms of expected utility theory. These problems are usually referred to as the
Allais paradoxThe Allais paradox is a choice problem designed by Maurice Allais to show an inconsistency of actual observed choices with the predictions of expected utility theory. The problem arises when comparing participants' choices in two different experiments, each of which consists of a choice between two...
and
Ellsberg paradoxThe Ellsberg paradox is a paradox in decision theory and experimental economics in which people's choices violate the expected utility hypothesis. It is generally taken to be evidence for ambiguity aversion...
.
Beginning in 1979 with the publication of the
prospect theoryProspect theory is a theory that describes decisions between alternatives that involve risk, i.e. alternatives with uncertain outcomes, where the probabilities are known...
of
Daniel KahnemanDaniel Kahneman is an Israeli psychologist and Nobel laureate, notable for his work on the psychology of judgment and decision-making, behavioral economics and hedonic psychology....
and
Amos TverskyAmos Nathan Tversky, was a cognitive and mathematical psychologist, and a pioneer of cognitive science, a longtime collaborator of Daniel Kahneman, and a key figure in the discovery of systematic human cognitive bias and handling of risk. Much of his early work concerned the foundations of...
, a range of generalized expected utility models were developed with the aim of resolving the Allais and Ellsberg paradoxes, while maintaining many of the attractive properties of expected utility theory.
Important examples were anticipated utility theory, later referred to as
rank-dependent utility theoryThe rank-dependent expected utility model is a generalized expected utility model of choice under uncertainty, designed to explain the behaviour observed in the Allais paradox, as well as for the observation that many people both purchase lottery tickets and insure against losses .A...
and weighted utility (Chew 1982).
The expected utility model developed by
John von NeumannJohn von Neumann was a Hungarian American mathematician who made major contributions to a vast range of fields, including set theory, functional analysis, quantum mechanics, ergodic theory, continuous geometry, economics and game theory, computer science, numerical analysis, hydrodynamics John...
and
Oskar MorgensternOskar Morgenstern was a German-born Austrian economist. He, along with John von Neumann, helped found the mathematical field of game theory .Morgenstern was born in Görlitz, Germany...
dominated decision theory from its formulation in 1944 until the late 1970s, not only as a prescriptive, but also as a descriptive model, despite powerful criticism from
Maurice AllaisMaurice Félix Charles Allais is a French economist, and was the 1988 winner of the Nobel Memorial Prize in Economics "for his pioneering contributions to the theory of markets and efficient utilization of resources."-The economist:...
and
Daniel EllsbergDaniel Ellsberg is a former US military analyst employed by the RAND Corporation who precipitated a national political controversy in 1971 when he released the Pentagon Papers, a top-secret Pentagon study of US government decision-making about the Vietnam War, to The New York Times and other...
who showed that, in certain choice problems, decisions were usually inconsistent with the axioms of expected utility theory. These problems are usually referred to as the
Allais paradoxThe Allais paradox is a choice problem designed by Maurice Allais to show an inconsistency of actual observed choices with the predictions of expected utility theory. The problem arises when comparing participants' choices in two different experiments, each of which consists of a choice between two...
and
Ellsberg paradoxThe Ellsberg paradox is a paradox in decision theory and experimental economics in which people's choices violate the expected utility hypothesis. It is generally taken to be evidence for ambiguity aversion...
.
Beginning in 1979 with the publication of the
prospect theoryProspect theory is a theory that describes decisions between alternatives that involve risk, i.e. alternatives with uncertain outcomes, where the probabilities are known...
of
Daniel KahnemanDaniel Kahneman is an Israeli psychologist and Nobel laureate, notable for his work on the psychology of judgment and decision-making, behavioral economics and hedonic psychology....
and
Amos TverskyAmos Nathan Tversky, was a cognitive and mathematical psychologist, and a pioneer of cognitive science, a longtime collaborator of Daniel Kahneman, and a key figure in the discovery of systematic human cognitive bias and handling of risk. Much of his early work concerned the foundations of...
, a range of generalized expected utility models were developed with the aim of resolving the Allais and Ellsberg paradoxes, while maintaining many of the attractive properties of expected utility theory.
Important examples were anticipated utility theory, later referred to as
rank-dependent utility theoryThe rank-dependent expected utility model is a generalized expected utility model of choice under uncertainty, designed to explain the behaviour observed in the Allais paradox, as well as for the observation that many people both purchase lottery tickets and insure against losses .A...
and weighted utility (Chew 1982). A general representation, using the concept of the local utility function was presented by Mark Machina.
Since then, generalizations of expected utility theory have proliferated, but the probably most frequently used model is nowadays
cumulative prospect theoryCumulative Prospect Theory is a model for descriptive decisions under risk which has been introduced by Amos Tversky and Daniel Kahneman in 1992 . It is a further development and variant of prospect theory...
, a further development of prospect theory, introduced in 1992 by
Daniel KahnemanDaniel Kahneman is an Israeli psychologist and Nobel laureate, notable for his work on the psychology of judgment and decision-making, behavioral economics and hedonic psychology....
and
Amos TverskyAmos Nathan Tversky, was a cognitive and mathematical psychologist, and a pioneer of cognitive science, a longtime collaborator of Daniel Kahneman, and a key figure in the discovery of systematic human cognitive bias and handling of risk. Much of his early work concerned the foundations of...
.
Given its motivations and approach, generalized expected utility theory may properly be regarded as a subfield of behavioral economics, but it is more frequently located within mainstream economic theory.