Generalized expected utility
Encyclopedia
The expected utility model developed by John von Neumann
and Oskar Morgenstern
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 Allais
and Daniel Ellsberg
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 paradox
and Ellsberg paradox
.
Beginning in 1979 with the publication of the prospect theory
of Daniel Kahneman
and Amos Tversky
, 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 theory
, weighted utility (Chew 1982), and expected uncertain utility theory. 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 theory
, a further development of prospect theory, introduced in 1992 by Daniel Kahneman
and Amos Tversky
.
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.
John von Neumann
John von Neumann was a Hungarian-American mathematician and polymath who made major contributions to a vast number of fields, including set theory, functional analysis, quantum mechanics, ergodic theory, geometry, fluid dynamics, economics and game theory, computer science, numerical analysis,...
and Oskar Morgenstern
Oskar Morgenstern
Oskar Morgenstern was a German-born Austrian-School economist. He, along with John von Neumann, helped found the mathematical field of game theory ....
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 Allais
Maurice Allais
Maurice Félix Charles Allais was 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."...
and Daniel Ellsberg
Daniel Ellsberg
Daniel Ellsberg, PhD, is a former United States military analyst who, while employed by the RAND Corporation, precipitated a national political controversy in 1971 when he released the Pentagon Papers, a top-secret Pentagon study of U.S. government decision-making in relation to the Vietnam War,...
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 paradox
Allais paradox
The 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.-Statement of the Problem:...
and Ellsberg paradox
Ellsberg paradox
The Ellsberg paradox is a paradox in decision theory and experimental economics in which people's choices violate the expected utility hypothesis.An alternate viewpoint is that expected utility theory does not properly describe actual human choices...
.
Beginning in 1979 with the publication of the prospect theory
Prospect theory
Prospect theory is a theory that describes decisions between alternatives that involve risk i.e. where the probabilities of outcomes are known. The model is descriptive: it tries to model real-life choices, rather than optimal decisions.-Model:...
of Daniel Kahneman
Daniel Kahneman
Daniel Kahneman is an Israeli-American psychologist and Nobel laureate. He is notable for his work on the psychology of judgment and decision-making, behavioral economics and hedonic psychology....
and Amos Tversky
Amos Tversky
Amos Nathan Tversky, was a cognitive and mathematical psychologist, 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 measurement...
, 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 theory
Rank-dependent expected utility
The 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...
, weighted utility (Chew 1982), and expected uncertain utility theory. 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 theory
Cumulative prospect theory
Cumulative prospect theory is a model for descriptive decisions under risk which was 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 Kahneman
Daniel Kahneman
Daniel Kahneman is an Israeli-American psychologist and Nobel laureate. He is notable for his work on the psychology of judgment and decision-making, behavioral economics and hedonic psychology....
and Amos Tversky
Amos Tversky
Amos Nathan Tversky, was a cognitive and mathematical psychologist, 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 measurement...
.
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.