The most common model used for decision making under risk and uncertainty is the Ex-pected utility theory (EUT). It has been accepted as a normative model of rational choice and widely applied as a descriptive model of economic behavior. Despite its prescriptive and normative strengths, the principle of expected utility theory maximization has encountered many problems: experimental evidence as well as choice patterns observed in the real world suggests that individuals often do not behave in a manner consistent with this model; in other words, human choice behavior deviates in systematic ways axioms of that theory, as captured originally in two classical demonstra-tions referred to as the Allais (1953) and Ellsberg (1961) paradoxes. The limits of the expected utility theory have led many authors to search new models for the representation of decision making under uncertainty. A large number of models al-ternative to the EUT are proposed to try to bridge the gap between theory and reality. This paper supplies an overview of EUT, its generalizations and some hints for further approaches and it is organized as follows. In section 2 the principle of EU maximization is described; in section 3, after underlying limits of the EUT, some paradoxes are ana-lyzed; in section 4, the SEU theory is presented; in section 5 the risk aversion is faced and some risk measures are described; in section 6 some models alternative to EU are showed by means of the Marschak-Machina triangle; finally, in section 7 some conclud-ing remarks are provided.

This paper supplies an overview of EUT, its generalizations and some hints for further approaches and it is organized as follows. In section 2 the principle of EU maximization is described; in section 3, after underlying limits of the EUT, some paradoxes are analyzed; in section 4, the SEU theory is presented; in section 5 the risk aversion is faced and some risk measures are described; in section 6 some models alternative to EU are showed by means of the Marschak-Machina triangle; finally, in section 7 'some concluding remarks are provided.

Decision making under risk and uncertainty

MARCARELLI G;SQUILLANTE M.
2011-01-01

Abstract

The most common model used for decision making under risk and uncertainty is the Ex-pected utility theory (EUT). It has been accepted as a normative model of rational choice and widely applied as a descriptive model of economic behavior. Despite its prescriptive and normative strengths, the principle of expected utility theory maximization has encountered many problems: experimental evidence as well as choice patterns observed in the real world suggests that individuals often do not behave in a manner consistent with this model; in other words, human choice behavior deviates in systematic ways axioms of that theory, as captured originally in two classical demonstra-tions referred to as the Allais (1953) and Ellsberg (1961) paradoxes. The limits of the expected utility theory have led many authors to search new models for the representation of decision making under uncertainty. A large number of models al-ternative to the EUT are proposed to try to bridge the gap between theory and reality. This paper supplies an overview of EUT, its generalizations and some hints for further approaches and it is organized as follows. In section 2 the principle of EU maximization is described; in section 3, after underlying limits of the EUT, some paradoxes are ana-lyzed; in section 4, the SEU theory is presented; in section 5 the risk aversion is faced and some risk measures are described; in section 6 some models alternative to EU are showed by means of the Marschak-Machina triangle; finally, in section 7 some conclud-ing remarks are provided.
2011
This paper supplies an overview of EUT, its generalizations and some hints for further approaches and it is organized as follows. In section 2 the principle of EU maximization is described; in section 3, after underlying limits of the EUT, some paradoxes are analyzed; in section 4, the SEU theory is presented; in section 5 the risk aversion is faced and some risk measures are described; in section 6 some models alternative to EU are showed by means of the Marschak-Machina triangle; finally, in section 7 'some concluding remarks are provided.
risk attitude; expected utility theory; ambiguity aversion; Ellsberg paradox; Allais paradox
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Utilizza questo identificativo per citare o creare un link a questo documento: https://hdl.handle.net/20.500.12070/2888
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