Choices Under Risk and Uncertainty with Windfall Gains and Catastrophic Losses

Abstract

This paper investigates a decision-making process involving both risk and uncertainty. The decision-maker is supposed to split events between "familiar", and "unfamiliar" ones, and she/he is assumed to behave differently with respect to them. In particular, it is showed that the DM overweighs unfamiliar gains and losses in his/her expected utility, formalized by means of the Choquet expected utility functional. If a specific subset of capacities is considered a further representation of the CEU is obtained in which the whole weight of uncertainty is placed on the windfall gain and the catastrophic loss.

Keywords: Knightian uncertainty, risk, capacity, Choquet expected utility.

JEL Classification: D81