Compound Utility Theory: A Simple Generalized Approach to Decision Under Risk
39 Pages Posted: 10 Apr 2005
Date Written: August 2004
Abstract
A three-dimension analytical framework for decision under risk is presented, in which preference is defined as a triadic reference-dependent relation as in Sugden (2003). Characterized by a set of von Neumann-Morgenstern-style axioms except that the independence axiom is assumed only for the valuation of utility-reward (u) and disutility-risk (d), compound utility theory (CUT) is developed that represents reference-dependent preferences in a straightforward manner. As a simple alternative to prospect theory, CUT is capable of accommodating nonlinear preferences without invoking the behavioral (nonadditive) subjective-probability or decision-weight assumptions. In applying CUT, a unique reference level can be identified given any choice context with monetary outcomes.
Keywords: Expected utility theory, prospect theory, reference-dependence, nonlinear preference, compound utility
JEL Classification: D81
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
On the Intuition of Rank-Dependent Utility
By Enrico Diecidue and Peter P. Wakker
-
Aspiration Level, Probability of Success and Failure, and Expected Utility
By Enrico Diecidue and Jeroen Van De Ven
-
Seeing the Forest When Entry is Unlikely: Probability and the Mental Representation of Events
By Cheryl J. Wakslak, Yaacov Trope, ...
-
Comonotonic Independence: The Critical Test between Classical and Rank-Dependent Utility Theories
By Peter P. Wakker, Ido Erev, ...
-
Valuing Money and Things: Why a $20 Item Can be Worth More and Less than $20
By A. Peter Mcgraw, Eldar Shafir, ...
-
By Laure Cabantous, Denis Hilton, ...
-
Representation Over Time: The Effects of Temporal Distance on Similarity
By Daniel M. Bartels and Samuel B Day