Normative and descriptive theories of decision making under risk

The approaches to the decision making process are typically either normative or descriptive. We sketch a historical development of the decision theory, starting with concept of utility that was first introduced by Daniel Bernoulli and then explaining the basic concepts of von Neumann and Morgenstern?s normative expected utility theory (including the basic axioms of rationality). Then we present the descriptively oriented prospect theory of Kahneman and Tversky as a critique of the expected utility theory. We compare these theories and conclude that their historical sequence captures the sequence of the developmental stages of the decision-making process itself. However, normative and descriptive theories are not mutually exclusive.

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Retrospectives: How Economists Came to Accept Expected Utility Theory: The Case of Samuelson and Savage

The Journal of Economic Perspectives ◽

10.1257/jep.30.2.219 ◽

2016 ◽

Vol 30 (2) ◽

pp. 219-236 ◽

Cited By ~ 36

Author(s):

Ivan Moscati

Keyword(s):

Expected Utility ◽

Utility Theory ◽

Expected Utility Theory ◽

Axiomatic System ◽

Individual Decision ◽

Decision Making Under Risk ◽

Von Neumann ◽

Cowles Commission ◽

Intellectual Journey ◽

The University

Expected utility theory dominated the economic analysis of individual decision-making under risk from the early 1950s to the 1990. Among the early supporters of the expected utility hypothesis in the von Neumann–Morgenstern version were Milton Friedman and Leonard Jimmie Savage, both based at the University of Chicago, and Jacob Marschak, a leading member of the Cowles Commission for Research in Economics. Paul Samuelson of MIT was initially a severe critic of expected utility theory. Between mid-April and early May 1950, Samuelson composed three papers in which he attacked von Neumann and Morgenstern's axiomatic system. By 1952, however, Samuelson had somewhat unexpectedly become a resolute supporter of the expected utility hypothesis. Why did Samuelson change his mind? Based on the correspondence between Samuelson, Savage, Marschak, and Friedman, this article reconstructs the joint intellectual journey that led Samuelson to accept expected utility theory and Savage to revise his motivations for supporting it.

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ECONOMICS OF RANDOMNESS: BEHAVIORAL ASPECTS OF DECISION MAKING UNDER RISK

Scientific Research of Faculty of Economics. Electronic Journal ◽

10.38050/2078-3809-2017-9-2-7-14 ◽

2017 ◽

Vol 9 (2) ◽

pp. 7-14

Author(s):

Alexander Krasilnikov

Keyword(s):

Decision Making ◽

Risk Analysis ◽

Uncertainty Analysis ◽

Expected Utility ◽

Utility Theory ◽

Expected Utility Theory ◽

Probabilistic Methods ◽

Risk And Uncertainty ◽

Decision Making Under Risk ◽

History Of

The paper discusses evolution of the concept of risk in economics. History of probabilistic methods and approaches to risk and uncertainty analysis is considered. Expected utility theory, behavioral approaches, heuristic models and methods of neuroeconomics are analyzed. Author investigates stability of neoclassical program related to risk analysis and suggests further directions of development.

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Measuring Utility, Destabilizing EUT

Measuring Utility ◽

10.1093/oso/9780199372768.003.0017 ◽

2018 ◽

pp. 261-280

Author(s):

Ivan Moscati

Keyword(s):

Decision Making ◽

Behavioral Economics ◽

Expected Utility ◽

Utility Theory ◽

Expected Utility Theory ◽

Behavioral Models ◽

Decision Making Under Risk ◽

Utility Measurement ◽

Elicitation Methods ◽

Series Of Experiments

Chapter 16 shows how the validity of expected utility theory (EUT) was increasingly called into question between the mid-1960s and the mid-1970s and discusses how a series of experiments performed from 1974 to 1985 undermined the earlier confidence that EUT makes it possible to measure utility. Beginning in the mid-1960s, in a series of experiments seminal to the field later called behavioral economics, Sarah Lichtenstein, Paul Slovic, Amos Tversky, and others showed that decision patterns violating EUT are systematic. The new experimenters who engaged with the EUT-based measurement of utility from the mid-1970s, namely Uday Karmarkar, Richard de Neufville, Paul Schoemaker, and coauthors, showed that different elicitation methods to measure utility, which according to EUT should produce the same outcome, generate different measures. These findings contributed to destabilizing EUT, undermined the confidence in EUT-based utility measurement, and helped foster a blossoming of novel behavioral models of decision-making under risk.

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Deal or No Deal? Decision Making under Risk in a Large-Payoff Game Show

The American Economic Review ◽

10.1257/aer.98.1.38 ◽

2008 ◽

Vol 98 (1) ◽

pp. 38-71 ◽

Cited By ~ 213

Author(s):

Thierry Post ◽

Martijn J van den Assem ◽

Guido Baltussen ◽

Richard H Thaler

Keyword(s):

Decision Making ◽

Risk Aversion ◽

Prospect Theory ◽

Expected Utility ◽

Utility Theory ◽

Path Dependence ◽

Expected Utility Theory ◽

Decision Making Under Risk ◽

Game Show ◽

Dependent Choice

We examine the risky choices of contestants in the popular TV game show “Deal or No Deal” and related classroom experiments. Contrary to the traditional view of expected utility theory, the choices can be explained in large part by previous outcomes experienced during the game. Risk aversion decreases after earlier expectations have been shattered by unfavorable outcomes or surpassed by favorable outcomes. Our results point to reference-dependent choice theories such as prospect theory, and suggest that path-dependence is relevant, even when the choice problems are simple and well defined, and when large real monetary amounts are at stake. (JEL D81)

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The Expected Utility Theory and Measurement Theory of von Neumann and Morgenstern, 1944–1947

Measuring Utility ◽

10.1093/oso/9780199372768.003.0010 ◽

2018 ◽

pp. 147-162 ◽

Cited By ~ 3

Author(s):

Ivan Moscati

Keyword(s):

Decision Making ◽

Utility Function ◽

Expected Utility ◽

Utility Theory ◽

Theory Of Measurement ◽

Measurement Theory ◽

Expected Utility Theory ◽

Economic Behavior ◽

Utility Analysis ◽

Von Neumann

Chapter 9 discusses the axiomatic version of expected utility theory (EUT), a theory of decision-making under risk, put forward by John von Neumann and Oskar Morgenstern in their book Theory of Games and Economic Behavior (1944). EUT was a changing factor in the history of utility measurement. In fact, while discussions of the measurability of utility before 1944 focused on the utility used to analyze decision-making between risk-free alternatives, after that year, discussions centered on the utility used to analyze decision-making between risky alternatives. In Theory of Games, the nature of the cardinal utility function u featured in von Neumann and Morgenstern’s EUT, and its relationship with the riskless utility function U of previous utility analysis remained ambiguous. Von Neumann and Morgenstern also put forward an axiomatic theory of measurement, which presents some similarities with Stanley Smith Stevens’s measurement theory but had no immediate impact on utility analysis.

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Farm decision making under risk and uncertainty

Netherlands Journal of Agricultural Science ◽

10.18174/njas.v45i2.520 ◽

1997 ◽

Vol 45 (2) ◽

pp. 307-328 ◽

Cited By ~ 4

Author(s):

G.B.C. Backus ◽

V.R. Eidman ◽

A.A. Dijkhuizen

Keyword(s):

Decision Making ◽

Expected Utility ◽

Utility Theory ◽

Expected Utility Theory ◽

Decision Problems ◽

Subjective Expected Utility ◽

Risk And Uncertainty ◽

Decision Making Under Risk ◽

Agricultural Risk ◽

Risk Research

Relevant portions of the risk literature are reviewed, relating them to observed behaviour in farm decision-making. Relevant topics for applied agricultural risk research are proposed. The concept of decision making under risk and uncertainty is discussed by reviewing the theory of Subjective Expected Utility and its limitations. Subjective Expected Utility theory is the major framework for thinking systematically through complex issues of decision. Limitations of Subjective Expected Utility theory were that its application to unique decisions is doubtful, that it does not contribute to difficulties in determining the available decision alternatives, and that it is cast in a timeless setting, making the theoretic framework to a very limited extent helpful to solve real world decision problems. Most empirical studies indicate that farmers are risk neutral to slightly risk averse. It is doubtful whether decision makers could be classified according to their risk preferences. A presented overview of applied risk responses reveals much attention for diversification of the enterprise and of production practices, maintaining reserves, and farm expansion. Research reports on observed problems in farm decision making behaviour are lacking. Proposed topics for agricultural risk research include the assessment of the need for a strategic change, the creation of databases to determine both the (co)variances of input and output prices, the effectiveness of various kinds of decision support for different decision problems, and methods for applied scenario analysis to deal with long-run risk.

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One-Reason Decision-Making: Modeling Violations of Expected Utility Theory

Heuristics ◽

10.1093/acprof:oso/9780199744282.003.0008 ◽

2011 ◽

pp. 186-199

Author(s):

Konstantinos V. Katsikopoulos ◽

Gerd Gigerenzer

Keyword(s):

Decision Making ◽

Expected Utility ◽

Utility Theory ◽

Expected Utility Theory

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An Implementation of Expected Utility Theory in Decision Based Design

Volume 3: 10th International Conference on Design Theory and Methodology ◽

10.1115/detc98/dtm-5670 ◽

1998 ◽

Author(s):

Matthew Marston ◽

Farrokh Mistree

Keyword(s):

Expected Utility ◽

Utility Theory ◽

Design Science ◽

Expected Utility Theory ◽

Simple Design ◽

Von Neumann ◽

Decision Based Design ◽

Mathematics And Physics ◽

Science Of The Artificial ◽

The Ideal

Abstract The development of a design science rests on the ideal that design is anchored in a set of fundamental axioms similar to the more ‘traditional’ sciences of mathematics and physics. However, the axioms upon which a design science is constructed must reflect that design is a science of the artificial. It is our contention that such axioms may exist in Decision-Based Design as those formulated by von-Neumann and Morgenstern for developing utilities under conditions of risk. In this paper we have a very narrow focus: evaluating a proposed framework for applying these axioms in the context of a simple design problem through the use of Monte Carlo simulation and expected utility theory.

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