scholarly journals The Standard Model of Rational Risky Decision-Making

2021 ◽  
Vol 14 (4) ◽  
pp. 158
Author(s):  
Kazem Falahati
Keyword(s):  
Decision Making ◽  
Utility Function ◽  
Utility Theory ◽  
Random Variable ◽  
Expected Utility Theory ◽  
Endowment Effect ◽  
Certainty Equivalent ◽  
New Paradigm ◽  
Risky Decision ◽  
Von Neumann

Expected utility theory (EUT) is currently the standard framework which formally defines rational decision-making under risky conditions. EUT uses a theoretical device called von Neumann–Morgenstern utility function, where concepts of function and random variable are employed in their pre-set-theoretic senses. Any von Neumann–Morgenstern utility function thus derived is claimed to transform a non-degenerate random variable into its certainty equivalent. However, there can be no certainty equivalent for a non-degenerate random variable by the set-theoretic definition of a random variable, whilst the continuity axiom of EUT implies the existence of such a certainty equivalent. This paper also demonstrates that rational behaviour under utility theory is incompatible with scarcity of resources, making behaviour consistent with EUT irrational and justifying persistent external inconsistencies of EUT. A brief description of a new paradigm which can resolve the problems of the standard paradigm is presented. These include resolutions of such anomalies as endowment effect, asymmetric valuation of gains and losses, intransitivity of preferences as well as the St. Petersburg Paradox.

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

2018 ◽  
pp. 147-162 ◽  
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.

scholarly journals Normative and descriptive theories of decision making under risk

2014 ◽  
Vol 57 (4) ◽  
pp. 25-50 ◽  
Author(s):  
Kaja Damnjanovic ◽  
Ivana Jankovic
Keyword(s):  
Decision Making ◽  
Expected Utility ◽  
Utility Theory ◽  
Developmental Stages ◽  
Expected Utility Theory ◽  
Decision Making Process ◽  
Decision Making Under Risk ◽  
Von Neumann ◽  
Basic Concepts ◽  
Descriptive Theories

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.

What Is That Function?

2018 ◽  
pp. 163-176
Author(s):  
Ivan Moscati
Keyword(s):  
Utility Function ◽  
Expected Utility ◽  
Utility Theory ◽  
Expected Utility Theory ◽  
Cardinal Utility ◽  
John Von Neumann ◽  
Von Neumann ◽  
Milton Friedman

Chapter 10 reconstructs the first part of the American debate on expected utility theory (EUT), which ranges from 1947, when the second edition of John von Neumann and Oskar Morgenstern’s Theory of Games was published, to April 1950. In this period, a number of eminent American economists, including Milton Friedman, Leonard J. Savage, Jacob Marschak, Paul Samuelson, and William Baumol, wrote papers in which they took stances on the validity of EUT and the nature of the cardinal utility function u featured in the expected utility formula. Friedman, Savage, and Marschak supported EUT, although for different reasons, while Samuelson and Baumol rejected it. Regarding the nature of the cardinal utility function u, however, they all shared the view that it is interchangeable with the utility function U that the earlier utility theorists had used to analyze choices between riskless alternatives.

scholarly journals Comparing utility functions between risky and riskless choice in rhesus monkeys

2021 ◽  
Author(s):  
Philipe M. Bujold ◽  
Simone Ferrari-Toniolo ◽  
Leo Chi U Seak ◽  
Wolfram Schultz
Keyword(s):  
Utility Function ◽  
Utility Theory ◽  
Utility Maximization ◽  
Choice Behavior ◽  
Expected Utility Theory ◽  
Utility Functions ◽  
Random Utility Maximization ◽  
Risky Choices ◽  
Neuronal Mechanisms ◽  
Subjective Value

AbstractDecisions can be risky or riskless, depending on the outcomes of the choice. Expected Utility Theory describes risky choices as a utility maximization process: we choose the option with the highest subjective value (utility), which we compute considering both the option’s value and its associated risk. According to the random utility maximization framework, riskless choices could also be based on a utility measure. Neuronal mechanisms of utility-based choice may thus be common to both risky and riskless choices. This assumption would require the existence of a utility function that accounts for both risky and riskless decisions. Here, we investigated whether the choice behavior of macaque monkeys in riskless and risky decisions could be described by a common underlying utility function. We found that the utility functions elicited in the two choice scenarios were different from each other, even after taking into account the contribution of subjective probability weighting. Our results suggest that distinct utility representations exist for riskless and risky choices, which could reflect distinct neuronal representations of the utility quantities, or distinct brain mechanisms for risky and riskless choices. The different utility functions should be taken into account in neuronal investigations of utility-based choice.

An Implementation of Expected Utility Theory in Decision Based Design

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.

scholarly journals Expected Utility Theory for Monitoring-Based Decision-Making

2016 ◽  
Vol 104 (8) ◽  
pp. 1647-1661 ◽  
Author(s):  
Carlo Cappello ◽  
Daniele Zonta ◽  
Branko Glisic
Keyword(s):  
Decision Making ◽  
Expected Utility ◽  
Utility Theory ◽  
Expected Utility Theory

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

2016 ◽  
Vol 30 (2) ◽  
pp. 219-236 ◽  
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.

scholarly journals Probability weighting explains Independence Axiom violations of Expected Utility Theory in monkeys

2021 ◽  
Author(s):  
Simone Ferrari-Toniolo ◽  
Leo Chi U Seak ◽  
Wolfram Schultz
Keyword(s):  
Expected Utility ◽  
Utility Theory ◽  
Expected Utility Theory ◽  
Risky Choice ◽  
Independence Axiom ◽  
Probability Weighting ◽  
Preference Reversals ◽  
Risky Decision ◽  
Linear Discriminant ◽  
Better Than

Expected Utility Theory (EUT) provides axioms for maximizing utility in risky choice. The independence axiom (IA) is its most demanding axiom: preferences between two options should not change when altering both options equally by mixing them with a common gamble. We tested common consequence (CC) and common ratio (CR) violations of the IA in thousands of stochastic choice over several months using a large variety of binary option sets. Three monkeys showed few outright Preference Reversals (8%) but substantial graded Preference Changes (46%) between the initial preferred gamble and the corresponding altered gamble. Linear Discriminant Analysis (LDA) indicated that gamble probabilities predicted most Preference Changes in CC (72%) and CR (87%) tests. The Akaike Information Criterion indicated that probability weighting within Cumulative Prospect Theory (CPT) explained choices better than models using Expected Value (EV) or EUT. Fitting by utility and probability weighting functions of CPT resulted in nonlinear and non-parallel indifference curves (IC) in the Marschak-Machina triangle and suggested IA non-compliance of models using EV or EUT. Indeed, CPT models predicted Preference Changes better than EV and EUT models. Indifference points in out-of-sample tests were closer to CPT-estimated ICs than EV and EUT ICs. Finally, while the few outright Preference Reversals may reflect the long experience of our monkeys, their more graded Preference Changes corresponded to those reported for humans. In benefitting from the wide testing possibilities in monkeys, our stringent axiomatic tests contribute critical information about risky decision-making and serves as basis for investigating neuronal decision mechanisms.

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