Stochastic expected utility theory

Pavlo Blavatskyy ()

Journal of Risk and Uncertainty, 2007, vol. 34, issue 3, pages 259-286

Abstract: This paper proposes a new decision theory of how individuals make random errors when they compute the expected utility of risky lotteries. When distorted by errors, the expected utility of a lottery never exceeds (falls below) the utility of the highest (lowest) outcome. This assumption implies that errors are likely to overvalue (undervalue) lotteries with expected utility close to the utility of the lowest (highest) outcome. Proposed theory explains many stylized empirical facts such as the fourfold pattern of risk attitudes, common consequence effect (Allais paradox), common ratio effect and violations of betweenness. Theory fits the data from ten well-known experimental studies at least as well as cumulative prospect theory. Copyright Springer Science+Business Media, LLC 2007

Keywords: Decision theory; Stochastic utility; Expected utility theory; Cumulative prospect theory; C91; D81 (search for similar items in EconPapers)

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