Nonlinear Utility Models Arising from Unmodelled Small World Intercorrelations

Robert F. Bordley and Gordon Hazen
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Robert F. Bordley: DRMS Program, National Science Foundation, 1800 G Street, NW, Washington, D.C., 20550
Gordon Hazen: Operating Sciences Department, General Motors Research Labs, Warren, Michigan 48090 and Department of Industrial Engineering and Management Sciences, Northwestern University, Evanston, Illinois 60208

Management Science, 1992, vol. 38, issue 7, 1010-1017

Abstract: Savage's axioms show the rationality of maximizing expected utility when all uncertainties are explicitly modelled. But individuals actually make decisions in bounded contexts called small worlds. Savage's axioms do not imply the optimality of maximizing expected utility in small worlds unless lotteries in different small worlds are probabilistically independent. Relaxing this independence assumption causes Savage's axioms to imply the optimality of maximizing a nonlinear utility model which includes, as special cases, the Chew weighted linear utility model, the Bell elation/disappointment model and the Allais mean/variance model in utility-independent small worlds.

Keywords: decision theory; small worlds; probability/utility interactions; nonlinear utility theory (search for similar items in EconPapers)
Date: 1992
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