A Rank-Dependent Theory for Decision under Risk and Ambiguity
Roger Laeven and
Mitja Stadje
Papers from arXiv.org
Abstract:
This paper axiomatizes, in a two-stage setup, a new theory for decision under risk and ambiguity. The axiomatized preference relation $\succeq$ on the space $\tilde{V}$ of random variables induces an ambiguity index $c$ on the space $\Delta$ of probabilities, a probability weighting function $\psi$, generating the measure $\nu_{\psi}$ by transforming an objective probability measure, and a utility function $\phi$, such that, for all $\tilde{v},\tilde{u}\in\tilde{V}$, \begin{align*} \tilde{v}\succeq\tilde{u} \Leftrightarrow \min_{Q \in \Delta} \left\{\mathbb{E}_Q\left[\int\phi\left(\tilde{v}^{\centerdot}\right)\,\mathrm{d}\nu_{\psi}\right]+c(Q)\right\} \geq \min_{Q \in \Delta} \left\{\mathbb{E}_Q\left[\int\phi\left(\tilde{u}^{\centerdot}\right)\,\mathrm{d}\nu_{\psi}\right]+c(Q)\right\}. \end{align*} Our theory extends the rank-dependent utility model of Quiggin (1982) for decision under risk to risk and ambiguity, reduces to the variational preferences model when $\psi$ is the identity, and is dual to variational preferences when $\phi$ is affine in the same way as the theory of Yaari (1987) is dual to expected utility. As a special case, we obtain a preference axiomatization of a decision theory that is a rank-dependent generalization of the popular maxmin expected utility theory. We characterize ambiguity aversion in our theory.
Date: 2023-12, Revised 2024-07
New Economics Papers: this item is included in nep-dcm, nep-mic, nep-rmg and nep-upt
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