Risky Curves: From Unobservable Utility to Observable Opportunity Sets

Daniel Friedman and Shyam Sunder

No 1819, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

Abstract: Most theories of risky choice postulate that a decision maker maximizes the expectation of a Bernoulli (or utility or similar) function. We tour 60 years of empirical search and conclude that no such functions have yet been found that are useful for out-of-sample prediction. Nor do we find practical applications of Bernoulli functions in major risk-based industries such as finance, insurance and gambling. We sketch an alternative approach to modeling risky choice that focuses on potentially observable opportunities rather than on unobservable Bernoulli functions.

Keywords: Expected utility; Risk aversion; St. Petersburg Paradox; Decisions under uncertainty; Option theory (search for similar items in EconPapers)
JEL-codes: C91 C93 D11 D81 G11 G12 G22 L83 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2011-08
New Economics Papers: this item is included in nep-for and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Working Paper: Risky Curves: From Unobservable Utility to Observable Opportunity Sets (2011)
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