Empirical testing of the expected utility model |
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Authors: | Huib van de Stadt Gerrit Antonides Bernard MS van Praag |
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Institution: | Central Bureau of Statistics, Netherlands;Erasmus University, Netherlands;Leyden University, Netherlands |
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Abstract: | Suppose an individual is faced with a set of alternatives with uncertain money outcomes, then according to the expected utilily moded the alternative with the highest cxpected utility will be chosen. In the present paper this model is tested against the more general model given by Kahneman and Iversky (1979) and others. As contrasted with usual practice, the test is based on an exogenously measured utility function. The result of the test is that the expected utility model has to be rejected, both for a concavee and for an S-shaped specification of the utility function. The subjective evaluation of an objectve probability of 0.5 is in this study estimated at a value of 0.45 or 0.47. depending on the functional specification used.Our main conclusion is that although the hypotlicsis of expected utility has to be rejected, for practical purposes the difference between 0.5 and 0.45 (0.47) is so slight, that the hypothesis is a good working approximation. We do not know whether this remains true for valus of the objective probability considerably different from 0.5. |
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