Stochastic expected utility theory |
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| Authors: | Pavlo R Blavatskyy |
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| Institution: | (1) Institute for Empirical Research in Economics, University of Zurich, Winterthurerstrasse 30, 8006 Zurich, Switzerland |
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| 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.
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| Keywords: | Decision theory Stochastic utility Expected utility theory Cumulative prospect theory |
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