Risk Perception,Risk Attitude,and Decision: A Rank-Dependent Analysis

The classical expected utility model of decision under risk has been criticized from an experimental point of view (Allais’ paradox) as well as for its restrictive lack of explanatory power. The Rank-Dependent Expected Utility model answers some of these criticisms. The decision maker is characterized by two functions: a utility function on consequences measuring preferences over sure outcomes and a probability weighting function measuring the subjective weighting of probabilities. The model allows for more diversified types of behavior: it is consistent with the behavior revealed by the Allais paradox; the decision maker could dislike risk (prefer its expectation to any lottery) without necessarily avoiding any increase in risk; diminishing marginal utility may coexist with “weak” risk-seeking attitudes; decision makers with the same utility function may differ in their choices between lotteries when they have different probability weighting functions; furthermore, the same decision maker may have different, context-dependent, subjective beliefs on events.