Decision Utility Theory: Back to von Neumann, Morgenstern, and Markowitz
26 Pages Posted: 4 Dec 2010
Date Written: December 1, 2010
Prospect Theory (1979) and its Cumulative version (1992) argue for probability weighting to explain lottery choices. Decision Utility Theory presents an alternative solution, which makes no use of this concept. The new theory distinguishes decision and perception utility, postulates a double S-shaped decision utility curve similar to one hypothesized by Markowitz (1952), and applies the expected decision utility value similarly to the theory by von Neumann and Morgenstern (1944). Decision Utility Theory proposes straightforward risk measures, presents a simple explanation of risk attitudes by using the aspiration level concept, and predicts that people might not consider probabilities and outcomes jointly, on the contrary to the expected utility paradigm.
Keywords: Expected Utility Theory, Markowitz Hypothesis, Prospect Theory, Decision Utility, Allais Paradox, Common Ratio Effect, Risk Attitude Measures, Aspiration Level
JEL Classification: C91, D03, D81
Suggested Citation: Suggested Citation