Download this Paper Open PDF in Browser

Risky Curves: From Unobservable Utility to Observable Opportunity Sets

30 Pages Posted: 10 Jun 2011 Last revised: 23 May 2017

Daniel Friedman

University of California, Santa Cruz - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Shyam Sunder

Yale University - School of Management; Yale University - Cowles Foundation

Date Written: June 6, 2011

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

JEL Classification: C91, C93, D11, D81, G11, G12, G22, L83

Suggested Citation

Friedman, Daniel and Sunder, Shyam, Risky Curves: From Unobservable Utility to Observable Opportunity Sets (June 6, 2011). Cowles Foundation Discussion Paper No. 1819. Available at SSRN: https://ssrn.com/abstract=1858769 or http://dx.doi.org/10.2139/ssrn.1858769

Daniel Friedman

University of California, Santa Cruz - Department of Economics ( email )

Social Sciences I
Santa Cruz, CA 95064
United States
831-459-4981 (Phone)
831-459-5900 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Shyam Sunder (Contact Author)

Yale University - School of Management ( email )

165 Whitney Avenue
P.O. Box 208200
New Haven, CT 06520-8200
United States
203-432-6160 (Phone)

HOME PAGE: http://www.som.yale.edu/faculty/sunder/

Yale University - Cowles Foundation

Box 208281
New Haven, CT 06520-8281
United States

Paper statistics

Downloads
260
Rank
97,848
Abstract Views
1,190