Optimism and Pessimism with Expected Utility
20 Pages Posted: 26 Oct 2011 Last revised: 1 Nov 2011
Date Written: October 25, 2011
Savage (1954) provided a set of axioms on preferences over acts that were equivalent to the existence of an expected utility representation. We show that in addition to this representation, there is a continuum of other "expected utility" representations in which for any act, the probability distribution over states depends on the corresponding outcomes. We suggest that optimism and pessimism can be captured by the stake-dependent probabilities in these alternative representations; e.g., for a pessimist, the probability of every outcome except the worst is distorted down from the Savage probability. Extending the DM's preferences to be defined on both subjective acts and objective lotteries, we show how one may distinguish optimists from pessimists and separate attitude towards uncertainty from curvature of the utility function over monetary prizes.
Keywords: Subjective expected utility, optimism, pessimism, stake-dependent probability
JEL Classification: D80, D81
Suggested Citation: Suggested Citation