Optimism and Pessimism with Expected Utility

20 Pages Posted: 2 Jan 2013

See all articles by David Dillenberger

David Dillenberger

University of Pennsylvania - Department of Economics

Andrew Postlewaite

University of Pennsylvania - Department of Economics

Kareen Rozen

Brown University - Department of Economics

Date Written: December 26, 2012

Abstract

Savage (1954) provides axioms on preferences over acts that are equivalent to the existence of a subjective expected utility representation. We show that there is a continuum of other "expected utility" representations in which for any act, the probability distribution over states depends on the corresponding outcomes and is first-order stochastically dominated by (dominates) the Savage distribution. We suggest that pessimism (optimism) can be captured by the stake-dependent probabilities in these alternate representations. We then extend the DM's preferences to be defined over both subjective acts and objective lotteries. Our result permits modeling ambiguity aversion in Ellsberg's two-urn experiment using pessimistic probability assessments, the same utility over prizes for lotteries and acts, and without relaxing Savage's axioms. An implication of our results is that the large body of existing research based on expected utility can, with a simple reinterpretation, be understood as modeling the behavior of optimistic or pessimistic decision makers.

Keywords: subjective expected utility, optimism, pessimism, stake-dependent probability

JEL Classification: D80, D81

Suggested Citation

Dillenberger, David and Postlewaite, Andrew and Rozen, Kareen, Optimism and Pessimism with Expected Utility (December 26, 2012). PIER Working Paper No. 13-001. Available at SSRN: https://ssrn.com/abstract=2195566 or http://dx.doi.org/10.2139/ssrn.2195566

David Dillenberger

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-1503 (Phone)

Andrew Postlewaite (Contact Author)

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-7350 (Phone)
215-573-2057 (Fax)

HOME PAGE: http://www.econ.upenn.edu/~apostlew

Kareen Rozen

Brown University - Department of Economics ( email )

64 Waterman Street
Providence, RI 02912
United States

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