Cautious Expected Utility and the Certainty Effect

46 Pages Posted: 10 Jul 2013

See all articles by Simone Cerreia-Vioglio

Simone Cerreia-Vioglio

Bocconi University - Department of Decision Sciences

David Dillenberger

University of Pennsylvania - Department of Economics

Pietro Ortoleva

Princeton University - Department of Economics

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Date Written: July 9, 2013

Abstract

Many violations of the Independence axiom of Expected Utility can be traced to subjects' attraction to risk-free prospects. Negative Certainty Independence, the key axiom in this paper, formalizes this tendency. Our main result is a utility representation of all preferences over monetary lotteries that satisfy Negative Certainty Independence together with basic rationality postulates. Such preferences can be represented as if the agent were unsure of how risk averse to be when evaluating a lottery p; instead, she has in mind a set of possible utility functions over outcomes and displays a cautious behavior: she computes the certainty equivalent of p with respect to each possible function in the set and picks the smallest one. The set of utilities is unique in a well-defined sense. We show that our representation can also be derived from a `cautious' completion of an incomplete preference relation.

Keywords: Preferences under risk, Allais paradox, Negative Certainty Independence, Incomplete preferences, Cautious Completion, Multi-Utility representation

JEL Classification: D80, D81

Suggested Citation

Cerreia-Vioglio, Simone and Dillenberger, David and Ortoleva, Pietro, Cautious Expected Utility and the Certainty Effect (July 9, 2013). PIER Working Paper No. 13-037; Columbia Business School Research Paper No. 13-52. Available at SSRN: https://ssrn.com/abstract=2291484 or http://dx.doi.org/10.2139/ssrn.2291484

Simone Cerreia-Vioglio

Bocconi University - Department of Decision Sciences ( email )

Via Roentgen 1
Milan, 20136
Italy

David Dillenberger (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
215-898-1503 (Phone)

Pietro Ortoleva

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States

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