43 Pages Posted: 10 Aug 2013
Date Written: August 9, 2013
This paper introduces the concept of range-dependent utility. Instead of reference dependence which evaluates outcomes relative to some reference point, we postulate dependence on a given lottery (set of lotteries) outcomes range. In this way the decision maker is a fully rational expected utility maximizer only within a certain range. Range-dependent utility enables experimental results to be explained without recourse to the probability weighting function. Experimental data show that range-dependent utilities can be normalized to obtain decision utility -- a single utility function able to describe decisions involving lotteries denied over different ranges. Both the data analysis as well as theoretical considerations concerning monotonicity indicate that the decision utility should be of S-shape.
Keywords: range-dependent utility, decision utility, Certainty Equivalent, quasilinear mean, Expected Utility Theory, Prospect Theory, Allais paradox, insurance and gambling
JEL Classification: D81, D03, C91
Suggested Citation: Suggested Citation