Cautious Expected Utility and the Certainty Effect
48 Pages Posted: 18 Feb 2014
Date Written: February 17, 2014
Many violations of the Independence axiom of Expected Utility can be traced to subjects' attraction to risk-free prospects. The key axiom in this paper, Negative Certainty Independence (Dillenberger, 2010), 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 to evaluate a given 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: Suggested Citation