Optimism and Pessimism with Expected Utility, Fifth Version
19 Pages Posted: 25 Feb 2015
Date Written: February 23, 2015
Maximizing subjective expected utility is the classic model of decision making under uncertainty. Savage (1954) provides axioms on preference over acts that are equivalent to the existence of a subjective expected utility representation, and further establishes that such a representation is essentially unique. We show that there is a continuum of other \expected utility" representations in which the probability distributions over states used to evaluate acts depend on the set of possible outcomes of the act and suggest that these alternate representations can capture pessimism or optimism. We then extend the DM's preferences to be defined over both subjective acts and objective lotteries, allowing for source-dependent preferences. Our result permits modeling ambiguity aversion in Ellsberg's two-urn experiment using a single utility function and pessimistic probability assessments over prizes for lotteries and acts, while maintaining the axioms of Savage and von Neumann-Morganstern on the appropriate domains.
Keywords: Subjective expected utility, optimism, pessimism, stake-dependent probability
JEL Classification: D80, D81
Suggested Citation: Suggested Citation