Decisions Under Risk Dispersion and Skewness
42 Pages Posted: 13 Feb 2018 Last revised: 13 Sep 2019
Date Written: September 12, 2019
When people take decisions under risk, it is not only the expected utility that is important, but also the shape of the distribution of utility: clearly the dispersion is important, but also the skewness. For given mean and dispersion, decision-makers treat positively and negatively skewed prospects differently. This paper presents a new behaviourally-inspired model for decision making under risk, incorporating both dispersion and skewness. We run a horse-race of this new model against six other models of decision-making under risk and show that it outperforms many in terms of goodness of fit and shows a reasonable performance in predictive ability. It can incorporate the prominent anomalies of standard theory such as the Allais paradox, the valuation gap, and preference reversals, and also the behavioural patterns observed in experiments that cannot be explained by Rank Dependent Utility Theory.
Keywords: Decision under Risk, Anomalies, Valuation Gap, Preference Reversals, Allais Paradox, Skewness, Dispersion, Preference Functionals, Experiments, Pairwise Choice, Expected Utility, Non‐Expected Utility, Stochastic Specifications
JEL Classification: D81
Suggested Citation: Suggested Citation