13 votes

Experiments contradicting the expected utility model

this paper http://else.econ.ucl.ac.uk/papers/uploaded/243.pdf (Choi 2007) has a nice state of the art experiment that deals with rationality and expected utility is a special case of it. In general ...
  • 1,423
12 votes

Would insurance plan be necessary if we had instant access to credit?

As Dave Harris' points out in his comment, I assume that your question deals with events that do not compromise the individual's ability to work, which would prevent her from taking on debt. Let's ...
  • 3,212
11 votes

Would insurance plan be necessary if we had instant access to credit?

I think the best way to answer your question is with a simple example showing why insurance is so prevalent in the economy. Hopefully, it should then be clear that it can still make sense to purchase ...
  • 291
10 votes

Experiments contradicting the expected utility model

Adding to the list of paradoxes, consider Machina's paradox. It is described in Mas-Colell, Whinston and Green's Microeconomic Theory. A person prefers a trip to Paris to watching a television ...
  • 2,187
8 votes
Accepted

Independence axiom of lottery when $\alpha \ge 1$

To understand why $\alpha$ must be constrained in $(0,1)$, one has to contemplate the meaning of the expression $$\alpha L$$ when $L$ is a "lottery". How is a lottery denoted mathematically? Authors ...
7 votes
Accepted

Can the Certainty Equivalent be negative?

If you start out with €0, then the certainty equivalent of losing €2.5 with probability 1 is -€2.5. Your exercise basically asks you to calculate what difference winning the lottery with a small ...
  • 27.6k
6 votes

How could the Euro zone be broken up in an ordered way?

No Time To Argue Most importantly, there cannot be an "18 months period of notice". Tt has to be decided suddenly and there cannot be any period in which individuals could respond to the new plan by ...
  • 10.6k
6 votes

Can the Machina Paradox be solved by expanding the choice set?

No, I would not say that this resolves the Machina paradox, because it is exactly the same as the Machina paradox: the paradox does indeed require from you to look at the three possible outcomes. The ...
6 votes

Most utility functions under risk and uncertainty generalizes expected utility. What is deadly wrong if a model does not include EU as special case?

Many people accept the axiomatizations of expected utility as normatively appealing, especially in contexts of pure risk. For people with this view, rational decision-makers should behave in ...
5 votes

Can the Machina Paradox be solved by expanding the choice set?

I think you are correct that this solves the Machina Paradox but I am not sure I would associate your reformulation of the model with the idea of state-dependent utility. State-dependent utility is ...
5 votes

Experiments contradicting the expected utility model

Picking up my comment under this answer. One striking issue relevant to decisions not captured by expected utility is the framing effect discussed by Tversky and Kahneman (1981) and others. In their ...
  • 5,110
5 votes

Experiments contradicting the expected utility model

Following @Pburg answer and the subsequent discussion in the comments, I wanted to post an alternative Machina Paradox I thought of. Although it might be less pervasive in real life, it seems stronger ...
5 votes

Will high computing power substitute the certainty-equivalence assumption?

This is perhaps a good opportunity to point out that the "certainty equivalence" concept means one thing in microeconomics/choice under uncertainty theory, while it means something different in ...
4 votes
Accepted

Decision Theory Question: Existence and uniqueness of the certainty equivalent of p

Your notation is a bit misleading: it would be better to write $\mathbb{E}u(p)$ or $U(p)$ for the expected-utility associated with $p$ instead of $u(p)$, and $u(\mathbb{E}p)$ for the utility of the ...
  • 3,212
4 votes

Would insurance plan be necessary if we had instant access to credit?

Not covered by the other answers: You have an accident in your car and it ploughs into a bus-stop severely injuring and permanently incapacitating several people. Not having insurance, you are ...
4 votes

How could the Euro zone be broken up in an ordered way?

People have argued that if the rich countries (sometimes just Germany) left the Euro the resulting dislocations would be much smaller: German departure would be less disruptive than Grexit for ...
  • 16.1k
4 votes

Economics of forgetting

This topic has been studied widely in the theory of repeated games. See for example: Robert J. Aumann, Sylvain Sorin: Cooperation and bounded recall, Games and Economic Behavior, Vol. 1, No. 1. (...
4 votes

Economics of forgetting

Maybe not what you are looking for, but a related concept is regret. Orphanides and Zervos (1995) is a classic paper on rational regret in a health economics concept http://www.jstor.org/discover/10....
  • 339
4 votes

Experiments contradicting the expected utility model

Let me mention another quite well-known one: The calibration theorem by Rabin (2000) and Rabin and Thaler (2002). The idea is that over small stakes individuals must be essentially risk-averse, but in ...
  • 5,110
4 votes

Experiments contradicting the expected utility model

Kahneman and Tversky's experiments and many in behavioural economics contradict the existence of a utility function (preferences not complete and transitive), therefore also contradict expected ...
4 votes

Would insurance plan be necessary if we had instant access to credit?

Insurance: pooled risk. Loan: borrowing against future income. With insurance, you may face higher premiums if you make a claim. But you won't pay anything against the claim itself. With a ...
  • 1,162
4 votes

References for particular definitions of risk and uncertainty

Knight's 1921 essay was not written in formal mathematics (and trying to formulate a direct translation into modern mathematics may be quite problematic). Since Knight's time, a formal decision theory ...
4 votes
Accepted

A growth model with regime switch

Continuing on the comments exchange, the conclusion that the overall effect is to change the discount factor, is similar to the one reached in the original Overlapping Generations Model of Blanchard, ...
4 votes
Accepted

Why Certainity Eqivalence in PIH only holds for quadratic utilities

Certainty equivalence in the context of the Permanent Income Hypothesis implies that $u'(E_t[c_{t+1}]) = E_t[u'(c_{t+1})]$, which only holds if marginal utility $u'(\cdot)$ is linear (by linearity of ...
  • 1,199
4 votes

Can we compare risks of lotteries?

You might be looking for the concept of stochastic dominance: Roughly speaking, first order stochastic dominance of distribution A over distribution B, means that for every possible outcome gamble A ...
  • 16.1k
4 votes

Comparing & contrasting decision problems and normal games

Decision under uncertainty is sometimes called a "game against chance", and can thus be modeled as a two-player normal form game: the decision-maker vs Nature/Chance. The possible states ...
  • 15k
3 votes

How is momentum justified as a common risk factor?

Just to add to the discussion of momentum, there is a new paper by Novy Marx on this topic: http://rnm.simon.rochester.edu/research/FMFM.pdf. In the paper, he argues that the price momentum that we ...
  • 151
3 votes
Accepted

How is momentum justified as a common risk factor?

The Jegadeesh and Titman (1993) paper is usually considered Original Source, though I'm sure you could find something earlier that looks similar if you looked hard enough. I don't think there is a ...
  • 2,046
3 votes
Accepted

What is the advantage and disadvantage of fiscal illusion policy in terms for the financial market?

Too long, didn't read: the market does not care. Colombia's Pension Reform: Fiscal and Macroeconomic Effects, by Klaus Schmidt-Hebbel, states black on white (p 22) that issuing explicit domestic ...
  • 1,266
3 votes
Accepted

What sort of impact would one expect on investment as a result of an approaching election?

There are many ideas to look into and some research: IDEAS Elections are presumably a time where the future becomes uncertain in the sense that there is a likelihood the new leader will change the ...
  • 2,608

Only top scored, non community-wiki answers of a minimum length are eligible