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Range-Dependent Utility

Author

Listed:
  • Krzysztof Kontek

    (SGH Warsaw School of Economics, 02-554 Warszawa, Poland)

  • Michal Lewandowski

    (SGH Warsaw School of Economics, 02-554 Warszawa, Poland)

Abstract

First, this paper introduces and axiomatizes range-dependent utility as a new conceptual framework for decision making under risk. It is a simple and well-defined generalization of expected utility theory in which utility depends on the range of lottery outcomes. Second, a special case of this framework is proposed for prediction. It is based on applying a single utility function (decision utility) to every normalized lottery range. The resultant decision utility model predicts well-known expected utility paradoxes without recourse to probability weighting. Necessary and sufficient conditions for the model to satisfy monotonicity with respect to first-order stochastic dominance are identified. The typical decision utility function, which is confirmed by both experimental data and normative considerations, is S shaped.

Suggested Citation

  • Krzysztof Kontek & Michal Lewandowski, 2018. "Range-Dependent Utility," Management Science, INFORMS, vol. 64(6), pages 2812-2832, June.
    • Handle: RePEc:inm:ormnsc:v:64:y:2018:i:6:p:2812-2832
    DOI: 10.287/mnsc.2017.2744
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    Citations

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    Cited by:

    1. William N. Caballero & Roi Naveiro & David Ríos Insua, 2022. "Modeling Ethical and Operational Preferences in Automated Driving Systems," Decision Analysis, INFORMS, vol. 19(1), pages 21-43, March.
    2. Michał Jakubczyk, 2023. "What if 0 is not equal to 0? Inter-personal health utilities anchoring using the largest health gains," The European Journal of Health Economics, Springer;Deutsche Gesellschaft für Gesundheitsökonomie (DGGÖ), vol. 24(7), pages 1217-1233, September.
    3. Krzysztof Kontek, 2018. "Boundary effects in the Marschak-Machina triangle," Judgment and Decision Making, Society for Judgment and Decision Making, vol. 13(6), pages 587-606, November.
    4. Michał Lewandowski & Łukasz Woźny, 2020. "On complementary symmetry and reference dependence," KAE Working Papers 2020-059, Warsaw School of Economics, Collegium of Economic Analysis.
    5. Michał Lewandowski, 2017. "Prospect Theory Versus Expected Utility Theory: Assumptions, Predictions, Intuition and Modelling of Risk Attitudes," Central European Journal of Economic Modelling and Econometrics, Central European Journal of Economic Modelling and Econometrics, vol. 9(4), pages 275-321, December.
    6. Emilia Tomczyk, 2013. "End of sample vs. real time data: perspectives for analysis of expectations," Working Papers 68, Department of Applied Econometrics, Warsaw School of Economics.
    7. Doron Sonsino & Yaron Lahav & Yefim Roth, 2022. "Reaching for Returns in Retail Structured Investment," Management Science, INFORMS, vol. 68(1), pages 466-486, January.
    8. repec:cup:judgdm:v:13:y:2018:i:6:p:587-606 is not listed on IDEAS
    9. Raman Kachurka & Michał Krawczyk & Joanna Rachubik, 2021. "State lottery in the lab: an experiment in external validity," Experimental Economics, Springer;Economic Science Association, vol. 24(4), pages 1242-1266, December.
    10. Comeig, Irene & Holt, Charles & Jaramillo-Gutiérrez, Ainhoa, 2022. "Upside versus downside risk: Gender, stakes, and skewness," Journal of Economic Behavior & Organization, Elsevier, vol. 200(C), pages 21-30.
    11. Guo, Julie & Tymula, Agnieszka, 2021. "Waterfall illusion in risky choice – exposure to outcome-irrelevant gambles affects subsequent valuation of risky gambles," European Economic Review, Elsevier, vol. 139(C).
    12. Chernulich, Aleksei, 2021. "Modelling reference dependence for repeated choices: A horse race between models of normalisation," Journal of Economic Psychology, Elsevier, vol. 87(C).
    13. Glimcher, Paul W. & Tymula, Agnieszka A., 2023. "Expected subjective value theory (ESVT): A representation of decision under risk and certainty," Journal of Economic Behavior & Organization, Elsevier, vol. 207(C), pages 110-128.
    14. Kontek, Krzysztof, 2015. "Fanning-Out or Fanning-In? Continuous or Discontinuous? Estimating Indifference Curves Inside the Marschak-Machina Triangle using Certainty Equivalents," MPRA Paper 63965, University Library of Munich, Germany.
    15. Kontek, Krzysztof & Birnbaum, Michael H., 2019. "The impact of middle outcomes on lottery valuations," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 78(C), pages 30-44.

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    More about this item

    Keywords

    range-frequency model; expected utility; certainty equivalent; Allais paradox; probability weighting; stochastic; dominance violations;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior

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