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Alternative utility functions: review, analysis and comparison

Author

Listed:
  • Arie Harel

    (City University of New York (CUNY))

  • Jack Clark Francis

    (City University of New York (CUNY))

  • Giora Harpaz

    (City University of New York (CUNY))

Abstract

The paper reviews the development of von Neumann and Morgenstern (vNM) utility theory. Kahneman and Tversky’s (KT’s) prospect theory is introduced. The vNM utility function is compared and contrasted with KT’s value function. We prove the uniqueness of two popular utility functions. First, we show that all power utility functions possess constant RRA. And, we show that all exponential utility functions have constant ARA. The paper concludes by discussing applications, strengths and weaknesses of various utility functions.

Suggested Citation

  • Arie Harel & Jack Clark Francis & Giora Harpaz, 2018. "Alternative utility functions: review, analysis and comparison," Review of Quantitative Finance and Accounting, Springer, vol. 51(3), pages 785-811, October.
    • Handle: RePEc:kap:rqfnac:v:51:y:2018:i:3:d:10.1007_s11156-017-0688-z
    DOI: 10.1007/s11156-017-0688-z
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    More about this item

    Keywords

    von Neumann–Morgenstern (vNM) utility theory; Expected utility theory; Kahneman and Tversky (KT); Prospect theory; Framing; Loss aversion; Risk aversion; Risk taking; Absolute risk aversion (ARA); Relative risk aversion (RRA); Subjective probabilities; Decision weights; Objective probabilities; Probability weighting;
    All these keywords.

    JEL classification:

    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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