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Expected utility theory with imprecise probability perception: explaining preference reversals

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  • Oben K. Bayrak
  • John D. Hey

Abstract

This article presents a new model for decision-making under risk, which provides an explanation for empirically-observed preference reversals. Central to the theory is the incorporation of probability perception imprecision, which arises because of individuals’ vague understanding of numerical probabilities. We combine this concept with the use of the Alpha EU model and construct a simple model which helps us to understand anomalies, such as preference reversals and valuation gaps, discovered in the experimental economics literature, that standard models cannot explain.

Suggested Citation

  • Oben K. Bayrak & John D. Hey, 2017. "Expected utility theory with imprecise probability perception: explaining preference reversals," Applied Economics Letters, Taylor & Francis Journals, vol. 24(13), pages 906-910, July.
    • Handle: RePEc:taf:apeclt:v:24:y:2017:i:13:p:906-910
    DOI: 10.1080/13504851.2016.1240332
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    References listed on IDEAS

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    1. Ulrich Schmidt & Chris Starmer & Robert Sugden, 2008. "Third-generation prospect theory," Journal of Risk and Uncertainty, Springer, vol. 36(3), pages 203-223, June.
    2. Loomes, Graham & Sugden, Robert, 1982. "Regret Theory: An Alternative Theory of Rational Choice under Uncertainty," Economic Journal, Royal Economic Society, vol. 92(368), pages 805-824, December.
    3. Budescu, David V. & Wallsten, Thomas S., 1990. "Dyadic decisions with numerical and verbal probabilities," Organizational Behavior and Human Decision Processes, Elsevier, vol. 46(2), pages 240-263, August.
    4. Charles R. Plott & Kathryn Zeiler, 2005. "The Willingness to Pay–Willingness to Accept Gap, the "Endowment Effect," Subject Misconceptions, and Experimental Procedures for Eliciting Valuations," American Economic Review, American Economic Association, vol. 95(3), pages 530-545, June.
    5. Andrea Isoni & Graham Loomes & Robert Sugden, 2011. "The Willingness to Pay—Willingness to Accept Gap, the "Endowment Effect," Subject Misconceptions, and Experimental Procedures for Eliciting Valuations: Comment," American Economic Review, American Economic Association, vol. 101(2), pages 991-1011, April.
    6. Sugden, Robert, 2003. "Reference-dependent subjective expected utility," Journal of Economic Theory, Elsevier, vol. 111(2), pages 172-191, August.
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    Cited by:

    1. Michael H. Birnbaum & Lucy Wan, 2020. "MARTER: Markov True and Error model of drifting parameters," Judgment and Decision Making, Society for Judgment and Decision Making, vol. 15(1), pages 47-73, January.
    2. Sean Horan & Paola Manzini & Marco Mariotti, 2018. "Precision May Harm: The Comparative Statics of Imprecise Judgement," Working Paper Series 1518, Department of Economics, University of Sussex Business School.
    3. Charles-Cadogan, G., 2021. "Incoherent Preferences," CRETA Online Discussion Paper Series 69, Centre for Research in Economic Theory and its Applications CRETA.
    4. repec:cup:judgdm:v:15:y:2020:i:1:p:47-73 is not listed on IDEAS
    5. Horan, Sean & Manzini, Paola & Mariotti, Marco, 2022. "When is coarseness not a curse? Comparative statics of the coarse random utility model," Journal of Economic Theory, Elsevier, vol. 202(C).

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