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Expected Utility Calibration for Continuous Distributions

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  • Just, David R.
  • Peterson, Hikaru Hanawa

Abstract

Recently, Rabin criticized the use of diminishing marginal utility in explaining risk aversion in small gambles with a mathematical theorem, which compares revealed risk averting behavior in small gambles to the risk behavior implied by expected utility theory in somewhat larger gambles, using discrete payoff distributions. To examine whether his criticism holds in more realistic risky situations, we generalize his theorem to the cases of continuous distributions and of continuous choice. The results suggest that the absolute size of the risk may not be as important as the relative size of the possible risk reduction, and that expected utility is likely a poor explanation for any short term risk response. We discuss some rules of thumb for judging the appropriateness of expected utility in practice.

Suggested Citation

  • Just, David R. & Peterson, Hikaru Hanawa, 2003. "Expected Utility Calibration for Continuous Distributions," Working Papers 127170, Cornell University, Department of Applied Economics and Management.
    • Handle: RePEc:ags:cudawp:127170
    DOI: 10.22004/ag.econ.127170
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    References listed on IDEAS

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    1. Mas-Colell, Andreu & Whinston, Michael D. & Green, Jerry R., 1995. "Microeconomic Theory," OUP Catalogue, Oxford University Press, number 9780195102680.
    2. William Neilson, 2001. "Calibration results for rank-dependent expected utility," Economics Bulletin, AccessEcon, vol. 4(10), pages 1-5.
    3. Chris Starmer, 2000. "Developments in Non-expected Utility Theory: The Hunt for a Descriptive Theory of Choice under Risk," Journal of Economic Literature, American Economic Association, vol. 38(2), pages 332-382, June.
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    Cited by:

    1. Just, David R. & Zilberman, David, 2005. "Behavior, Production and Competition," Working Papers 127075, Cornell University, Department of Applied Economics and Management.

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    Keywords

    Risk and Uncertainty;

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