What We Know About Decision Making Under Uncertainty And Why We Do Not Use What We Know

This paper reviews two major approaches used in the past for risk analysis-the expected utility approach and the use of safety rules-and endeavors to reconcile their applicability and use in light of the recent nonexpected utility risk literature. This leads to the identification of several "reduced form" hypotheses that hold under a variety of theoretical structures and to a discussion of some empirical evidence that we have in view of these hypothesis. We conclude that, in spite of the conceptual confusion, we have identified several "down to earth" relationships that allow prediction of outcome and choices under uncertain conditions. Economic studies of choices under uncertainty also established that the expected utility approach is an appropriate normative tool for risk management, especially in cases· where variability associated with risk affects income but may not lead to disastrous situations such as bankruptcy. The major lesson of recent research of individual behavior under uncertainty is that it is not always consistent with the expected utility approach; in short, there is not a generic model for evaluating behavior under uncertainty.