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The time interpretation of expected utility theory

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  • Ole Peters
  • Alexander Adamou

Abstract

Ergodicity economics is a new branch of economic theory that notes the conceptual difference between time averages and expectation values, which coincide only for ergodic observables. It postulates that individual agents maximise the time average growth rate of wealth, known widely as growth optimality. This contrasts with the dominant behavioural model in economics, expected utility theory, in which agents maximise expectation values of changes in psychologically transformed wealth. Historically, growth optimality was explored for additive and multiplicative gambles. Here we apply it to a general class of wealth dynamics, extending the range of economic situations where it may be used. Moreover, we show a correspondence between growth optimality and expected utility theory, in which the ergodicity transformation in the former is identified as the utility function in the latter. This correspondence offers a theoretical basis for choosing utility functions and predicts that wealth dynamics are strong determinants of risk preferences.

Suggested Citation

  • Ole Peters & Alexander Adamou, 2018. "The time interpretation of expected utility theory," Papers 1801.03680, arXiv.org, revised Feb 2021.
    • Handle: RePEc:arx:papers:1801.03680
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    Cited by:

    1. Jos'e Cl'audio do Nascimento, 2019. "Behavioral Biases and Nonadditive Dynamics in Risk Taking: An Experimental Investigation," Papers 1908.01709, arXiv.org, revised Apr 2023.
    2. Yonatan Berman & Mark Kirstein, 2021. "Risk Preferences in Time Lotteries," Papers 2108.08366, arXiv.org.
    3. , Stone Center & Adamou, Alexander & Berman, Yonatan & Peters, Ole, 2020. "The Two Growth Rates of the Economy," SocArXiv vw2ed, Center for Open Science.
    4. Alexander T. I. Adamou & Yonatan Berman & Diomides P. Mavroyiannis & Ole B. Peters, 2019. "Microfoundations of Discounting," Papers 1910.02137, arXiv.org, revised Jan 2020.
    5. Carlos Rodríguez Raposo & Pablo Coello Pulido, 2021. "Ergodicity transformation for additive-ruin wealth dynamic," Working Papers hal-03198073, HAL.
    6. David Meder & Finn Rabe & Tobias Morville & Kristoffer H Madsen & Magnus T Koudahl & Ray J Dolan & Hartwig R Siebner & Oliver J Hulme, 2021. "Ergodicity-breaking reveals time optimal decision making in humans," PLOS Computational Biology, Public Library of Science, vol. 17(9), pages 1-25, September.
    7. Sonntag, Dominik, 2018. "Die Theorie der fairen geometrischen Rendite [The Theory of Fair Geometric Returns]," MPRA Paper 87082, University Library of Munich, Germany.
    8. Andreozzi, Luciano, 2021. "Ergodicity in Economics: a Decision theoretic evaluation," SocArXiv axkfg, Center for Open Science.

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