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Accounting for Optimism and Pessimism in Expected Utility

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  • Craig Webb
  • Horst Zank

Abstract

We provide a preference foundation for decision under risk resulting in a model where probability weighting is linear as long as the corresponding probabilities are not extreme (i.e., 0 or 1). This way, most of the elegance and mathematical tractability of expected utility is maintained and also much of its normative foundation. Yet, the new model can accommodate the extreme sensitivity towards changes from 0 to almost impossible and from almost certain to 1 that has widely been documented in the experimental literature. The model can be viewed as “expected utility with the best and worst in mind” as suggested by Chateauneuf, Eichberger and Grant (Chateauneuf, Alain, Eichberger, Jürgen, Grant, Simon, 2007. Choice under uncertainty with the best and worst in mind: NEO-Additive capacities. Journal of Economic Theory 137, 538–567) or, following our preference foundation, interpreted as “expected utility with consistent optimism and pessimism”.
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  • Craig Webb & Horst Zank, 2011. "Accounting for Optimism and Pessimism in Expected Utility," Economics Discussion Paper Series 1111, Economics, The University of Manchester.
    • Handle: RePEc:man:sespap:1111
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    File URL: http://hummedia.manchester.ac.uk/schools/soss/economics/discussionpapers/EDP-1111.pdf
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    References listed on IDEAS

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    Cited by:

    1. Jinrui Pan & Craig S. Webb & Horst Zank, 2019. "Delayed probabilistic risk attitude: a parametric approach," Theory and Decision, Springer, vol. 87(2), pages 201-232, September.
    2. Katarzyna Werner & Horst Zank, 2012. "Foundations for Prospect Theory Through Probability Midpoint Consistency," Economics Discussion Paper Series 1210, Economics, The University of Manchester.
    3. Rémi Stellian & Gabriel I. Penagos & Jenny P. Danna-Buitrago, 2021. "Firms in financial distress: evidence from inter-firm payment networks with volatility driven by ‘animal spirits’," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 16(1), pages 59-101, January.
    4. Katarzyna M. Werner & Horst Zank, 2019. "A revealed reference point for prospect theory," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 67(4), pages 731-773, June.
    5. Craig Webb, 2015. "Piecewise additivity for non-expected utility," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 60(2), pages 371-392, October.
    6. Meng, Jingyi & Webb, Craig S. & Zank, Horst, 2024. "Mixture independence foundations for expected utility," Journal of Mathematical Economics, Elsevier, vol. 111(C).
    7. Ulrich Schmidt & Horst Zank, 2013. "Chance Theory: A Separation of Riskless and Risky Utility," Economics Discussion Paper Series 1324, Economics, The University of Manchester.
    8. Mohammed Abdellaoui & Horst Zank, 2023. "Source and rank-dependent utility," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 75(4), pages 949-981, May.
    9. Baillon, Aurélien & Placido, Lætitia, 2019. "Testing constant absolute and relative ambiguity aversion," Journal of Economic Theory, Elsevier, vol. 181(C), pages 309-332.
    10. Mark Schneider, 2019. "A Bias Aggregation Theorem," Working Papers 19-03, Chapman University, Economic Science Institute.
    11. Ulrich Schmidt & Horst Zank, 2022. "Chance theory: A separation of riskless and risky utility," Journal of Risk and Uncertainty, Springer, vol. 65(1), pages 1-32, August.
    12. Mohammed Abdellaoui & Olivier l’Haridon & Horst Zank, 2009. "Separating Curvature and Elevation: A Parametric Weighting Function," Economics Discussion Paper Series 0901, Economics, The University of Manchester.
    13. Craig S. Webb, 2017. "Piecewise linear rank-dependent utility," Theory and Decision, Springer, vol. 82(3), pages 403-414, March.
    14. Mohammed Abdellaoui & Horst Zank, 2022. "Source and Rank-dependent Utility," Post-Print hal-03924295, HAL.

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