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Expected Utility Theory with Probability Grids and Preference Formation

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  • Mamoru Kaneko

    (Waseda University)

Abstract

We reformulate expected utility theory, from the viewpoint of bounded rationality, by introducing probability grids and a cognitive bound; we restrict permissible probabilities only to decimal (`-ary in general) fractions of Önite depths up to a given cognitive bound. We distinguish between measurements of utilities from pure alternatives and their extensions to lotteries involving more risks. Our theory is constructive, from the viewpoint of the decision maker. When a cognitive bound is small, the preference relation involves many incomparabilities, but these diminish as the cognitive bound is is relaxed. Similarly, the EU hypothesis would hold more for a weaker cognitive bound. The main part of the paper is a study of preferences including incomparabilities in cases with Önite cogntive bounds; we give representation theorems in terms of a 2-dimensional vector-valued utility functions. We exemplify the theory with one experimental result reported by Kahneman-Tversky.

Suggested Citation

  • Mamoru Kaneko, 2019. "Expected Utility Theory with Probability Grids and Preference Formation," Working Papers 1902, Waseda University, Faculty of Political Science and Economics.
    • Handle: RePEc:wap:wpaper:1902
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    References listed on IDEAS

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    More about this item

    Keywords

    Expected Utility; Measurement of Utility; Bounded Rationality; Probability;
    All these keywords.

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • C79 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Other
    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior

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