Using Descriptive Findings of Prospect Theory to Improve Prescriptive Applications of Expected Utility

Content Provider	Semantic Scholar
Author	Wakker, Peter P.
Copyright Year	1999
Abstract	This paper proposes a quantitative modification of standard utility measurement procedures, such as the probability and certainty equivalence methods, to correct for commonly observed violations of expected utility. Traditionally, decision analysis assumes expected utility not only for the prescriptive purpose of calculating optimal decisions but also for the descriptive purpose of analyzing subjects’ behavior in utility measurements. However, descriptive violations of expected utility have been known for many years. In the early 1980s, it became apparent that these violations bias utility measurements. Systematic discrepancies were found between different utility measurement methods that, under expected utility, should have provided identical utilities. As it is not clear how to correct for these biases without further knowledge of their size or nature, most utility elicitations are still analyzed in terms of expected utility today. This paper uses findings from nonexpected utility theory to speculate on the biases and on their sizes. In particular, we use the quantitative assessments of probability transformation and loss aversion suggested by prospect theory. By means of these, quantitative corrections are proposed for the probability and certainty equivalence methods. In an experiment, the discrepancies between these two methods are removed by our proposal.
File Format	PDF HTM / HTML
Alternate Webpage(s)	http://cwis.kub.nl/~few5/center/staff/wakker/pdf/corrsg.pdf
Language	English
Access Restriction	Open
Content Type	Text
Resource Type	Article