Resolving Inconsistencies in Utility Measurement Under Risk: Tests of Generalizations of Expected Utility

This paper explores inconsistencies that occur in utility measurement under risk when expected utility theory is assumed and the contribution that prospect theory and some other generalizations of expected utility can make to the resolution of these inconsistencies. We used five methods to measure u...

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Bibliographic Details
Published in:Management science 2007-03, Vol.53 (3), p.469-482
Main Authors: Bleichrodt, Han, Abellan-Perpinan, Jose Maria, Pinto-Prades, Jose Luis, Mendez-Martinez, Ildefonso
Format: Article
Language:English
Subjects:
Analysis
Applied sciences
Business management
Business studies
Decision analysis
Decision theory. Utility theory
Exact sciences and technology
Expected utility
health
Loss aversion
Management science
Measurement techniques
Mensuration
nonexpected utility
Operational research and scientific management
Operational research. Management science
Organizational effectiveness
Parametric models
Probability
Prospect theory
Risk
Risk aversion
Risk management
Statistical median
Studies
Term weighting
Utility functions
Utility measurement
Utility theory
Weighting functions
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Summary:This paper explores inconsistencies that occur in utility measurement under risk when expected utility theory is assumed and the contribution that prospect theory and some other generalizations of expected utility can make to the resolution of these inconsistencies. We used five methods to measure utilities under risk and found clear violations of expected utility. Of the theories studied, prospect theory was the most consistent with our data. The main improvement of prospect theory over expected utility was in comparisons between a riskless and a risky prospect (riskless-risk methods). We observed no improvement over expected utility in comparisons between two risky prospects (risk-risk methods). An explanation for the latter observation may be that there was less distortion in probability weighting in the interval [0.10, 0.20] than has commonly been observed.
ISSN:0025-1909
1526-5501
DOI:10.1287/mnsc.1060.0647