Alternative utility functions: review, analysis and comparison

The paper reviews the development of von Neumann and Morgenstern (vNM) utility theory. Kahneman and Tversky’s (KT’s) prospect theory is introduced. The vNM utility function is compared and contrasted with KT’s value function. We prove the uniqueness of two popular utility functions. First, we show t...

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Bibliographic Details
Published in:Review of quantitative finance and accounting 2018-10, Vol.51 (3), p.785-811
Main Authors: Harel, Arie, Francis, Jack Clark, Harpaz, Giora
Format: Article
Language:English
Subjects:
Accounting/Auditing
Corporate Finance
Econometrics
Economic models
Economics and Finance
Finance
Kahneman, Daniel (1934-2024)
Operations Research/Decision Theory
Original Research
Power
Prospect theory
Uniqueness
Utility functions
Utility theory
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Summary:The paper reviews the development of von Neumann and Morgenstern (vNM) utility theory. Kahneman and Tversky’s (KT’s) prospect theory is introduced. The vNM utility function is compared and contrasted with KT’s value function. We prove the uniqueness of two popular utility functions. First, we show that all power utility functions possess constant RRA. And, we show that all exponential utility functions have constant ARA. The paper concludes by discussing applications, strengths and weaknesses of various utility functions.
ISSN:0924-865X
1573-7179
DOI:10.1007/s11156-017-0688-z