Expected Utility Theory and Risk Aversion
Expected Utility Theory and Risk Aversion
Seminar Paper
1
Contents
S.no.
Topic
Page No.
1.
Acknowledgment
2
2.
Introduction
3
3.
Is this theory Empirically true?
8
4.
5.
How do different people with different levels of risk aversion behave, under the EUT?
Major Criticism: Coherence of Large & Small Stake gambles 13
16
6.
Conclusion
20
7.
References
21
2
Acknowledgement
I would like to thank Mr. because without his constant guidance and support this paper would not have been possible. His timely feedback and valuable inputs kept me on the right path to complete this paper.
I would also like to take this opportunity to thank University who provided me with the required facilities and reading material which greatly helped in completing this paper.
I would also like to thank my family and friends who always pushed me and motivated me to work hard whenever I lost all hopes of completing this paper on time.
All in all, it was a wonderful and enriching experience completing this paper.
3
2.
Introduction
Expected Utility Theory (EUT) states that the decision maker (DM) chooses between risky or uncertain prospects by comparing their expected utility values, i.e., the weighted sums obtained by adding the utility values of outcomes multiplied by their respective probabilities.
In economics, game theory, and decision theory the expected utility hypothesis is a theory of utility in which “betting preferences” of people with regard to uncertain outcomes (gambles) are represented by a function of the payouts (whether in money or other goods), the probabilities of occurrence, risk aversion, and the different utility of the same payout to people with different assets or personal preferences. This theory has proved useful to explain some popular choices that seem to contradict the expected value criterion (which takes into account only the sizes of the payouts
Seminar Paper
1
Contents
S.no.
Topic
Page No.
1.
Acknowledgment
2
2.
Introduction
3
3.
Is this theory Empirically true?
8
4.
5.
How do different people with different levels of risk aversion behave, under the EUT?
Major Criticism: Coherence of Large & Small Stake gambles 13
16
6.
Conclusion
20
7.
References
21
2
Acknowledgement
I would like to thank Mr. because without his constant guidance and support this paper would not have been possible. His timely feedback and valuable inputs kept me on the right path to complete this paper.
I would also like to take this opportunity to thank University who provided me with the required facilities and reading material which greatly helped in completing this paper.
I would also like to thank my family and friends who always pushed me and motivated me to work hard whenever I lost all hopes of completing this paper on time.
All in all, it was a wonderful and enriching experience completing this paper.
3
2.
Introduction
Expected Utility Theory (EUT) states that the decision maker (DM) chooses between risky or uncertain prospects by comparing their expected utility values, i.e., the weighted sums obtained by adding the utility values of outcomes multiplied by their respective probabilities.
In economics, game theory, and decision theory the expected utility hypothesis is a theory of utility in which “betting preferences” of people with regard to uncertain outcomes (gambles) are represented by a function of the payouts (whether in money or other goods), the probabilities of occurrence, risk aversion, and the different utility of the same payout to people with different assets or personal preferences. This theory has proved useful to explain some popular choices that seem to contradict the expected value criterion (which takes into account only the sizes of the payouts