ExtensionsoftheSubjectiveExpectedUtilityModel.docVIP

Extensions of the Subjective Expected Utility Model Robert Nau Fuqua School of Business, Duke University In Advances in Decision Analysis: From Foundations to Applications Ward Edwards, Ralph Miles, Jr., and Detlof von Winterfeldt (eds.) Cambridge University Press, 2007 Abstract: The subjective expected utility (SEU) model rests on very strong assumptions about the consistency of decision making across a wide range of situations. The descriptive validity of these assumptions has been extensively challenged by behavioral psychologists during the last few decades, and the normative validity of the assumptions has also been reappraised by many statisticians, philosophers, and economists, motivating the development of more general utility theories and decision models. These generalized models are characterized by features such as imprecise probabilities, nonlinearly weighted probabilities, source-dependent risk attitudes, and state-dependent utilities, permitting the pattern of the decision maker’s behavior to change with the decision context and to perhaps satisfy the usual SEU assumptions only locally. Recent research in the emerging field of neuroeconomics sheds light on the physiological basis of decision making, the nature of preferences and beliefs, and interpersonal differences in decision competence. These findings do not necessarily invalidate the use of SEU-based decision analysis tools, but they suggest that care needs to be taken to structure preferences and to assess beliefs and risk attitudes in a manner that is appropriate for the decision and also for the decision maker. Key words: subjective probability, expected utility, non-expected utility, Savages axioms, sure-thing principle, Allais paradox, Ellsbergs paradox, risk aversion, uncertainty aversion, exponential utility function, logarithmic utility function, risk tolerance, ambiguity, incomplete preferences, imprecise probabilities, robust Bayesian analysis, rank-dependent utility, comonotonic ac