ISSN:
1572-9338
Keywords:
Stochastic optimization with recourse
;
decision-making under uncertainty
;
expected utility
;
certainty equivalents
;
the Allais paradox and other decision theoretic paradoxes
;
risk aversion
;
production under price uncertainty
;
investment in risky and safe assets
;
insurance
Source:
Springer Online Journal Archives 1860-2000
Topics:
Mathematics
,
Economics
Notes:
Abstract We propose a new criterion fordecision-making under uncertainty. The criterion is based on acertainty equivalent (CE) of a (monetary valued) random variable Z, $$S_\upsilon (Z) = \mathop {\sup }\limits_z \{ z + E_Z \upsilon (Z - z)\} ,$$ wherev(·) is the decision maker'svalue-risk function. This CE is derived from considerations ofstochastic optimization with recourse, and is calledrecourse certainty equivalent (RCE). We study (i) the properties of the RCE, (ii) the recoverability ofv(·) fromS v (·) (in terms of the rate of change in risk), (iii) comparison with the “classical CE”u −1 Eu(·) inexpected utility (EU) theory, (iv) relation to risk-aversion, (v) connection with Machina'sgeneralized expected utility theory, and its use to explain theAllais paradox and other decision theoretic paradoxes, and (vi) applications to models ofproduction under price uncertainty, investment in risky and safe assets andinsurance. In these models the RCE gives intuitively appealing answers forall risk-averse decision makers, unlike the EU model which gives only partial answers, and requires, in addition to risk-aversion, also assumptions on the so-calledArrow-Pratt indices.
Type of Medium:
Electronic Resource
URL:
http://dx.doi.org/10.1007/BF02204807
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