Expected utility theory and prospect theory: one wedding and a decent funeral

    Authors

    G. W. Harrison;E. E. Rutstrom

    Comments

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    Abbreviated Journal Title

    Exp. Econ.

    Keywords

    Expected utility theory; Prospect theory; Mixture models; PROBABILITY WEIGHTING FUNCTION; CHOICE CONTINGENT-VALUATION; NON-NESTED; HYPOTHESES; MODEL SELECTION; RISK-AVERSION; PREFERENCES; VARIABLES; DECISION; Economics

    Abstract

    Choice behavior is typically evaluated by assuming that the data is generated by one latent decision-making process or another. What if there are two (or more) latent decision-making processes generating the observed choices? Some choices might then be better characterized as being generated by one process, and other choices by the other process. A finite mixture model can be used to estimate the parameters of each decision process while simultaneously estimating the probability that each process applies to the sample. We consider the canonical case of lottery choices in a laboratory experiment and assume that the data is generated by expected utility theory and prospect theory decision rules. We jointly estimate the parameters of each theory as well as the fraction of choices characterized by each. The methodology provides the wedding invitation, and the data consummates the ceremony followed by a decent funeral for the representative agent model that assumes only one type of decision process. The evidence suggests support for each theory, and goes further to identify under what demographic domains one can expect to see one theory perform better than the other. We therefore propose a reconciliation of the debate over two of the dominant theories of choice under risk, at least for the tasks and samples we consider. The methodology is broadly applicable to a range of debates over competing theories generated by experimental and non-experimental data.

    Journal Title

    Experimental Economics

    Volume

    12

    Issue/Number

    2

    Publication Date

    1-1-2009

    Document Type

    Article

    Language

    English

    First Page

    133

    Last Page

    158

    WOS Identifier

    WOS:000268184800001

    ISSN

    1386-4157

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