Decision theory under risk and uncertainty
An introduction to decision theory under risk and uncertainty
Meglena Jeleva (University of Paris-Ouest-Nanterre-La Défense)
The purpose of this course is to present the main models of individual decision making under risk and non probabilized uncertainty as well as some of their applications to portfolio choices, insurance choices, and risk measurement.
The classical axiomatic models of Von Neumann and Morgenstern (1944) and Savage (1954) proposing an evaluation of decisions by an expected utility of their consequences have been challenged since the 1960s as descriptive and even as normative theories. These critiques were at the origin of new models of decision making under risk, and mainly under non probabilized uncertainty. These more recent models allow to better take into account the degrees, and sources of uncertainty (or ambiguity), as well as the decision maker’s attitude towards risk and non probabilized uncertainties.
The applications of these more recent models to different contexts, as portfolio, and insurance choices, allow a better understanding of observed individual behavior, market characteristics, and public policy efficiency.
Outlines of the course
1. The classical expected utility models under risk and uncertainty
2. Critiques of expected utility
a. Under risk: the Allais Paradox and the reference dependence;
b. Under non probabilized uncertainty: the Ellsberg paradox
3. Alternative theories
a. Prospect theory
b. Choquet Expected Utility
c. Models with multiple priors
a. Portfolio choices
b. Insurance demand
c. Risk measurement