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

Glenn W. Harrison; E. Elisabet Rutström

doi:10.1007/s10683-008-9203-7

Experimental Economics

June 2009, 12:133

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

Authors
Authors and affiliations

Glenn W. HarrisonEmail author
E. Elisabet Rutström

Article

First Online:: 13 June 2008

Received:: 20 July 2007
Revised:: 20 February 2008
Accepted:: 10 April 2008

DOI: 10.1007/s10683-008-9203-7

Cite this article as:: Harrison, G.W. & Rutström, E.E. Exp Econ (2009) 12: 133. doi:10.1007/s10683-008-9203-7

106 Citations

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.

Keywords

Expected utility theory Prospect theory Mixture models

JEL Classification

D81 C91 C51 C12

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Authors and Affiliations

Glenn W. Harrison
- 1
Email author
E. Elisabet Rutström
- 1

1.Department of Economics, College of Business AdministrationUniversity of Central FloridaOrlandoUSA

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

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Keywords

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