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Alternatives to Expected Utility: Formal Theories

  • Ulrich Schmidt
Chapter

Abstract

The first attempts to develop a utility theory for choice situations under risk were undertaken by Cramer (1728) and Bernoulli (1738). Considering the famous St. Petersburg Paradox1 — a lottery with an infinite expected monetary value — Bernoulli (1738, p. 209) observed that most people would not spend a significant amount of money to engage in that gamble. To account for this observation, Bernoulli (1738, pp. 199–201) proposed that the expected monetary value has to be replaced by the expected utility (“moral expectation”) as the relevant criterion for decision making under risk. However, Bernoulli’s argument and particularly his choice of a logarithmic utility function2 seem to be rather arbitrary since they are based entirely on intuitively appealing examples.3

Keywords

Risk Aversion Expect Utility Utility Theory Loss Aversion Indifference Curve 
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© Springer Science+Business Media New York 2004

Authors and Affiliations

  • Ulrich Schmidt
    • 1
  1. 1.Universität HannoverGermany

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