Choice Under Risk and Uncertainty
This entry outlines what is meant by decision-making under risk and uncertainty. It illustrates the model of expected utility, its properties, and the Allais paradox as the main violation of the model. It describes the subjective expected utility model of decision under uncertainty, and the Ellsberg paradox as an example of the Knight’s approach to uncertainty.
In real economic life, many decisions are taken under risk and uncertainty, for example, investment decisions, decisions about consumption through time, buying and selling insurance, investment in new industries and countries, choosing new technologies, stock market purchases, and sales.
The literature on decision-making under risk and uncertainty can be divided in: (1) the literature concerning decision-making under risk, which includes: (a) the expected utility model (EU) and its axiomatizations (Bernoulli 1954; von Neumann and Morgenstern 1947); (b) the criticisms to the EU model (Allais 1953) and its...
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