Dual Representation of Choice and Aspirational Preferences
Series
University of St. Gallen Law & Economics Working Paper
Type
working paper
Date Issued
2009
Author(s)
Abstract
In this paper, we axiomatize a target-based model of choice that allows decision makers to be both risk averse and risk seeking, depending on the payoff's position relative to a pre-specified target. The approach can be viewed as a hybrid model, capturing in spirit two celebrated ideas: first, the satisficing concept of Simon (1955); second, the switch between risk aversion and risk seeking popularized by the prospect theory of Kahneman and Tversky (1979). Our axioms are simple and intuitive; in order to be implemented in practice, our approach requires only the specification of an aspiration level. We show that this approach is dual to a known approach using risk measures, thereby allowing us to connect to existing theory. Though our approach is intended to be normative, we also show that it resolves the classical paradoxes of Allais (1953) and Ellsberg (1961), neither of which can be explained by expected utility theory.
http://ssrn.com/abstract=1406399
http://ssrn.com/abstract=1406399
Language
English
Keywords
satisficing
aspiration levels targets
prospect theory
reflection effect
risk measures
coherent risk measures
convex risk measures
portfolio optimization
HSG Classification
contribution to scientific community
Refereed
No
Publisher place
St. Gallen
Number
2009-07
Subject(s)
Eprints ID
53936