Behavior under risk: recent developments in theory and applications

Abstract

In the last decade a number of new theories have been proposed to explain individual behavior under risk where, following Knight (1921), risk is defined as randomness with a known probability distribution. Some of these theories are formally atemporal and generalize the classical expected utility model of choice. Their development was inspired primarily by the growing body of laboratory evidence regarding static or one-shot choices, that has cast doubt upon the descriptive validity of the expected utility model. Other theories are explicitly intertemporal and generalize the time-additive expected utility model which is standard in capital theory. The noted laboratory evidence also provides some motivation for this work since it is clearly desirable that a theory of intertemporal utility, when restricted to static gambles, be consistent with the evidence.