Research Seminars

Multiple Expectations, Disappointment, and Risk Measures: A Unifying Model of Decision under Risk

Speaker: Philippe DELQUIE
INSEAD

16 April 2008 - From 14h00 to 16h00

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The standard theory of Disappointment is built on the assumption that an individual forms a prior expectation about a risky prospect and will experience disappointment if the outcome obtained falls below the expectation. Here we abandon the hypothesis of a well-defined prior expectation: we propose instead that disappointment may arise from comparing the outcome received with any of the prospect's missed outcomes. This alternative behavioral hypothesis yields the so-called Disappointment without Prior Expectation (DWPE) model, which bridges a number of landmark theories of choice under risk that have evolved from distinct intellectual paths. For example, DWPE leads to a Rank Dependent Utility representation. Second, DWPE is equivalent to a general class of Risk-Value models, an appealing structure because decision makers often seek to rank projects in terms of two criteria: reward and risk. The new risk measure we obtain includes some classic measures such as the Variance or Gini Mean Difference, but it is not part of the families traditionally considered. We show necessary and sufficient conditions for this risk measure to satisfy first- and second-order stochastic dominance (thus generalizing results by Yitzhaki 1982) and coherence, key properties required for prescriptive applications, e.g. in Finance, Insurance, or R&D portfolio selection. Results from calibration of the model to experimental data will be presented.

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