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Dual Representation of Choice and Aspirational Preferences

David B Brown, Enrico De Giorgi & Melvyn Sim

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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
   
type working paper (English)
   
keywords satisficing, aspiration levels targets, prospect theory, reflection effect, risk measures, coherent risk measures, convex risk measures, portfolio optimization
   
date of appearance 2009
issuer institution University of St. Gallen Law Faculty
series title University of St. Gallen Law & Economics Working Paper
review not reviewed
   
citation Brown, D. B., De Giorgi, E., & Sim, M., University of St. Gallen Law Faculty (Eds.), (2009). Dual Representation of Choice and Aspirational Preferences. University of St. Gallen Law & Economics Working Paper. St. Gallen.