Uncertainty, utility and paradox

Brooklyn Museum - An Embarrassment of Choices,...

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Allais

Allais devised two choices:

  1. between a definite £1M versus a gamble whose expected return was much greater, but could give nothing
  2. between two gambles

He showed that most people made choices that were inconsistent with expected utility theory, and hence paradoxical.

In the first choice, one option has a certain payoff and so is reasonably prefered. In the other choice both choices have similarly uncertain outcomes and so it is reasonable to choose based on expected utility. In general, uncertainty reasonably detracts from expected utility.

Ellsberg

Ellsberg devised a similar paradox, but again people consistently prefer alternatives with the least uncertainty.

See also

mathematics, illustrations, examples.

Dave Marsay

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