Abstract
This paper assesses whether a paradigm shift should be made from expected utility framework to prospect theory framework – in the economics of choice under risk. A brief overview of the subject is outlined, starting with expected utility theory and noting its descriptive limitations. Proposed theories to make up for these limitations is also provided. Prospect theory emerged as the most serious challenger to expected utility theory. A review of some descriptive predictions of prospect theory, suggests that there is no scientific reason why expected utility should not be ousted from dominance by prospect theory. The shift to prospect theory however is not without costs. Conceptual complexities and non-universality of application associated with prospect theory should be embraced with the shift while not entirely abandoning expected utility theory.
Highlights
The ongoing debate in the economics profession, in particular the economics of choice under risk, underpins the subject of this essay
In attempting to assess whether a paradigm shift from expected utility theory (EUT) denominated analysis to prospect theory (PT) denominated analysis in the economics of risk the paper proceeds by outlining the two theories and making a head-to-head comparison to come to a conclusion
This article has provided an assessment of the economics of choice under risk with respect to the competing behavioral hypotheses, EUT and PT
Summary
The ongoing debate in the economics profession, in particular the economics of choice under risk, underpins the subject of this essay. In the light of this evidence a proliferation of theories, collectively known as non-EU theories, has been put forth in an attempt to provide a better descriptive picture of observed behaviour under risk. In the economics of risk the paper proceeds by outlining the two theories and making a head-to-head comparison to come to a conclusion.
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