Two-Stage Lotteries without the Reduction Axiom

Abstract

Preference relations over two-stage lotteries are analyzed. Empirical evidence indicates that decisionmakers do not always behave in accordance with the reduction of compound lotteries axiom, but they seem to satisfy a compound independence axiom. Although the reduction and the compound independence axioms, together with continuity, imply expected utility theory, each of them by itself is compatible with all possible preference relations over simple lotteries. Using these axioms, the author analyzes three different versions of expected utility for two-stage lotteries. The author suggests several different compound dominance axioms as possible replacements of the reduction axiom, which are strictly weaker than the reduction of compound lotteries axiom. Copyright 1990 by The Econometric Society.