Seminar What's in a u?

Abstract

We revisit the long-lasting debate about the meaning of the utility function used in Expected Utility (EU). Contrary to the common view that EU inherently links risk aversion to diminishing marginal utility, we demonstrate that these two concepts need not coincide. Marginal utility of money is an input into risk attitude, but it is not its sole determinant. An independent ‘pure risk’ attitude is also a contributing factor. We discuss some theoretical implications of this result for the following topics: non-neutral risk attitudes for profit maximizing firms; risk aversion over time lotteries in the presence of discounting, and convex time budget decisions; the equity premium puzzle. We also discuss matters of identification: for firms; via proxies; via MLE methods under parametric restrictions; in intertemporal choice problems; and cross-context elicitation in multi-dimensional settings, and its relationship with the methods and results from Psychology