Template-Type: ReDIF-Article 1.0
Author-Name: Hui Huang
Author-Name-First: Hui
Author-Name-Last: Huang
Author-Workplace-Name: Faculty of Business Administration, University of Regina
Author-Workplace-Location: Regina, Saskatchewan, S4S 0A2, Canada
Author-Name: Shunming Zhang
Author-Name-First: Shunming
Author-Name-Last: Zhang
Author-Workplace-Name: China Financial Policy Research Center, Renmin University of China
Author-Workplace-Location: Beijing, 100872, P.R.China
Title: The Distorted Theory of Rank-Dependent Expected Utility
Abstract: This paper re-examines the rank-dependent expected utility theory. Firstly, we follow Quiggin's assumption (Quiggin 1982) to deduce the rank-dependent expected utility formula over lotteries and hence extend it to the case of general random variables. Secondly, we utilize the distortion function which reflects decision-makers' beliefs to propose a distorted independence axiom and then to prove the representation theorem of rank-dependent expected utility. Finally, we make direct use of the distorted independence axiom to explain the Allais paradox and the common ratio effect.
Classification-JEL: D81
Keywords: Expected utility, Rank-dependent expected utility, Distortion function, Distorted independence axiom, The Allais paradox, The Common ratio effect
Journal: Annals of Economics and Finance
Pages: 233-263
Volume: 12
Issue: 2
Number: 3
Year: 2011
Month: Nov
File-URL: http://www.aeconf.net/Articles/Nov2011/aef120203.pdf
File-Format: Application/pdf
File-URL: http://down.aefweb.net/AefArticles/aef120203.pdf
File-Format: Application/pdf
Handle: RePEc:cuf:journl:y:2011:v:12:i:2:p:233-263