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4. Non-linear decision models in the face of risk and uncertainty
Expected utility theory was criticized early on, however, both in terms of its axioms (the independence axioms were strongly contested) and its conclusions. Two famous paradoxes constitute serious challenges to the independence axiom, on the one hand, and to the existence of subjective probabilities, on the other.
4.1 Allais paradox and Ellsberg urn
The first of these paradoxes (Allais paradox) is based on the following laboratory experiment. Respondents are first asked to choose between the following two lotteries A and B :
A: Receive €10,000 with certainty;
B: receive €15,000 with a probability of 0.9 but receive nothing with a probability of 0.1.
A very...
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Non-linear decision models in the face of risk and uncertainty
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