Risk in a simple temporal framework for expected utility theory and for SKAT,the Stages of Knowledge Ahead Theory

Abstract

The paper re-expresses arguments against the normative validity of expected utility theory in Pope (1983, 1991a, 1991b, 1985, 1995, 2000, 2001, 2005, 2006, 2007). These concern the neglect of the evolving stages of knowledge ahead (stages of what the future will bring). Such evolution is fundamental to an experience of risk, yet not consistently incorporated even in axiomatised temporal versions of expected utility. Its neglect entails a disregard of emotional and financial effects on well-being before a particular risk is resolved.

These arguments are complemented with an analysis of the essential uniqueness property in the context of temporal and atemporal expected utility theory and a proof of the absence of a limit property natural in an axiomatised approach to temporal expected utility theory.

Problems of the time structure of risk are investigated in a simple temporal framework restricted to a subclass of temporal lotteries in the sense of Kreps and Porteus (1978). This subclass is narrow but wide enough to discuss basic issues. It will be shown that there are serious objections against the modification of expected utility theory axiomatised by Kreps and Porteus (1978, 1979). By contrast the umbrella theory proffered by Pope that she has now termed SKAT, the Stages of Knowledge Ahead Theory, offers an epistemically consistent framework within which to construct particular models to deal with particular decision situations. A model by Caplin and Leahy (2001) will also be discussed and contrasted with the modelling within SKAT (Pope, Leopold and Leitner, 2006).