Table Of ContentECONOMIC AND ENVIRONMENTAL RISK AND UNCERTAINTY
THEORY AND DECISION LIBRARY
General Editors: W. Leinfellner (Vienna) and G. Eberlein (Munich)
Series A: Philosophy and Methodology of the Social Sciences
Series B: Mathematical and Statistical Methods
Series C: Game Theory, Mathematical Programming and Operations Research
Series D: System Theory, Knowledge Engineering and Problem Solving
SERIES B: MATHEMATICAL AND STATISTICAL METHODS
VOLUME 35
Editor: H. J. Skala (Paderborn); Assistant Editor: M. Kraft (Paderborn); Editorial Board:
J. Aczel (Waterloo, Ont.), G. Bamberg (Augsburg), H. Drygas (Kassel), W. Eichhorn
(Karlsruhe), P. Fishburn (Murray Hill, N.J.), D. Fraser (Toronto), W. Janko (Vienna), P. de
Jong (Vancouver), T. Kariya (Tokyo), M. Machina (La Jolla, Calif.), A. Rapoport (Toronto),
M. Richter (Kaiserslautern), B. K. Sinha (Cattonsville, Md.), D. A. Sprott (Waterloo, Ont.),
P. Suppes (Stanford, Calif.), H. Theil (St. Augustine, Fla.), E. Trillas (Madrid), L. A. Zadeh
(Berkeley, Calif.).
Scope: The series focuses on the application of methods and ideas of logic, mathematics and
statistics to the social sciences. In particular, formal treatment of social phenomena, the
analysis of decision making, information theory and problems of inference will be central
themes of this part of the library. Besides theoretical results, empirical investigations and the
testing of theoretical models of real world problems will be subjects of interest. In addition
to emphasizing interdisciplinary communication, the series will seek to support the rapid
dissemination of recent results.
The titles published in this series are listed at the end of this volume.
ECONOMIC AND
ENVIRONMENTAL RISK
AND UNCERTAINTY
New Models and Methods
edited by
ROBERTNAU
Duke University, Fuqua School ofB usiness,
Durham, North Carolina, U.SA.
ERIKGR0NN
Norwegian School ofM anagement, Department ofB usiness Economics,
Sandvika, Norway
MARK. MACHINA
University of California at San Diego, Department ofE conomics,
La lolla, California, U.S.A.
and
OLVA R BERGLAND
Agricultural University ofN orway, Department ofE conomics and Social Sciences,
Aas,Norway
SPRINGER-SCIENCE+BUSINESS MEDIA, B.V.
A C.I.P. Catalogue record for this book is available from the Library of Congress.
ISBN 978-90-481-4849-3 ISBN 978-94-017-1360-3 (eBook)
DOI 10.1007/978-94-017-1360-3
Printed on acid-free paper
All Rights Reserved
© 1997 Springer Science+Business Media Dordrecht
Originally published by Kluwer Academic Publishers in 1997
No part of the material protected by this copyright notice may be reproduced or
utilized in any form or by any means, electronic or mechanical,
including photocopying, recording or by any information storage and
retrieval system, without written permission from the copyright owner.
Dedicated to the memory of OLE HAGEN
1921-1994
TABLE OF CONTENTS
Preface ix
Ole Hagen and the FUR Conferences FRED WENST0P xi
L Models of Environmental Risk
1
Valuing Health and Safety: Some Economic and Psychological Issues
MICHAEL J. JONES-LEE AND GRAHAM LOOMES 3
Improving Efficiency in Environmental Enforcement D. MARC KILGOUR 33
Valuation of Environmental Goods: Frame Effects in the Estimation of Multi-Criteria
Utility Functions FRED WENST0P AND ARNE J. CARLSEN 53
Stochastic Trees and Medical Decision Making
GORDONB. HAZEN AND JAYAVEL SOUNDERPANDIAN 65
Manipulation of Emission Permit Markets
EIRIKROMSTAD AND OLVARBERGLAND 75
n.
Risk and Uncertainty in Economic Theory 87
Allais Theory Offers Solution and Explanation for Equity Premium Puzzle
JOHN GOLOB 89
Generalized Expected Utility and the Demand for Insurance:
The Limits of Machina THOMAS RUSSELL 109
The Derivation of Generalized Expected Utility Expansions:
Reply to Russell MARK MACHINA 115
Necessary Conditions for Efficient Multiple-Bid Auctions FRIEDEL BOLLE 123
Balanced Equilibrium: A Theory of Behavior in Games Based on Continuity and
Insufficient Reason MARCO MARIOTTI 145
Mixed Extensions of Games and the St. Petersburg Paradox HANS HALLER 163
Consumption with Fluctuations in Preference
KOm NAKAZAW A AND JOHN HEY 173
vii
viii TABLE OF CONTENTS
ill. Recent Progress in Modeling Preferences and Risk Attitudes 193
Dynamically Consistent Preferences, Quadratic Beliefs, and Choice Under Uncertainty
JURGEN EICHBERGER AND SIMON GRANT 195
Induced Preferences and Decision Making Under Risk and Uncertainty
DAVID KELSEY AND FRANK MILNE 207
On Socks, Ties, and Extended Outcomes HARRY MARKOWITZ 219
Hierarchies and the Self-Control of Risk Attitude LUC WATIllEU 227
Allais Phenomena and Completeness of Preferences
S. ruos, s. ruOS-INSUA, D. ruOS-INSUA, J. PACHON, M.A. PACIOS,
AND P. GARCiA BARRENO 245
Representing Preference Relations with Nontransitive Indifference by a Single Real-
Valued Function GIANNI BOSI AND ROMANO ISLER 257
INDEX 263
PREFACE
Since the early 1980's, the biannual international conferences on Foundations and
Applications of Utility, Risk, and Decision Theory (the "FUR" conferences) have
provided a forum in which much of the most innovative contemporary research on risk
and uncertainty has been presented. This volume contains a selection of the best papers
presented at the FUR VII conference, which was organized by the late Ole Hagen and
held in Oslo from June 30 to July 3, 1994. The theme of the FUR VII conference was
"Environmental Risk," which is reflected in the title and organization of the volume:
Part I contains papers dealing with health and environmental applications of risk theory,
including the plenary address given at the conference by Graham Loomes. Part II
contains papers dealing with more general issues of risk and uncertainty in economic
models of auctions, markets, and games. Part III contains papers which focus on the
modeling of preferences and risk attitudes within individuals. As Professor Wenst0p
observes in his memorial to Hagen on the following pages, the FUR conferences have
chronicled an exciting period in the history of utility and risk theory, during which
many revolutionary ideas have been proposed, debated, and applied to the study of
economic institutions and individual decision-making. The papers in this volume
continue that distinguished tradition.
The editing of this volume has been a truly collaborative effort between Erik Gmnn
(Norwegian School of Management), Mark Machina (University of California at San
Diego), Olvar Bergland (Agricultural University of Norway), and myself. Special
thanks are due to Erik Gmnn, who chaired the National Organizing Committee for the
conference and who, at the last minute, also inherited the Program Chair's duties from
Professor Hagen. He handled the difficult early work of collecting and organizing the
many manscripts that were submitted for consideration in the volume, from which the
papers presented here were later selected through a reviewing process that spanned four
universities. The FUR VII conference was made possible through the generous
financial support of the Norwegian School of Management and contributions from the
Central Bank of Norway and the Norwegian Trade Council.
Robert Nau
Durham, North Carolina
August 14, 1996
IX
OLE HAGEN AND THE FUR CONFERENCES
Volume 21 of the Theory and Decision Library, entitled Expected Utility and the Allais
Paradox, was edited by Maurice Allais and Ole Hagen in 1979. Their intent was to
initiate a debate concerning the foundations of risk and utility theory, and they were
indeed successful. Volume 21 contained contributions by many distinguished authors,
including Oskar Morgenstern, and addressed the conflict between what was then called
the American School (Expected Utility Theory) and the French school (Allais' Positive
Theory of Choice). That volume provided the inspiration for the FUR conferences. The
idea was due to Werner Leinfellner, who was co-editor ofthe Theory and Decision
Library. As a follow-up to the volume, he proposed that Ole Hagen arrange an
international conference on the foundations of utility and risk theory.
Hagen had performed several empirical studies demonstrating that people do not in fact
behave according to the von Neumann-Morgenstern theory. To account for the observed
behavior, he had in the years 1969-1972 developed an axiomatic theory of choice which
generalizes the standard theory in that the third moment of the probability distribution
over utilities is taken into account as well. The theory was certainly not welcomed in all
quarters, but as it turned out to be similar to Allais', Hagen and Allais became allies in
an endeavor to instigate an open debate. Leinfellner's encouragement was therefore a
welcome opportunity for Hagen to create a forum where both proponents of new ideas
and defenders of the established paradigm could participate.
As a consequence, the first FUR conference took place at the Norwegian School of
Management in Oslo in 1982. Hagen received enthusiastic local support during the
preparations, notably at the University of Oslo where Bernt Stigum was instrumental.
The conference attracted about 100 participants from around the world, and turned out
to be a success by all standards. The debate turned decisively from whether new theories
are at all required, to which ones are the most suitable under different conditions. By
that time, there was mounting evidence from behavioral experiments about violations of
the von Neumann-Morgenstern axioms--particularly the independence axiom. Several
alternative axiomatic utility theories had recently been proposed to account for such
behavior, and their authors were also present at the meeting. The contrasts among the
new theories, the earlier theories of Allais and Hagen, and the standard theory of
expected utility generated many exciting discussions. A revolution in "non-expected
utility theory" had begun, and subsequent conferences in the FUR series would track the
course of this revolution through the 1980's and into the 1990's.
It is no secret that the early debate appeared more like a combat than an exchange of
ideas between scientists. Hagen was no exception: he felt he had to pound very hard on
the door of established science to make people listen and consequently developed a very
personal, almost polemic writing style to achieve it. For Hagen, the first FUR
conference turned out to be a personal triumph when his many years of opposition to the
established theory were finally vindicated. He did not rest on his laurels, however, but
participated with keen interest in the ensuing series of conferences in Venice (1994),
xi
