"Expected Utility- Mean Absolute Semideviation" Model of Individual Decision Making under Risk

Abstract. This paper presents a new theory of decision under risk. Individual preferences over lotteries are assumed to be complete, transitive, continuous and satisfy transformed independence axiom. Such preferences admit representation of the form U(L)-ρ·r (L), where U(L) denotes the expected utility of lottery L, ρ∈[-1,1] is a constant and r (L) is the mean absolute (utility) semideviation of lottery L. The model is interpreted as a linear trade-off between expected utility and utility dispersion. The model is compatible with all major behavioral regularities. In particular, it respects stochastic dominance, allows for the Allais paradox and rationalizes switching behavior in the Samuelson's example