Skip to main content
Log in

Decisions under imperfect knowledge: The certainty equivalence theory as an alternative to the von Neumann-Morgenstern theory of uncertainty

  • Published:
Erkenntnis Aims and scope Submit manuscript

Abstract

This paper offers a modified version of the certainty equivalence (CE) theory of utility for uncertain prospects and a new set of axioms as its basis. It shows that the CE and the von Neumann-Morgenstern (NM) approaches to uncertainty are opposite in spirit: The CE approach represents a flight from the world of uncertainty to the rules of certainty while the NM approach represents a flight from the world of certainty to one of uncertainty. The two approaches differ even in their treatment of compound prospects and their actuarially identical simple counterparts.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

References

  • ArchibaldG. C., ‘Utility, Risk and Linearity,’ Journal of Political Economy 67 (1959), 437–450.

    Google Scholar 

  • ArrowK. J., Essays in the Theory of Risk-bearing, Markham, Chicago, 1971.

    Google Scholar 

  • BeckerG. M., DeGrootM. H. and MarschakJ., ‘An Experimental Study of some Stochastic Models for Wagers,’ Behavioral Science 8 (1963), 199–202.

    Google Scholar 

  • BorchK., The Economics of Uncertainty, Princeton University Press, Princeton, New Jersey, 1968.

    Google Scholar 

  • CohenJ., Behaviour in Uncertainty, Allen and Unwin, London, 1964.

    Google Scholar 

  • EllsbergE., ‘Risk, Ambiguity and the Savage Axioms’, Quarterly Journal of Economics 75 (1961), 643–669.

    Google Scholar 

  • FellnerW., ‘Distortion of Subjective Probabilities as a Reaction to Uncertainty’, Quarterly Journal of Economics 75 (1961), 670–689.

    Google Scholar 

  • FellnerW., Probability and Profit, Irwin, Homewood, Ill., 1965.

    Google Scholar 

  • FishburnP. C., ‘On Handa's “New Theory of Cardinal Utility” and the Maximization of Expected Return’, Journal of Political Economy 86 (1978) 321–324.

    Google Scholar 

  • FriedmanM. and SavageL. J., ‘The Utility Analysis of Choices Involving Risk’, Journal of Political Economy 56 (1948), 279–304.

    Google Scholar 

  • Georgescu-RoegenN., ‘The Nature of Expectation and Uncertainty’, in M. J.Bowman (ed.), Expectation, Uncertainty and Business Behaviour, Social Science Research Council, New York, 1958.

    Google Scholar 

  • HandaJ. C., ‘Risk, Probabilities and a New Theory of Cardinal Utility’, Journal of Political Economy 85 (1977), 97–122.

    Google Scholar 

  • HicksJ. R., Critical Essays in Monetary Theory, Oxford University Press, Oxford, 1967.

    Google Scholar 

  • Keynes, J. M., The Collected Writings of John Maynard Keynes, Macmillan, London (Various years).

  • KnightF. H., Risk, Uncertainty and Profit, Houghton Mifflin, Boston, 1921.

    Google Scholar 

  • KrantzD. H., LuceR. D., SuppesP., and TverskyA., Foundations of Measurement, Vol. I, Academic Press, New York, 1971.

    Google Scholar 

  • LancasterK. J., ‘A New Approach to Consumer Theory’, Journal of Political Economy 74 (1966), 132–157.

    Google Scholar 

  • LuceR. D., and KrantzD. H., ‘Conditional Expected Utility’, Econometrica 39 (1971), 253–71.

    Google Scholar 

  • MishanE. J., ‘Choices Involving Risk: Simple Steps Towards an Ordinalist Analysis’, Economic Journal 86 (1976), 759–777.

    Google Scholar 

  • MostellerF., and NogeeP., ‘An Experimental Measurement of Utility’, Journal of Political Economy 59 (1951), 371–404.

    Google Scholar 

  • NiehansJ., ‘Reflections on Shackle, Probability, and our Uncertainty about Uncertainty’, Metroeconomica 11 (1959), 74–88.

    Google Scholar 

  • RaiffaH., ‘Risk, Ambiguity, and the Savage Axioms: Comment’, Quarterly Journal of Economics 75 (1961), 690–695.

    Google Scholar 

  • RothenbergJ., The Measurement of Social Welfare, Prentice-Hall, Englewood Cliffs, N.J., 1961.

    Google Scholar 

  • SamuelsonP. A., ‘Risk and Uncertainty: A Fallacy of Large Numbers’, Scientia 57 (1963), 1–6.

    Google Scholar 

  • SamuelsonP. A., The Collected Scientific Papers of Paul A. Samuelson, M.I.T. Press, Cambridge, Mass., vol. I, 1966.

    Google Scholar 

  • SavageL. J., The Foundations of Statistics, Dover Publications, New York, 1972.

    Google Scholar 

  • ShackleG. L. S., Decision, Order and Time in Human Affairs, Cambridge University Press, Cambridge, 1969.

    Google Scholar 

  • TverskyA., ‘Additivity, Utility and Subjective Probability’, Journal of Mathematical Psychology 4 (1967) 175–201.

    Google Scholar 

  • WallstenT. S., ‘Subjectively Expected Utility Theory and Subjects' Probability Estimates: Use of Measurement-free Techniques’, Journal of Experimental Psychology 88 (1971) 31–40.

    Google Scholar 

Download references

Author information

Authors and Affiliations

Authors

Rights and permissions

Reprints and permissions

About this article

Cite this article

Handa, J. Decisions under imperfect knowledge: The certainty equivalence theory as an alternative to the von Neumann-Morgenstern theory of uncertainty. Erkenntnis 20, 295–328 (1983). https://doi.org/10.1007/BF00166391

Download citation

  • Received:

  • Accepted:

  • Issue Date:

  • DOI: https://doi.org/10.1007/BF00166391

Keywords

Navigation