An operational approach to rational decision making based on rank dependent utility

Non-expected utility (non-EU) theories, such as rank dependent utility (RDU) theory, have been proposed as alternative models to EU theory in decision making under risk. These models do not share the separability property of EU theory hence, in dynamic decision problems, the sophisticated strategy is likely to be dominated w.r.t. stochastic dominance. Although a rational non-EU behavior is necessarily a non-consequentialist behavior (i.e., the choice in a subtree depends on what happens in the rest of the tree), we show that it is nonetheless possible to define a procedure which: i) involves a ”rolling back” of the decision tree; and ii) selects a non-dominated strategy that realizes a compromise between the decision maker’s discordant goals at the different decision nodes. Relative to the computations involved in the standard EU evaluation of a decision problem, the main computational increase is due to the identification of non-dominated strategies by linear programming. A simulation, using the RDU criterion, confirms the computational tractability of the model.