EXPECTED UTILITY THEORY UNDER EXTREME RISKS
EXPECTED UTILITY THEORY UNDER EXTREME RISKS

Summary/Abstract: Expected utility theory provides a framework for modeling choice of a rational individual, whose goal is to maximize expected utility to the preferences towards risk. However, extreme risks, such as, for example, a stock market crash or a natural disaster, significantly affect the function of the probability distribution of outcomes by adding the weight to the tails of the distribution. In such cases, the application of the theory of decision-making is extremely sensitive to assumptions on the probability distribution function. Therefore, this paper will provide a review of models of decision-making in terms of expected utility theory under extreme risk.

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