TRIPLE PREFERENCE THEORY OF CHOICE UNDER RISK AND UNCERTAINTY Janne Gustafsson

This paper develops a theory of choice under risk and uncertainty which, together with the associated definition of risk aversion, separates the concepts of risk aversion and diminishing marginal utility from each other. Building on separate definition of the decision maker’s two elementary preference relations—preferences over lotteries and preferences over consequences—and a set of consistency properties that link these two together, the paper derives a third preference relation on a set of “utility lotteries,” and shows that the preference functional for lotteries necessarily separates into the representation functions of the two other preference relations of the theory. The paper then demonstrates that a reasonable definition of risk aversion necessitates the use of cardinal utility, whereby it is also possible to achieve the separation result of the paper. The theory is compatible with expected utility theory, and allows for multi-attribute consequences, mean-risk preferences and state-dependent utility.