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There are studies that show that people follow EE and not EUT. It's the other way around EUT fails as a theory of financial decision making since it doesn't ex

There are studies that show that people follow EE and not EUT. It's the other way around EUT fails as a theory of financial decision making since it doesn't explain the observed reality.

hntrader 6y ago
I'm talking about the concept of expected utility. If EE does away with that concept, then it is a failed theory on conceptual grounds. Without this concept, tell me how EE is supposed to grapple with: (1) gamblers who take on negative EV bets (2) old people who shift into fixed income (3) low risk-tolerance young people who keep only cash (4) high risk-tolerance young people who put everything into crypto (5) why some people buy insurance and some don't, despite earning the same income The fact is, you can't explain this heterogeneous behaviour without the concept of expected utility of outcomes. Our brains are emotional, irrational vehicles designed by evo psych, and you can't grapple with that reality without some notion of subjective preference pertaining to expected outcome.
- ReflectedImage 6y ago
  Okay so let me cut this down. EE shows that EUT only gives correct results when U = log (Wealth), that means as soon as you set U to anything other than log (Wealth), it is no longer giving correct results. So it would be fair to say EUT also has no concept of utility.
  - kgwgk 6y ago
    How do you define "correct results"? Talking about portfolio selection, for example, the EE - a.k.a. U=log(wealth) - solution may be the "correct solution" to the "we never spend a dollar problem and we have an infinite horizon" problem. But EE cannot get any results, correct or otherwise, for many other problems that are much more interesting where EUT can be applied. Like investment decisions when your horizon is not infinite and you intend to use the money at some point.
  - hntrader 6y ago
    You misunderstand the concept of subjective utility. There's no such thing as a "correct result" because people's preferences (utility) varies by individual. What's "correct" for a risk-seeking gambler is very different to what's "correct" for an investor who's trying to build generational wealth. That's why we have a U(x) to begin with. Without addressing this concept, you're no longer attempting to describe reality, you're making a prescriptive normative assertion that everyone should follow a specific strategy of your choosing.
  - kgwgk 6y ago
    > EE shows that EUT only gives correct results when U = log (Wealth) You seem to think that this invalidates EUT. On the contrary, it's a vindication of EUT. In that particular case, EUT works and the preferences of the agent would be correctly described by that particular utility function. Otherwise you wouldn't say that EE and U=log(w) give "correct results". It can also happen in other cases that EE cannot be used to explain the preferences of the agent while EUT is still applicable because a utility function (maybe logarithmic, maybe not) can be found which describes them adequately.
- ReflectedImage 6y ago
  "There's no such thing as a "correct result" because people's preferences (utility) varies by individual." But there are incorrect results and setting U to anything other than log (Wealth) results in an incorrect result. "It can also happen in other cases that EE cannot be used to explain the preferences of the agent while EUT is still applicable because a utility function (maybe logarithmic, maybe not) can be found which describes them adequately." I just told you that you can not use an utility function other than log (Wealth). Any other utility function you use will give you a mathematically incorrect result. The log (Wealth) term covers up the maths error, so it can't be changed to another term. If you want to do something like that then you need to use the maths from EE.
  - hntrader 6y ago
    "Any other utility function you use will give you a mathematically incorrect result." Tell that to the drunk gambler who just empirically falsified your fantasy theory.
  - kgwgk 6y ago
    What does “mathematically incorrect” mean? The role of the utility function in EUT is to represent the agents preferences. Preferences can be rational (i.e. consistent) and not be represented by the logarithm of wealth. If Mr. X has some amount to invest now to pay for his child’s college in five years it’s not “irrational” to opt for something less risky than taking a loan to get a leveraged equity investment. Mr. X may not care that his portfolio wouldn’t growth at the optimal highest possible rate if left untouched forever, if that’s what you mean by “mathematically incorrect result”. Mr. X doesn’t care about your idea of “correct result”, he cares about being reasonably certain to have enough money available in five years. Now, you tell me to use the maths from EE to find the “correct” utility functions. How can I use the maths from EE to select a portfolio if I want to take out a certain amount of money in five years?
- mrow84 6y ago
  I think that the errors you are making are that EE does not do away with expected utility, and expected utility is not a strict requirement for the development of a theory to describe economic outcomes. 1) It seems to me that it is only utility, rather than its expectation, that is the concept you are treating as necessary. There are an infinity of ways to reduce a distribution of utility-weighted outcomes to a single summary, albeit not with the same simplicity (and perhaps value) as the expectation. 2) All of the phenomena you list could be described by some mechanism other than the agents involved computing expected utilities - whether or not this is a useful or effective description is beside the point, it is possible. (Expected) Utility is not required to describe these phenomena. 3) The basic EE claim is that the ergodic hypothesis, roughly that the temporal and ensemble distributions are the same, is false in the context of these economic systems. This has nothing to do with whether or not you can associate utility values with states, nor whether it is possible to compute expected utilities, but instead is a claim about how, and from where, those utilities should be measured, in particular when considering problems like optimising long-term returns.
  - deleted 6y ago
    [deleted]
  - kgwgk 6y ago
    1) If the expectation is there it's because the expected value of the utilities for a probability distribution over outcomes allows for an ordering of the available choices which is consistent with the preferences over outcomes. Is that true for any other among that infinity of ways of producing a summary? 3) Ok. Some people seem to think that EE disproves EUT somehow, though. That's the context of the comment your reply to.
    - mrow84 6y ago
      The comment I replied to was discussing the necessity of the concept of expected utility for the success of any economic theory. My points were with reference to that - I am only claiming that it is not a requirement for a reasonable economic theory, for the reason I stated. There are other syntheses that might better describe actual economic behaviour. More generally, there are two aspects of the value of EUT being discussed: 1) Does expected utility theory describe observed economic behaviour. There is evidence that it does not, and my previous points concern that fact. 2) Can expected utility theory be used to design a system that will produce optimal outcomes. EE confronts this question, and claims that, in the usual formulation of EUT, it cannot (because the ergodic hypothesis does not apply). As others have mentioned, in practice some people do account for non-ergodic behaviour. Others, however, do not, and being explicit about the limitations of any given model rarely hurts anything except people's egos.
kgwgk 6y ago
No. There are people who don't seem to understand what is EUT who claim so, though. [1] If EE just puts the U in EUT it will also fail as a theory of financial decision making in all the cases where EUT fails. [1] Did Ergodicity Economics and the Copenhagen Experiment Really Falsify Expected Utility Theory? https://researchers.one/articles/20.02.00002 https://researchers.one/articles/20.02.00002
- ReflectedImage 6y ago
  EE does not put an U in EUT. EE stats that in EUT the U term must equal log (Wealth) otherwise EUT produces wrong results. EE uses a completely different formula. It has an open space for a (slightly restricted) function (similar to U). An example of EE with this open space filled is Kelly's criterion, which of course looks nothing like EUT.
  - kgwgk 6y ago
    > An example of EE with this open space filled is Kelly's criterion, which of course looks nothing like EUT. I’m not sure if I’m reading this correctly: Kelly’s criterion looks nothing like EUT? Maybe I completely misunderstood what you were trying to say. https://en.wikipedia.org/wiki/Kelly_criterion https://en.wikipedia.org/wiki/Kelly_criterion “The Kelly bet size is found by maximizing the expected value of the logarithm of wealth, which is equivalent to maximizing the expected geometric growth rate.”

There are studies that show that people follow EE and not EUT. It's the other way around EUT fails as a theory of financial decision making since it doesn't explain the observed reality.

hntrader 6y ago

I'm talking about the concept of expected utility. If EE does away with that concept, then it is a failed theory on conceptual grounds. Without this concept, tell me how EE is supposed to grapple with: (1) gamblers who take on negative EV bets (2) old people who shift into fixed income (3) low risk-tolerance young people who keep only cash (4) high risk-tolerance young people who put everything into crypto (5) why some people buy insurance and some don't, despite earning the same income The fact is, you can't explain this heterogeneous behaviour without the concept of expected utility of outcomes. Our brains are emotional, irrational vehicles designed by evo psych, and you can't grapple with that reality without some notion of subjective preference pertaining to expected outcome.

ReflectedImage 6y ago
Okay so let me cut this down. EE shows that EUT only gives correct results when U = log (Wealth), that means as soon as you set U to anything other than log (Wealth), it is no longer giving correct results. So it would be fair to say EUT also has no concept of utility.
- kgwgk 6y ago
  How do you define "correct results"? Talking about portfolio selection, for example, the EE - a.k.a. U=log(wealth) - solution may be the "correct solution" to the "we never spend a dollar problem and we have an infinite horizon" problem. But EE cannot get any results, correct or otherwise, for many other problems that are much more interesting where EUT can be applied. Like investment decisions when your horizon is not infinite and you intend to use the money at some point.
- hntrader 6y ago
  You misunderstand the concept of subjective utility. There's no such thing as a "correct result" because people's preferences (utility) varies by individual. What's "correct" for a risk-seeking gambler is very different to what's "correct" for an investor who's trying to build generational wealth. That's why we have a U(x) to begin with. Without addressing this concept, you're no longer attempting to describe reality, you're making a prescriptive normative assertion that everyone should follow a specific strategy of your choosing.
- kgwgk 6y ago
  > EE shows that EUT only gives correct results when U = log (Wealth) You seem to think that this invalidates EUT. On the contrary, it's a vindication of EUT. In that particular case, EUT works and the preferences of the agent would be correctly described by that particular utility function. Otherwise you wouldn't say that EE and U=log(w) give "correct results". It can also happen in other cases that EE cannot be used to explain the preferences of the agent while EUT is still applicable because a utility function (maybe logarithmic, maybe not) can be found which describes them adequately.
ReflectedImage 6y ago
"There's no such thing as a "correct result" because people's preferences (utility) varies by individual." But there are incorrect results and setting U to anything other than log (Wealth) results in an incorrect result. "It can also happen in other cases that EE cannot be used to explain the preferences of the agent while EUT is still applicable because a utility function (maybe logarithmic, maybe not) can be found which describes them adequately." I just told you that you can not use an utility function other than log (Wealth). Any other utility function you use will give you a mathematically incorrect result. The log (Wealth) term covers up the maths error, so it can't be changed to another term. If you want to do something like that then you need to use the maths from EE.
- hntrader 6y ago
  "Any other utility function you use will give you a mathematically incorrect result." Tell that to the drunk gambler who just empirically falsified your fantasy theory.
- kgwgk 6y ago
  What does “mathematically incorrect” mean? The role of the utility function in EUT is to represent the agents preferences. Preferences can be rational (i.e. consistent) and not be represented by the logarithm of wealth. If Mr. X has some amount to invest now to pay for his child’s college in five years it’s not “irrational” to opt for something less risky than taking a loan to get a leveraged equity investment. Mr. X may not care that his portfolio wouldn’t growth at the optimal highest possible rate if left untouched forever, if that’s what you mean by “mathematically incorrect result”. Mr. X doesn’t care about your idea of “correct result”, he cares about being reasonably certain to have enough money available in five years. Now, you tell me to use the maths from EE to find the “correct” utility functions. How can I use the maths from EE to select a portfolio if I want to take out a certain amount of money in five years?
mrow84 6y ago
I think that the errors you are making are that EE does not do away with expected utility, and expected utility is not a strict requirement for the development of a theory to describe economic outcomes. 1) It seems to me that it is only utility, rather than its expectation, that is the concept you are treating as necessary. There are an infinity of ways to reduce a distribution of utility-weighted outcomes to a single summary, albeit not with the same simplicity (and perhaps value) as the expectation. 2) All of the phenomena you list could be described by some mechanism other than the agents involved computing expected utilities - whether or not this is a useful or effective description is beside the point, it is possible. (Expected) Utility is not required to describe these phenomena. 3) The basic EE claim is that the ergodic hypothesis, roughly that the temporal and ensemble distributions are the same, is false in the context of these economic systems. This has nothing to do with whether or not you can associate utility values with states, nor whether it is possible to compute expected utilities, but instead is a claim about how, and from where, those utilities should be measured, in particular when considering problems like optimising long-term returns.
- deleted 6y ago
  [deleted]
- kgwgk 6y ago
  1) If the expectation is there it's because the expected value of the utilities for a probability distribution over outcomes allows for an ordering of the available choices which is consistent with the preferences over outcomes. Is that true for any other among that infinity of ways of producing a summary? 3) Ok. Some people seem to think that EE disproves EUT somehow, though. That's the context of the comment your reply to.
  - mrow84 6y ago
    The comment I replied to was discussing the necessity of the concept of expected utility for the success of any economic theory. My points were with reference to that - I am only claiming that it is not a requirement for a reasonable economic theory, for the reason I stated. There are other syntheses that might better describe actual economic behaviour. More generally, there are two aspects of the value of EUT being discussed: 1) Does expected utility theory describe observed economic behaviour. There is evidence that it does not, and my previous points concern that fact. 2) Can expected utility theory be used to design a system that will produce optimal outcomes. EE confronts this question, and claims that, in the usual formulation of EUT, it cannot (because the ergodic hypothesis does not apply). As others have mentioned, in practice some people do account for non-ergodic behaviour. Others, however, do not, and being explicit about the limitations of any given model rarely hurts anything except people's egos.

kgwgk 6y ago

No. There are people who don't seem to understand what is EUT who claim so, though. [1] If EE just puts the U in EUT it will also fail as a theory of financial decision making in all the cases where EUT fails. [1] Did Ergodicity Economics and the Copenhagen Experiment Really Falsify Expected Utility Theory? https://researchers.one/articles/20.02.00002 https://researchers.one/articles/20.02.00002

ReflectedImage 6y ago
EE does not put an U in EUT. EE stats that in EUT the U term must equal log (Wealth) otherwise EUT produces wrong results. EE uses a completely different formula. It has an open space for a (slightly restricted) function (similar to U). An example of EE with this open space filled is Kelly's criterion, which of course looks nothing like EUT.
- kgwgk 6y ago
  > An example of EE with this open space filled is Kelly's criterion, which of course looks nothing like EUT. I’m not sure if I’m reading this correctly: Kelly’s criterion looks nothing like EUT? Maybe I completely misunderstood what you were trying to say. https://en.wikipedia.org/wiki/Kelly_criterion https://en.wikipedia.org/wiki/Kelly_criterion “The Kelly bet size is found by maximizing the expected value of the logarithm of wealth, which is equivalent to maximizing the expected geometric growth rate.”