Econometric applications of maxmin expected utility

Gary Chamberlain

65 citations0/0 files storedJournal of Applied Econometrics

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Decision-Making and Behavioral Economics Statistical Methods and Bayesian Inference Risk and Portfolio Optimization

Abstract

Abstract Gilboa and Schmeidler (1989) develop a set of axioms for decision making under uncertainty. The axioms imply a utility function and a set of distributions such that the preference ordering is obtained by calculating expected utility with respect to each distribution in the set, and then taking the minimum of expected utility over the set. In a portfolio choice problem, the distributions are joint distributions for the data that will be available when the choice is made and for the future returns that will determine the value of the portfolio. The set of distributions could be generated by combining a parametric model with a set of prior distributions. We apply this framework to obtain a preference ordering over decision rules, which map the data into a choice. We seek a decision rule that maximizes the minimum expected utility (or, equivalently, minimizes maximum risk) over the set of distributions. An algorithm is provided for the case of a finite set of distributions. It is based on solving a concave programme to find the least‐favourable mixture of these distributions. The minimax rule is a Bayes rule with respect to this least‐favourable distribution. The minimax value is a lower bound for minimax risk relative to a larger set of distributions. An upper bound can be found by fixing a decision rule and calculating its maximum risk. We apply the algorithm to an estimation problem in an autoregressive, random‐effects model for panel data. Copyright © 2000 John Wiley & Sons, Ltd.

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References

1989Maxmin expected utility with non-unique prior 2000Investing for the Long Run when Returns Are Predictable 1955Theory of Games and Statistical Decisions.1952Rational Decisions 1955Theory of Games and Statistical Decisions

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