Normative and Descriptive Theories of Decision Making under Risk : A Short Review

Abstract

The paper discusses some recent developments in analysis of decision making under risk and uncertainty.First we present the expected utility theory and the basic assumptions of rationality.Second we discuss the critique that has been directed towards the expected utility theory.Next we present the alternative theories: regret theory, prospect theory and theory of stochastic preference.Finally we discuss some practical examples from casinos and gambling markets.It is argued that descriptive theories (e.g.prospect theory) have taken room from normative theories (e.g.expected utility theory).We conclude that we should push forward with empirical testing, both experimental and non-experimental, and develop descriptive theories in the future.However normative and descriptive theories are not mutually exclusive.Both are needed in real life decision making.

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