Making valuations with the priority heuristic

Abstract

The priority heuristic is a lexicographic semi-order for choosing between gambles. It has merits such as predicting, out-of-sample, people’s majority choice more accurately than benchmarks such as prospect theory, having been axiomatized, and logically implying major violations of expected utility theory. The heuristic has shortcomings too, such as failing to account for individual differences and intricate choice patterns, and predicting less accurately than various model ensembles and neural networks. This note focuses on an important purported shortcoming of the heuristic, that it cannot produce valuations of gambles. I point out that the certainty equivalent of a gamble for the priority heuristic is known and suggest that this fact can be used to enhance the scope of the heuristic. Indeed, by making simple auxiliary assumptions and calculations, I demonstrate that the priority heuristic can explain the Saint Petersburg paradox and the equity premium puzzle, and to do so arguably more parsimoniously and plausibly than standard approaches.

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