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IAI Actuarial Core Principles · Economic Modelling · Rational choice theory and utility

Which of the following is an axiom underlying the expected utility theorem of von Neumann and Morgenstern?

Independence is a von Neumann-Morgenstern axiom: if one lottery is preferred to another, mixing both with the same third lottery in the same proportions keeps that preference. Concavity and constant risk aversion are additional assumptions, not axioms.

  1. AIndependence: if lottery A is preferred to B, then mixing each with a third lottery C in the same proportions preserves the preferenceCorrect
  2. BNon-satiation implies utility must be concave
  3. CUtility must be measured in rupees
  4. DIndividuals always maximise expected monetary value
  5. Absolute risk aversion must be constant

Explanation

The vNM axioms are completeness, transitivity, continuity and independence. Concavity, constant risk aversion and expected-value maximisation are not axioms; they are extra assumptions or specific cases.

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