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Transitive regret

Sushil Bikhchandani

Anderson School of Management, University of California, Los Angeles

Uzi Segal

Department of Economics, Boston College

Preferences may arise from regret, i.e., from comparisons with alternatives for-

gone by the decision maker. We ask whether regret-based behavior is consistent

with nonexpected utility theories of transitive choice and show that the answer

is no. If choices are governed by ex ante regret and rejoicing, then nonexpected

utility preferences must be intransitive.

Keywords. Regret, transitivity, nonexpected utility.

JEL classification. D81.

1. Introduction

Standard models of choice assume that decision makers act as if they maximize a prefer-

ence relation over sets of options and these preferences are assumed to be independent

of the environment. There are, however, good reasons to challenge this assumption.

Preferences may depend on the decision makers holding (reference point), on other

peoples holdings (envy), or on the choice set itself.

One such model is regret theory (Bell 1982 and Loomes and Sugden 1982). Accord-

ing to this theory the decision maker anticipates his future feelings about the choice he

is about to make and acts according to these feelings. This approach is natural when

the decision maker has to choose between two (or more) random variables. Once the

uncertainty is resolved, he will know what outcome he received, but also what outcome

he could have received had he chosen an alternative option. This comparison may lead

to rejoicingif his actual outcome is better than the alternativeor regret.

Formally, let A and Y be two random variables with money outcomes. Let (:, ,)

measure the regret or rejoicing a person feels when observing that he won : while the

alternative choice would have landed him,. Choosing A over Y thus leads, ex ante, to a

lottery +(A, Y) where the outcomes are (:, ,). Choice is based on regret and rejoicing

if there is a functional ! over regret/rejoice lotteries such that A is chosen over Y if and

only if ! (+(A, Y)) >0.

Sushil Bikhchandani: sbikhcha@anderson.ucla.edu

Uzi Segal: segalu@bc.edu

We thank Beth Allen, Kim Border, Eddie Dekel, Larry Epstein, Matt Jackson, Graham Loomes, Joel Sobel,

Bob Sugden, Peter Wakker, the editor, and the referees for helpful comments and suggestions.

Copyright 2011 Sushil Bikhchandani and Uzi Segal. Licensed under the Creative Commons Attribution-

NonCommercial License 3.0. Available at http://econtheory.org.

DOI: 10.3982/TE738

96 Bikhchandani and Segal Theoretical Economics 6 (2011)

The question we ask is simple: What functionals ! and regret/rejoice functions

are consistent with transitive choice? That is, when is it true that if ! (+(A, Y)) >0 and

! (+(Y, 7)) > 0, then ! (+(A, 7)) > 0 as well? If regret is separable across events, that

is, if ! (+(A, Y)) =

i

!

i

((:

i

, ,

i

), s

i

), then the possibility of having a violation of tran-

sitivity is well known (see Bell 1982, Loomes and Sugden 1982, and Fishburn 1989). In

fact, in that case, violations of transitivity must be observed unless (:, ,) =u(:) u(,),

which means that the original preferences are expected utility.

1

The main result of our

paper is that regret-based transitive choice implies expected utility and this conclusion

does not depend on ! being linear in probabilities or even separable across states.

To see why this result is not obvious, consider the following intuition. For equiprob-

able partition S

1

, . . . , S

n

, transitivity implies that for any vector of outcomes (:

1

, . . . , :

n

)

and any permutation of {1, . . . , n},

(:

1

, S

1

; . . . ; :

n

, S

n

) (:

(1)

, S

1

; . . . ; :

(n)

, S

n

)

(see Proposition 1 below). Separability of ! implies that the regret evaluation of

(:

i

, :

(i)

) in event S

i

does not depend on what happens in event S

]

, ] =i. Therefore, any

regret pair (:, ,) can be evaluated through a lottery and its permutation as above. With-

out separability this cannot be done, as the evaluation of the regret pair (:, ,) depends

on the rest of the lottery.

One can read the result of the paper in two different ways. It offers a necessary and

sufcient conditionfor a functional to be expectedutility without making any references

to mixture spaces (see Kreps 1988 for summary of terms and basic results). But the real

contribution is the impossibility result that shows that regret is inherently intransitive. If

so, then one must either conclude that (i) regret, despite its clear psychological appeal,

cannot be used in standard economic models; (ii) models of regret that are richer than

in Bell (1982) and Loomes and Sugden (1982) are necessaryfor example, as is done

in Sarver (2008) or by dening regret with respect to foregone distributions rather than

foregone outcomes (see Machina 1987 and Starmer 2000 for some steps in this direc-

tion); (iii) models of intransitive preferences must be incorporated into economics as in

Fishburn and LaValle (1988), Loomes and Sugden (1987), or Hayashi (2008).

2

The paper is organized as follows. The model and the main result are presented in

the next section. Section 3 offers an outline of the proof, while the details of the proof

appear in the Appendix.

2. The model and main result

Let L be the set of real nite-valued random variables over (S, l, P) with S = [0, 1], l

being the standard Borel algebra on S, P = being the Lebesgue measure, and the

set of outcomes being the bounded interval [

relation over L. In the sequel, we denote events by S

i

and T

i

.

1

For this observation, see Sugden (2004, p. 739). We offer a formal proof of this claim in Lemma 7 below

as we are not aware of one in the literature.

2

See also Starmer (2000) for further references.

Theoretical Economics 6 (2011) Transitive regret 97

Definition 1. The continuous function : [

:, :] [

all :, (:, :) =0, (:, ,) is strictly increasing in : and strictly decreasing in ,.

If in some event A yields : and Y yields ,, then (:, ,) is a measure of the decision

makers ex post feelings (of regret if : - , or rejoicing if : > ,) about the choice of A

over Y. This leads to the next denition.

Definition 2. Let A, Y L, where A = (:

1

, S

1

; . . . ; :

n

, S

n

) and Y = (,

1

, S

1

; . . . ; ,

n

, S

n

).

The regret lottery evaluating the choice of A over Y is

+(A, Y) =((:

1

, ,

1

),

1

; . . . ; (:

n

, ,

n

),

n

),

where

i

= P(S

i

), i = 1, . . . , n. Denote the set of regret lotteries by R = {+(A, Y) :

A, Y L}.

For brevity we refer to and + as regret function and regret lottery, respectively,

even though they encompass both regret and rejoicing.

Definition 3. The preference relation is regret based if there is a regret function

and a continuous functional ! that is dened over regret lotteries such that for any

A, Y L,

A Y if and only if ! (+(A, Y)) 0.

The main result of this paper is the following.

Theorem 1. Let be a complete, transitive, continuous, and monotonic preference re-

lation over the set L of random variables. The relation is regret based if and only if it is

expected utility.

This theorem implies, in particular, the known result that the regret models of Bell

(1982), Loomes and Sugden (1982), and Sugden (1993) are intransitive.

3

We take this

result a step further and show that this intransitivity is not caused by separability across

events, but is the result of regret itself.

4

Recently, Sarver (2008) presented a nonexpected utility model of regret that is transi-

tive, but it departs fromthe standard regret model of Bell (1982) and Loomes and Sugden

(1982). In Sarvers model, the decision maker chooses between menus of lotteries and

a lottery from the selected menu. At the time these two choices are made, the decision

maker is uncertain about the utility of different outcomes. Later, after uncertainty is

3

An important exception is the case where the choice set consists of statistically independent random

variables, and for the two lotteries (:

1

,

1

; . . . ; :

n

,

n

) and (,

1

, q

1

; . . . ; ,

n

, q

n

), the probability of the regret

(:

i

, ,

]

) is

i

q

]

(see Machina 1987, pp. 138140 and Starmer 2000, pp. 355356). For example, Hong (1983)

weighted utility theory is consistent with this form of regret.

4

Guls (1991) model of disappointment is transitive and nonexpected utility. The comparison in this

model is between the outcome of a lottery and the lottery itself, rather than between possible outcomes of

a pair of lotteries.

98 Bikhchandani and Segal Theoretical Economics 6 (2011)

resolved, the decision maker may experience ex post regret if the selected lottery turns

out to be inferior to another lottery that is also in the menu he selected. This induces

a transitive, nonexpected utility preference relation over menus of lotteries in the initial

period. However, this is not inconsistent with Theorem 1. First, if menus are single-

tons, then Sarvers model reduces to expected utility. Second, the source of uncertainty

is different. In our model, the decision maker does not know which state of nature will

hold and, therefore, he does not know what outcome he will receive. In Sarvers model,

the decision maker does not know his future preferences and regret may emerge from

realizing that given his (now) known preferences, he chose the wrong option.

Theorem 1 is proved as follows. It is well known that expected utility is regret based

(with (:, ,) =u(:)u(,) and ! (+(A, Y)) =

i

(:

i

, ,

i

)). That any transitive regret-

based preferences must be expected utility is proved in a sequence of steps summarized

below.

Step 1. Preferences satisfy the equivalence condition (Loomes and Sugden 1982,

p. 818). That is, if A and Y have the same distribution, then A Y (Section 3.1,

Proposition 1).

Step 2. The indifference curve of ! through zero, {F: ! (F) =0}, is linear in probabili-

ties (Section 3.3, Lemmas 35).

Step 3. There exists ! as in Denition 3 that is linear in probabilities for all regret lot-

teries F (Section 3.4, Lemma 6).

Step 4. The preference relation is expected utility (Section 3.4, Lemma 7).

3. Proof of the theorem

3.1 Probabilistic equivalence

Whenpreferences are regret based, the decisionmaker cares about what events will hap-

pen as this will tell him what are the alternative outcomes he could have received had

he chosen differently. When the decision maker learns that the number 4 on a die yields

$100 under A and $150 under Y, the fact that these two outcomes are linked to the same

state of the world is important, but the state itself is not. Consequently, only the prob-

abilities of the underlying states are relevant for regret between A and Y. As long as

the probability of the number 1 is the same as that of 4, it makes no difference whether

the regret (100, 150) is obtained when the number is 1 or 4. This is why regret lotteries

are evaluated with respect to their probabilities and not with respect to the generating

events.

Proposition 1 shows that this observation, together with transitivity, has a signi-

cant implication to the evaluation of random variables. To see this, consider a box with

n balls, numbered 1, . . . , n. Draw one ball at random, and let A = (:

1

, S

1

; . . . ; :

n

, S

n

),

where S

i

is the event ball i is drawn. Let : {1, . . . , n} {1, . . . , n} be a permutation

of the n numbers and let (A) (:

(1)

, S

1

; . . . ; :

(n)

, S

n

). If A (A), then according

to the discussion in the last paragraph, it should also be the case that (A)

2

(A),

2

(A)

3

(A), . . . ,

n!1

(A)

n!

(A). By transitivity, we obtain that A

n!

(A) =A,

a contradiction.

Theoretical Economics 6 (2011) Transitive regret 99

For A L, let I

A

be the distribution of A, that is, I

A

(:) =P(A :).

Proposition 1 (Probabilistic equivalence). Let be a continuous and transitive regret-

based preference relation over L. For any two random variables A, Y L, if I

A

= I

Y

,

then A Y.

Loomes and Sugden (1987) and Fishburn and LaValle (1988) use cycles as above to

justify violations of transitivity. In Fishburn and LaValle (1988), a fair die is rolled and

payments are made according to the number shown. Consider the randomvariables A

1

and A

2

=(A

1

) given by

S

1

S

2

S

3

S

4

S

5

S

6

A

1

$1,000 $500 $600 $700 $800 $900

A

2

$900 $1,000 $500 $600 $700 $800

As in ve of six cases A

1

yields $100 more than A

2

, Fishburn and LaValle suggest that

preferring A

1

to A

2

is natural. But of course, using such a permutation ve more times

leads to a nontransitive cycle.

The converse of Proposition 1 is not true. As is demonstrated by the follow-

ing example, there are nontransitive regret-based preferences that satisfy probabilistic

equivalence.

Example 1. For two random variables A and Y, nd comonotonic A

and Y

with

the same distributions as A and Y. Formally, for A = (:

1

, S

1

; . . . ; :

n

, S

n

) and Y =

(,

1

, T

1

; . . . ; Y

n

, T

n

), nd A

= (:

1

, L

1

; . . . ; :

, L

) and Y

= (,

1

, L

1

; . . . ; ,

, L

) such that

:

1

:

, ,

1

,

, I

A

= I

A

, and I

Y

= I

Y

. Observe that A

and Y

depend

on both A and Y. Dene now A Y if and only if ! (A

, Y

) 0, where ! (A

, Y

) =

P(L

i

)(:

i

,

i

)

3

. In other words, is regret based with respect to the probability distri-

bution functions. As such, it satises probabilistic equivalence.

Let P(L

1

) =P(L

2

) =P(L

3

) =

1

3

. The random variables A, Y, 7 are given by

L

1

L

2

L

3

A 8 19 30

Y 9 20 28

7 10 18 29

Clearly ! (A, Y) =! (Y, 7) =! (7, A) =6, hence A Y, Y 7, but 7 A.

3.2 Preliminary results

We assume that outcomes are in a nite interval [

:, :]. Let

r = (

:, :) and r = ( :,

:).

By the continuity of the regret functional, -

r -0 - r -. As (:, ,) is continuous,

increasing in :, and decreasing in ,, it follows that the set of regret lotteries Rdened in

Denition 2 is the set of nite-valued lotteries with outcomes in the interval [

r, r]. The

following monotonicity properties of ! are inherited from the monotonicity of .

100 Bikhchandani and Segal Theoretical Economics 6 (2011)

Lemma 1. Let F and F

by rst-

order stochastic dominance (FOSD).

(i) If ! (F) =0, then ! (F

) -0.

(ii) If ! (F

The next lemma permits a selection of regret lotteries that are skew symmetric in

regret and rejoicing.

Lemma 2. (i) If (:, ,) =(:

, ,

, :

).

(ii) The equality (:, ,) =(,, :) is without loss of generality.

We will assume throughout that (:, ,) =(,, :) and that +(A, Y) =+(Y, A)

((,

1

, :

1

),

1

; . . . ; (,

n

, :

n

),

n

). Moreover,

r = r.

3.3 The indifference curve through zero is linear

A regret lottery F is generated by a permutation if there exists a random variable A =

(:

1

, S

1

; . . . ; :

n

, S

n

), P(S

i

) = 1,n, and a permutation of A such that +(A, (A)) = F.

By Proposition 1, if F is generated by a permutation, then ! (F) = 0. The next lemma

shows that the subset of {F: ! (F) =0} that is generated by permutations is convex.

Lemma 3. If F and F

1

2

F+

1

2

F

.

As F and F

) = 0 and, by

Lemma 3, ! (

1

2

F +

1

2

F

that every regret lottery F = (r

1

, 1,n; . . . ; r

n

, 1,n) such that ! (F) = 0 is generated by a

permutation.

Example 2. Consider an expected value maximizer whose choice set consists of ran-

dom variables with prizes in the interval [3, 3]. This individuals regret function is

(:, ,) =: , and he is indifferent between A and Y dened below, where P(S

i

) =0.2:

A = (3, S

1

; 3, S

2

; 1, S

3

; 1, S

4

; 1, S

5

)

Y = (3, S

1

; 3, S

2

; 3, S

3

; 3, S

4

; 3, S

5

).

As A Y, ! (+(A, Y)) =! (6, 0.2; 6, 0.2; 4, 0.2; 4, 0.2; 4, 0.2) =0. But there does not

exist a random variable

7 with outcomes in the interval [3, 3] and a permutation

such that +(A, Y) =+(

7, (

7)). To see why, observe that the rejoicing 6 must be gen-

erated by the outcomes 3 and 3. From outcome 3, only regret is possible, and as the

only regret level is 4, the outcome 3 must be paired with 1. From outcome 1, one

cannot generate rejoicing 6 or have regret 4.

5

5

If, instead, we had assumed that the set of outcomes was (, ), then any F = (r

1

, 1,n; . . . ; r

n

, 1,n)

such that ! (F) =0 would be generated by a permutation, leading to a simpler proof of Theorem 1.

Theoretical Economics 6 (2011) Transitive regret 101

The problem is that the outcomes in A and Y are far apart. However, as is shown by

the next example, one can nd in Example 2 a random variable 7 whose outcomes are

sufciently close to both A and Y such that A 7 Y, and the regret lotteries +(A, 7)

and +(7, Y) are generated by permutations.

Example 3. Using the notationof Example 2, let 7 =(0, S

1

; 0, S

2

; 1, S

3

; 1, S

4

; 1, S

5

). Thus

+(A, 7) =+(7, Y) =(3, 0.2; 3, 0.2; 2, 0.2; 2, 0.2; 2, 0.2).

Dene

7 = (3, S

1

; 0, S

2

; 3, S

3

; 1, S

4

; 1, S

5

)

(

7) = (0, S

1

; 3, S

2

; 1, S

3

; 1, S

4

; 3, S

5

).

Then +(

7, (

7)) =+(A, 7) =+(7, Y).

This idea is formalized below.

Lemma 4. Let A Y, where A = (:

1

, S

1

; . . . ; :

n

, S

n

), Y = (,

1

, S

1

; . . . ; ,

n

, S

n

), and

P(S

i

) = 1,n. Then there is a sequence A = 7

1

7

2

7

l

= Y such that for

every = 1, . . . , l 1, there is a regret lottery

7

and a permutation

so that

+(7

, 7

+1

) =+(

7

(

7

)).

Thus, even if a regret lottery F=(r

1

, 1,n; . . . ; r

n

, 1,n) with ! (F) =0 is not generated

by a permutation, one can nd a sequence of random variables 7

1

7

l

such that

each +(7

, 7

+1

) is generated by a permutation and F = +(7

1

, 7

l

). This is used to

prove that the set {F: ! (F) =0} is convex.

Lemma 5. If ! (F) =! (F

) =0, then ! (

1

2

F+

1

2

F

) =0.

3.4 V is linear in probabilities and is expected utility

The following lemma establishes that all indifference curves of ! are linear.

Lemma 6. (i) There is a function : : [ r, r] such that ! (F) 0 if and only if

E[:(F)] 0.

(ii) Moreover, : is strictly increasing with :(0) =0 and :((:, ,)) =:((,, :)) for all

:, ,.

We now use the function : to create a function u on outcomes that will turn out to

be the von NeumanMorgenstern utility claimed by Theorem 1.

Lemma 7. There exists an increasing function u: [

:, :] such that

:((:, ,)) =u(:) u(,).

102 Bikhchandani and Segal Theoretical Economics 6 (2011)

From the last two lemmas, we have for A = (:

1

, S

1

; . . . ; :

n

, S

n

) and Y = (,

1

, S

1

; . . . ;

,

n

, S

n

), where P(S

i

) =

i

,

A Y ! (+(A, Y)) 0

i

:((:

i

, ,

i

)) 0

i

[u(:

i

) u(,

i

)] 0

E[u(A)] E[u(Y)],

which is the claim of the theorem.

Appendix

Proof of Proposition 1. Let A = (:

1

, S

1

; . . . ; :

n

, S

n

) and Y = (,

1

, S

1

; . . . ; ,

n

, S

n

) be

such that I

A

=I

Y

.

Case 1. S

i

= S

i

and P(S

i

) = 1,n, i = 1, . . . , n. Then there is a permutation such that

Y = (A). Obviously, +(A, (A)) = +(

i

(A),

i+1

(A)). Hence, as there exists n n!

such that

n

(A) = A, it follows by transitivity that for all i, A

i

(A). In particular,

A Y.

Case 2. For all i, ], P(S

i

S

]

) is a rational number. Let N be a common denominator

of all these fractions. Random variables A and Y can now be written as in Case 1 with

equiprobable events T

1

, . . . , T

N

.

Case 3. There exist i and ], such that P(S

i

S

]

) is irrational. Any random variable

7 = (:

1

, T

1

; . . . ; :

n

, T

n

) is the limit of 7

l

= (:

l

1

, T

l

1

; . . . ; :

l

2

l

, T

l

2

l

), where for all l and ,

P(:

l

) =2

l

. This case follows by continuity from Case 2.

Proof of Lemma 1. Let F and F

by

FOSD if and only if there is a list of probabilities

1

, . . . ,

n

adding up to 1 such that

F=(r

1

,

1

; . . . ; r

n

,

n

) and F

=(r

1

,

1

; . . . ; r

n

,

n

), and for all i, r

i

r

i

.

Fromthe continuity of , we knowthat for every r [

r, r] there exist :, , [

:, :] such

that r =(:, ,). Hence there are A, Y L such that +(A, Y) =F. By the continuity and

monotonicity of , we can nd A

and Y

such that :

i

:

i

, ,

i

,

i

, (:

i

, ,

i

) =r

i

for each

i, and +(A

, Y

) =F

by FOSD or Y

strictly dominates

Y by FOSD (or both). Monotonicity of implies that A A

and Y

Y with at least

one of these preferences being strict.

(i) If ! (F) = 0, then A Y. By transitivity, A

and hence ! (F

) =

! (+(A

, Y

)) -0.

Theoretical Economics 6 (2011) Transitive regret 103

(ii) If ! (F

) = 0, then A

! (+(A, Y)) >0.

Proof of Lemma 2. (i) Let S

1

and S

2

be two disjoint events, where P(S

1

) = P(S

2

) =

0.5. Dene the lotteries A = (:, S

1

; ,, S

2

), Y = (,, S

1

; :, S

2

), A

= (:

, S

1

; ,

, S

2

), and

Y

=(,

, S

1

; :

, S

2

). Let r =(:, ,) =(:

, ,

). Then

+(A, Y) = (r, 0.5; (,, :), 0.5)

+(A

, Y

) = (r, 0.5; (,

, :

), 0.5).

By Proposition 1, A Y and A

, Y

)) = 0.

But if (,, :) =(,

, :

, Y

),

contradicting Lemma 1.

(ii) Recall that (:, :) =0. Let ] : [

r, r] [ r, r] be dened as

] (r) =

r if r 0.

By the rst part of this lemma, the value of ] (r) for r -0 does not depend on the choice

of :, , in the above denition; hence ] is well dened. Monotonicity of implies that ]

is strictly increasing. We can, therefore, dene

!

(r

1

,

1

; . . . ; r

n

,

n

) =! (]

1

(r

1

),

1

; . . . ; ]

1

(r

n

),

n

).

Let

(:, ,) =

(:, ,) if : ,

] ((:, ,)) if : -,.

Now

A Y ! (+(A, Y)) ! (+(Y, A))

!

(+

(A, Y)) !

(+

(Y, A)),

where +

(:, ,).

Proof of Lemma 3. In the sequel, random variables Q with n (not necessarily dis-

tinct) outcomes are of the form (q

1

, S

n

1

; . . . ; q

n

, S

n

n

) for some canonical partition where

P(S

n

i

) =1,n, i =1, . . . , n. For Q and Q

Q, Q

=(q

1

, S

2n

1

; . . . ; q

n

, S

2n

n

; q

1

, S

2n

n+1

; . . . ; q

n

, S

2n

2n

),

where P(S

2n

i

) =1,(2n).

Let F and F

be generated by permutations of A = (:

1

, S

1

; . . . ; :

n

, S

n

) and

of

Y = (,

1

, S

1

; . . . ; ,

n

, S

n

), respectively, where P(S

i

) = P(S

i

) = 1,n, i = 1, . . . , n. That is,

F =+(A, (A)) and F

=+(Y,

104 Bikhchandani and Segal Theoretical Economics 6 (2011)

length is without loss of generality.) Dene 7 =A, Y and

by

(i) =

(i) if i n

(i n) +n if i >n

to obtain +(7,

(7)) =+(A, Y,

A, Y) =

1

2

F+

1

2

F

.

Proof of Lemma 4. All random variables in this proof have n outcomes on the

equiprobable events S

1

, . . . , S

n

. For 7 = (:

1

, S

1

; . . . ; :

n

, S

n

) and 7

= (:

1

, S

1

; . . . ; :

n

, S

n

),

dene 7 7

=max

i

|:

i

:

i

|.

The proof follows from Claims 1 and 2.

Claim 1. Let A Y. For any > 0, there exist 7

1

, . . . , 7

l

such that A = 7

1

7

l

=Y and 7

1

7

, =2, . . . , l.

Proof. We construct the sequence 7

1

, . . . inductively. Suppose that A =Y and that we

have already dened A =7

1

7

such that 7

i1

7

i

, i =2, . . . , . If 7

=Y,

we are through. Otherwise, dene L

+

={i : :

i

>,

i

} and L

={i : :

i

-,

i

}. As 7

Y and

7

=Y, both L

+

and L

+

= min

iL

+

{:

i

,

i

}

= min

iL

{,

i

:

i

}.

Dene ]

() such that 7

7

+1

() (:

+1

1

(), S

1

; . . . ; :

+1

n

(), S

n

), where

:

+1

i

() =

i

if i L

+

:

i

+]

() if i L

1

i

otherwise.

By continuity and monotonicity of , ]

increasing. Its inverse exists and is continuous. Dene

=min{,

+

, ]

1

)} and let

7

+1

=7

+1

(

). Note that 7

1

, . . . , 7

+1

satisfy the hypothesis of the claim.

If

= , then 7

+1

Y 7

Y . If

+

, then |L

+1

+

| |L

+

| 1. If

=]

1

), then |L

+1

| |L

steps with 7

l

=Y.

Claim 2. There exists

n

>0 such that if for all i, |r

i

| -

n

, then there exist a randomvari-

able

7 and a permutation such that F=(r

1

, 1,n; . . . ; r

n

, 1,n) satises F=+(

7, (

7)).

Proof. The domain of outcomes is [

:, :]. Let

:

1

=

: +

:

2

n

=

:

:

2n

=

:

1

:

n

=

: :

1

n

>0.

Theoretical Economics 6 (2011) Transitive regret 105

Thus, :

1

+n

n

= : and :

1

n

n

=

:.

The function is continuous on the compact segment [

n

>0, there exists

n

>0 such that |(:, ,)| -

n

implies |:,| -

n

. Thus, with |r

i

| -

n

we can construct

7 such that

S

1

S

2

S

3

S

4

S

n1

S

n

7 :

1

:

2

:

3

:

4

:

n1

:

n

(

7) :

2

:

3

:

4

:

5

:

n

:

1

+(

7, (

7)) r

1

r

2

r

3

r

4

r

n1

( :

n

, :

1

)

Outcome :

1

is chosen to be the midpoint between

+1

is cho-

sen so that ( :

, :

+1

) =r

, =1, 2, . . . , n 1. As |r

| -

n

, we have | :

:

+1

| -

n

and

each :

7, (

7))) = 0, it must be that ( :

n

, :

1

) = r

n

. Other-

wise, F either dominates or is dominated by +(

7, (

7)), contradicting Lemma 1. Thus,

F=+(

7, (

7)).

This completes the proof of Lemma 4.

Proof of Lemma 5. For F = (r

1

, 1,n; . . . ; r

n

, 1,n) and F

= (r

1

, 1,n; . . . ; r

n

, 1,n) such

that (F) = (F

) = 0, let A, Y, A

, Y

, Y

) = F

.

By Lemma 4, there exist sequences A =7

1

7

l

=Y and A

=7

1

7

l

=Y

7

,

7

satisfying +(

7

(

7

)) =

+(7

, 7

+1

) and +(

7

(

7

)) = +(7

, 7

+1

).

6

Thus, for each = 1, 2, . . . , l 1, the

pair of regret lotteries +(7

, 7

+1

) and +(7

, 7

+1

) satises the hypothesis of Lemma 3.

Therefore,

!

1

2

+(7

, 7

+1

) +

1

2

+(7

, 7

+1

)

=0.

Note that

1

2

+(7

, 7

+1

) +

1

2

+(7

, 7

+1

) = +(7

, 7

, 7

+1

, 7

+1

), where , is de-

ned in the proof of Lemma 3. Consequently,

A, A

=7

1

, 7

1

7

l

, 7

l

=Y, Y

.

Hence

!

+(A, A

, Y, Y

=0,

but

+(A, A

, Y, Y

) =

1

2

F+

1

2

F

and we obtain ! (

1

2

F+

1

2

F

) =0.

As each A L is the limit of a sequence {A

l

}, where for each l, A

l

=(:

l

1

, 1,n

l

; . . . ;

:

l

n

l

, 1,n

l

), the lemma now follows by continuity for all F and F

! (F

) =0.

6

We use the same l in both sequences without loss of generality, as the sequences may become station-

ary from a certain point on.

106 Bikhchandani and Segal Theoretical Economics 6 (2011)

Proof of Lemma 6. Recall that ! (

r

) > 0 > ! (

r

), where

i

is the constant lottery

yielding i.

(i) For a regret lottery F such that ! (F) > 0, let (F) be dened by ! ((F)F +

(1 (F))

r

) = 0, and for F such that ! (F) - 0, let (F) be dened by ! ((F)F +

(1 (F))

r

) = 0. By Lemma 1 and the continuity of ! , (F) is well dened and

(F) -1. Let

satisfy ! (

r

+(1

)

r

) =0.

We show rst that is a continuous function. Let F

l

F

0

and suppose that

(F

l

)

.

7

Suppose without loss of generality that for all l, ! (F

l

) 0. By the conti-

nuity of ! ,

! (

F

0

+(1

)

r

) =lim

l

!

(F

l

)F

l

+(1 (F

l

))

r

=0,

hence

=(F

0

).

Dene now

U(F) =

(F)

if ! (F) >0

0 if ! (F) =0

1

(F)

if ! (F) -0.

For F such that ! (F) = 0, (F) - 1; hence U(F) 0 if and only if ! (F) 0. The

continuity of () implies that U(F) is continuous. We show next that U is linear. That

is, for all F and F

, U(

1

2

F+

1

2

F

) =

1

2

U(F) +

1

2

U(F

).

By Lemma 5 and the continuity of ! we have the following conclusion.

Conclusion 1. If ! (F) =! (F

) =0.

For arbitrary regret lotteries F and F

lotteries over F, F

,

r

,

r

. Take a linear transformation K of A such that K(

r

) =

(0, 0, 1), K(

r

) = (0, 0, (1

)), K(F) = (:

, ,

, :

), K(F

) = (:

, ,

, :

), and, by

Conclusion 1, ! (:, ,, :) =0 if and only if : =0. It follows that for : >0, (:, ,, :) solves

: (1 ) =0 (:, ,, :) =

1

: +1

and for : -0, (:, ,, :) solves

: +(1 )

1

=0 (:, ,, :) =

1

:

.

In both cases, U(:, ,, :) =

:.

Dene now a preference relation

on regret lotteries by F

if and only if

U(F) U(F

). Since U is continuous, so is

satises the

independence axiom. Therefore, there is a function : such that U(F) 0 if and only if

E[:(F)] 0. The lemma follows since U(F) 0 if and only if ! (F) 0.

7

If (F

l

) does not have a limit, then we take a subsequence that has a limit.

Theoretical Economics 6 (2011) Transitive regret 107

(ii) Suppose that :() is not strictly increasing. Then there exists r

1

- r

2

such that

:(r

1

) :(r

2

). Take F=(r

1

,

1

; r

2

,

2

; . . . ; r

n

,

n

) such that ! (F) =0. The continuity of !

implies that such an F exists. Construct F

= (r

1

,

1

; r

2

,

2

+; . . . ; r

n

,

n

). Clearly

F

:(0) =0 follows from! (0, 1) =0.

Finally, let S

1

and S

2

be two disjoint events where P(S

1

) = P(S

2

) = 0.5. Dene

A = (:, S

1

; ,, S

2

) and Y (,, S

1

; :, S

2

). By Proposition 1, A Y. Thus :((:, ,)) =

:((,, :)).

Proof of Lemma 7. The following claim follows from a theorem in Aczl (1966) and is

mentioned, without an explicit proof, in Sugden (2004, p. 739).

Claim 3. If G(:, ,) + G(,, :) = G(:, :) for all : - , - :, then there exists a function

g: such that G(:, ,) =g(:) g(,).

Proof. Dene

H(:, ,) =

G(:, ,) if : -,

0 if : =,

G(,, :) if : >,.

It may be veried that for all :, ,, :,

H(:, ,) +H(,, :) =H(:, :).

Therefore, Aczl (1966, Theorem 1, p. 223) implies that there exists g: such that

H(:, ,) =g(:) g(,).

Select :

1

-:

2

-:

3

and , q >0, =q, +q -

1

3

. Dene lotteries A and Y as follows:

S

1

S

4

S

7

S

2

S

5

S

8

S

3

S

6

S

9

P(S

i

) q q q

1

3

q

1

3

q

1

3

q

A :

1

:

2

:

3

:

1

:

2

:

3

:

1

:

2

:

3

Y :

3

:

1

:

2

:

2

:

3

:

1

:

1

:

2

:

3

Proposition 1 implies A Y, as each of these lotteries gives :

1

, :

2

, and :

3

with

probability

1

3

each. Thus, ! (+(A, Y)) = 0 and, by Lemma 6, E[:(+(A, Y))] = 0. As

:((:, ,)) =:((,, :)) and :((:, :)) =0 (see Lemma 6), it follows that

[q ]:((:

1

, :

2

)) +[q ]:((:

2

, :

3

)) +[q]:((:

1

, :

3

)) =0.

Since = q, we obtain for all :

1

- :

2

- :

3

, :((:

1

, :

2

)) + :((:

2

, :

3

)) = :((:

1

, :

3

)).

By Claim 3, there exists a function u: such that :((:

1

, :

2

)) = u(:

1

) u(:

2

).

Monotonicity of u follows from the monotonicity of .

108 Bikhchandani and Segal Theoretical Economics 6 (2011)

References

Aczl, J. (1966), Lectures on Functional Equations and Their Applications. Academic

Press, New York. [107]

Bell, David E. (1982), Regret in decision making under uncertainty. Operations Re-

search, 30, 961981. [95, 96, 97]

Fishburn, Peter C. (1989), Non-transitive measurable utility for decision under uncer-

tainty. Journal of Mathematical Economics, 18, 187207. [96]

Fishburn, Peter C. and Irving H. LaValle (1988), Context-dependent choice with non-

linear and nontransitive preferences. Econometrica, 56, 12211239. [96, 99]

Gul, Faruk (1991), A theory of disappointment aversion. Econometrica, 59, 667686.

[97]

Hayashi, Takashi (2008), Regret aversion and opportunity dependence. Journal of Eco-

nomic Theory, 139, 242268. [96]

Hong, Chew Soo (1983), A generalization of the quasilinear mean with applications to

the measurement of income inequality and decision theory resolving the Allais para-

dox. Econometrica, 51, 10651092. [97]

Kreps, David M. (1988), Notes on the Theory of Choice. Westview Press, Boulder, Col-

orado. [96]

Loomes, Graham and Robert Sugden (1982), Regret theory: An alternative theory of

rational choice under uncertainty. Economic Journal, 92, 805824. [95, 96, 97, 98]

Loomes, Grahamand Robert Sugden (1987), Some implications of a more general form

of regret theory. Journal of Economic Theory, 41, 270287. [96, 99]

Machina, Mark J. (1987), Choice under uncertainty: Problems solved and unsolved.

Journal of Economic Perspectives, 1, 121154. [96, 97]

Sarver, Todd (2008), Anticipating regret: Why fewer options may be better. Economet-

rica, 76, 263305. [96, 97]

Starmer, Chris (2000), Developments in non-expected utility theory: The hunt for a

descriptive theory of choice under risk. Journal of Economic Literature, 38, 332382.

[96, 97]

Sugden, Robert (1993), An axiomatic foundation for regret theory. Journal of Economic

Theory, 60, 159180. [97]

Sugden, Robert (2004), Alternatives to expected utility: Foundations. In Handbook

of Utility Theory, Volume 2 (Salvador Barber, Peter J. Hammond, and Christian Seidl,

eds.), 685756, Kluwer, Dordrecht. [96, 107]

Submitted 2010-2-26. Final version accepted 2010-7-6. Available online 2010-7-6.

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