Instituto de Economía

Abstract: Recent research in neuroscience provides a foundation for a von Neumann Morgenstern utility function that is both hedonic and adaptive. We model such adaptation as arising from a limited capacity to make fine distinctions, where the utility functions adapt in real time. For minimizing the probability of error, an optimal mechanism is particularly simple. For maximizing expected fitness, a still simple mechanism is approximately optimal. The model predicts the S-shaped utility characteristic of prospect theory. It also predicts that risk aversion or risk preference will remain evident over low stakes, resolving a vexing puzzle concerning experiments.