Comparison of Mean-Variance Theory and Expected-Utility Theory through a Laboratory Experiment

Abstract

In the 40's and early 50''s two decision theories were proposed and have dominated the scene of the fascinating field of decision-making. Since 1944 - when von Neumann and Morgenstern showed that if preferences are consistent with a set of axioms then it is possible to represent these preferences by the expectation of some utility function - Expected Utility theory provides a natural way to establish "measurable utility". In the early 50''s Markowitz introduced the Mean-Variance theory that is the basis of modern portfolio selection theory. Since then, both models were analyzed from virtually all possible points of view and were tested against several generalizations. However, these two models should be tested against each other. This paper tries to fill this gap, investigating (using experimental data) which of these two models better approximate subjects'' preferences.preference functional