Compound Lotteries; Call Option Spreads in Black-Scholes Markets

Abstract

From the earliest days of risky utility theory decision, theorists have elicited information from decision makers by analyzing their reaction to elementary lotteries, or gambles. The Purpose of the process was to define a mathematical function which could yield an ordering on a set of risky objects of choice. The information processing demands on the DM were minimal; everyone has an intuitive feel for endpoints such as $0 and $100. The purpose of this paper is to develop a reliable means of ordering compound lotteries in which the unaided decision maker does not even know the endpoints. Since the ordering will occur in several dimensions, several concepts from multiple criteria decision making will be used.