Bounded rationality with subjective evaluations in enlivened but truncated decision trees

Abstract In normative models a decision-maker is usually assumed to be Bayesian rational, and so to maximize subjective expected utility, within a complete and correctly specified decision model. Following the discussion in Hammond (HEI 179–195, 2007) of Schumpeter’s (Theorie der wirtschaftlichen Entwicklung; Eine Untersuchung über Unternehmergewinn, Kapital, Kredit, Zins und den Konjunkturzyklus, Leipzig, 1911; The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle, 1934) concept of entrepreneurship, as well as Shackle’s (Economica NS, 20:112-117, 1953) concept of potential surprise, we consider enlivened decision trees whose growth over time cannot be accurately modelled in full detail. An enlivened decision tree involves more severe limitations than a mis-specified model, unforeseen contingencies, or unawareness, all of which are typically modelled with reference to a universal state space large enough to encompass any decision model that an agent may consider. We consider a motivating example based on Homer’s classic tale of Odysseus and the Sirens. Though our novel framework transcends standard notions of risk or uncertainty, for finite decision trees that may be truncated because of bounded rationality, an extended and refined form of Bayesian rationality is still possible, with real-valued subjective evaluations instead of consequences attached to terminal nodes where truncations occur. Moreover, these subjective evaluations underlie, for example, the kind of Monte Carlo tree search algorithm used by recent chess-playing software packages. They may also help rationalize the contentious precautionary principle.