Risk Aversion and Expected-utility Theory: A Calibration Theorem

Rabin, Matthew

doi:10.1111/1468-0262.00158

Cited by 1,401 publications

(841 citation statements)

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“…When is small, the former dominates, and to a good approximation for large gambles risk aversion is relative to wealth, while for small gambles it is relative to pocket cash. 18 We can see this effect graphically in the case of Rabin's [2000] paradox of risk aversion in the small and in the large:…”

Section: The Above Establishesmentioning

confidence: 96%

“…However, when these same individuals are faced with the choice between the same relative quantities a year from now and a year and a day from now, they choose to consume the greater quantity a year and a day from now. 3 The second regularity is Rabin's [2000] paradox of risk aversion in the large and small. The paradox is that the risk aversion experimental subjects show to very small gambles implies hugely unrealistic willingness to reject large but favorable gambles.…”

Section: Introductionmentioning

confidence: 99%

“…In particular, a sufficiently small unanticipated cash receipt will be spent in its entirety, and so winnings from sufficiently small cash gambles are evaluated by the shortrun self's preferences, which are over consumption. These preferences are more riskaverse than the preferences over long-term consumption that are used to evaluate large gambles, so this "cash effect" provides an explanation of Rabin's [2000] paradox of risk aversion in the small and in the large. 8 We also apply the dual-self model to the study of procrastination and delay in a stationary stopping-time environment that is very similar to that of O'Donoghue and Rabin [2001].…”

Section: Introductionmentioning

confidence: 99%

See 2 more Smart Citations

A Dual-Self Model of Impulse Control

Fudenberg

Levine

2006

American Economic Review

749

282

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Abstract:We propose that a simple "dual-self" model gives a unified explanation for several empirical regularities, including the apparent time-inconsistency that has motivated models of hyperbolic discounting and Rabin's paradox of risk aversion in the large and small. The model also implies that self-control costs imply excess delay, as in the O'Donoghue and Rabin models of hyperbolic utility, and it explains experimental evidence that increased cognitive load makes temptations harder to resist. Finally, the reduced form of the base version of our model is consistent with the Gul-Pesendorfer axioms. 1 We thank David Laibson and Matt Rabin for many years of instructive conversations on related topics, Stefano DellaVigna and Ulrike Malmendier for helpful discussion of their research, and Drazen Prelec and Antonio Rangel for detailed comments on an earlier draft. We are grateful to NSF grants SES-01-12018, SES-03-14713, and SES-04-26199 for financial support.

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Section: The Above Establishesmentioning

confidence: 96%

Section: Introductionmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

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A Dual-Self Model of Impulse Control

Fudenberg

Levine

2006

American Economic Review

749

282

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“…Consequently, this group of individuals can essentially be characterized as expected value maximizers. This result is particularly interesting in the light of Rabin's calibration theorem (Rabin, 2000), which shows that expected utility maximizers should be approximately risk neutral for small stakes typically encountered in laboratory experiments if behavior under high stakes is to remain within a plausible range of risk aversion. Therefore, we label subjects belonging to this group of nearly risk neutral people as "EUT types".…”

Section: Introductionmentioning

confidence: 93%

Risk and Rationality: Uncovering Heterogeneity in Probability Distortion

2009

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It has long been recognized that there is considerable heterogeneity in individual risk taking behavior but little is known about the distribution of risk taking types. We present a parsimonious characterization of risk taking behavior by estimating a finite mixture regression model for three different experimental data sets, two Swiss and one Chinese, over a large number of real gains and losses. We find two distinct types of individuals: In all three data sets, the choices of roughly 80% of the subjects exhibit significant deviations from linear probability weighting, consistent with prospect theory. 20% of the subjects weight probabilities near linearly and behave essentially as expected value maximizers. Moreover, individuals are cleanly assigned to one type with probabilities close to unity. The reliability and robustness of our classification suggest using a mix of preference theories in applied economic modeling.

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“…Our main result establishes that the optimal price distribution consists of low and variable "sale" prices and a high and atomic "regular" price. The sale prices are chosen such that it is not 1 For instance, Rabin (2000b) and Rabin and Thaler (2001) show that in an expected-utility-over-wealth model, nontrivial aversion to modest-scale risk must be associated with implausible and empirically unobserved extreme aversion to large-scale risk, so that expected utility over wealth cannot explain attitudes toward both modest-scale and large-scale risks. They argue that loss aversion is likely a better explanation for aversion to small-and modest-scale risks.…”

Section: Introductionmentioning

confidence: 99%

Regular Prices and Sales

Heidhues

Kőszegi

2010

SSRN Journal

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It is widely known that loss aversion leads individuals to dislike risk and, as has been argued by many researchers, in many instances this creates an incentive for firms to shield consumers and employees against economic risks. Complementing previous research, we show that consumer loss aversion can also have the opposite effect: it can lead a firm to optimally introduce risk into an otherwise deterministic environment. We consider a profit-maximizing monopolist selling to a loss-averse consumer, where (following Kőszegi and Rabin 2006) we assume that the consumer's reference point is her recent rational expectations about the purchase. We establish that for any degree of consumer loss aversion, the monopolist's optimal price distribution consists of low and variable "sale" prices and a high and atomic "regular" price. Realizing that she will buy at the sales prices and hence that she will purchase with positive probability, the consumer chooses to avoid the painful uncertainty in whether she will get the product by buying also at the regular price. This pricing pattern is consistent with several recently documented facts regarding retailer pricing. We show that market power is crucial for this result: when firms compete ex ante for consumers, they choose deterministic prices.

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Risk Aversion and Expected-utility Theory: A Calibration Theorem

Cited by 1,401 publications

References 20 publications

A Dual-Self Model of Impulse Control

A Dual-Self Model of Impulse Control

Risk and Rationality: Uncovering Heterogeneity in Probability Distortion

Regular Prices and Sales

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