Risk Aversion and Rationality

Journal of Risk and Uncertainty, 2007

The winner's curse is one of the most well documented empirical deviations from rational behavior. The primary explanation for the winner's curse is decision error: bidders do not realize that their bids result in lotteries with negative expected value. Given many unsuccessful attempts to reduce winner's curse behavior, this paper hypothesizes that, in addition to decision error, some people prefer these lotteries. We test this hypothesis with two experiments. Study 1 shows that half the subjects accept a significant number of lotteries that are objectively identical to positive bids in the Takeover game but that cannot be explained by the decision error used to explain bids in the Takeover game. Study 1 also finds that half the subjects make decision errors. These results offer a positive interpretation on past efforts to reduce decision error; whereas past studies implicitly assume that eliminating 100 percent of winner's curse behavior reflects the highest possible success, the current results suggest that no more than half the subjects prefer avoiding the winner's curse even with no decision error. Study 2 shows that preferences consistent with winner's curse behavior can only partially be attributed to risk-seeking, and can mostly be attributed to contextual factors beyond the monetary distribution. These results reinforce substantial evidence that preferences over lotteries are not independent of the context in which the lotteries are presented.

Journal of Economic Perspectives, 1987

2010

The Journal of Socio-Economics, 2010

In this paper I propose that the development of descriptive theories of choice in economics has been profoundly influenced by an arbitrary and seemly innocuous decision as to how to present risky choices to experimental subjects. This decision to represent lotteries as prospects has lead to a preoccupation with the question of whether preferences conform to what is known as the "independence axiom." Had the profession chosen to represent lotteries in the action-by-state matrices favored by Savage, the independence axiom would have appeared uncontroversial but we would have questioned whether preferences obeyed arguably more fundamental tenets of rationality like transitivity. That different ways of representing lotteries lead to different conclusions regarding which axioms preferences do and don't obey suggests that the choices people make aren't necessarily reflecting properties of their preferences at all. Instead the choices reveal properties of the decision rule individuals use to try to satisfy their preferences-a rule that involves judgments regarding the similarity or dissimilarity of prizes and their associated payoffs across alternatives. The paper discusses how such judgments explain observed behaviors given both prospect and matrix representations of lottery choices as well as explaining anomalies in other choice domains.

Canadian Journal of Philosophy, 2015

There are decision problems where the preferences that seem rational to many people cannot be accommodated within orthodox decision theory in the natural way. In response, a number of alternatives to the orthodoxy have been proposed. In this paper, I offer an argument against those alternatives and in favour of the orthodoxy. I focus on preferences that seem to encode sensitivity to risk. And I focus on the alternative to the orthodoxy proposed by Lara Buchak’s risk-weighted expected utility theory. I will show that the orthodoxy can be made to accommodate all of the preferences that Buchak’s theory can accommodate.

Synthese, 2007

Among recent objections to Pascal's Wager, two are especially compelling. The first is that decision theory, and specifically the requirement of maximizing expected utility, is incompatible with infinite utility values. The second is that even if infinite utility values are admitted, the argument of the Wager is invalid provided that we allow mixed strategies. Furthermore, Hájek (Philosophical Review 112, 2003) has shown that reformulations of Pascal's Wager that address these criticisms inevitably lead to arguments that are philosophically unsatisfying and historically unfaithful. Both the objections and Hájek's philosophical worries disappear, however, if we represent our preferences using relative utilities (generalized utility ratios) rather than a one-place utility function. Relative utilities provide a conservative way to make sense of infinite value that preserves the familiar equation of rationality with the maximization of expected utility. They also provide a means of investigating a broader class of problems related to the Wager.

2008

Journal of Experimental Psychology: Learning, Memory, and Cognition, 1987

This article is concerned with a recent debate on the generality of utility theory. It has been argued by Lopes (198 i) that decisions regarding preferences between gambles are different for unique and repeated gambles. The present article provides empirical support for the need to distinguish between these two. It is proposed that violations of utility theory obtained under unique conditions (e.g., Kahneman & Tversky, 1979), cannot necessarily be generalized to repeated conditions. We would like to thank Baruch Fischhoff, Sarah Lichtenstein, Charles Lewis, and Charles Vlek for many valuable comments on previous drafts of this article.

Experimental Economics, 2014

Experiments on choice under risk typically involve multiple decisions by individual subjects. The choice of mechanism for selecting decision(s) for payoff is an essential design feature that is often driven by appeal to the isolation hypothesis or the independence axiom. We report two experiments with 710 subjects. Experiment 1 provides the first simple test of the isolation hypothesis. Experiment 2 is a crossed design with six payoff mechanisms and five lottery pairs that can elicit four paradoxes for the independence axiom and dual independence axiom. The crossed design discriminates between: (a) behavioral deviations from postulated properties of payoff mechanisms; and (b) behavioral deviations from theoretical implications of alternative decision theories. Experiment 2 provides tests of the isolation hypothesis and four paradoxes. It also provides data for tests for portfolio effect, wealth effect, reduction, adding up, and cross-task contamination. Data from Experiment 2 suggest that a new mechanism introduced herein may be less biased than random selection of one decision for payoff.

1995

The dominance principle states that one should prefer the option with consequences that are at least as good as those of other options for any state of the world. When applied to judged prices of gambles, the dominance principle requires that increasing one or more outcomes of a gamble should increase the judged price of the gamble, with everything else held constant. Previous research has uncovered systematic violations of the dominance principle: people assign higher prices to a gamble with a large probability of winning an amount, Y, otherwise zero, than they do to a superior gamble with the same chance of winning Y, otherwise winning a small amount, X! These violations can be explained by a configural-weight theory in which two-outcome gambles are represented with two sets of decision weights; one set for outcomes having values of zero and another set for lower-valued outcomes that have nonzero values. The present paper investigates whether dominance violations are limited to two-outcome gambles. Results show that people violate the dominance principle with three-outcome gambles even with financial incentives. Furthermore, results could be predicted from the configural-weight theory. The data do not support the view that configural weighting is caused by a shift in strategy that would apply only to two-outcome gambles.