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Pre-Decision Side-Bet Sequences

Author

Listed:
  • Kim Kaivanto

    (University of Lancaster)

  • David A. Peel

    (University of Lancaster)

Abstract

Risk-averse Expected Utility (EU) decision makers with wealth-dependent utility functions may find themselves indifferent between accepting and rejecting an indivisible risky prospect. Bell (1988) showed that under these circumstances it may be EU-enhancing for the decision maker to engage in an actuarially fair pre-decision side bet, accepting the indivisible risky prospect conditional upon winning the side bet. In this letter we show that decision makers restricted to actuarially unfair side bets may optimally engage in a sequence of individually EU-enhancing side bets. This contrasts with the case of actuarially fair side bets where only one such bet will be undertaken. The actuarially unfair side bet's optimal stake size can be a significant proportion of the individual's initial wealth. Nevertheless after losing the side bet wealth may still remain within the interval of interim (utility) convexity, whereupon it is optimal to place another side bet.

Suggested Citation

  • Kim Kaivanto & David A. Peel, 2019. "Pre-Decision Side-Bet Sequences," Economics Bulletin, AccessEcon, vol. 39(1), pages 533-539.
    • Handle: RePEc:ebl:ecbull:eb-18-00863
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    References listed on IDEAS

    as
    1. Philippe Delquié, 2008. "The Value of Information and Intensity of Preference," Decision Analysis, INFORMS, vol. 5(3), pages 129-139, September.
    2. Harry Markowitz, 1952. "The Utility of Wealth," Journal of Political Economy, University of Chicago Press, vol. 60, pages 151-151.
    3. Milton Friedman & L. J. Savage, 1948. "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, University of Chicago Press, vol. 56, pages 279-279.
    4. David E. Bell, 1988. "The Value of Pre-Decision Side Bets for Utility Maximizers," Management Science, INFORMS, vol. 34(6), pages 797-800, June.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Expected Utility; risk aversion; side bets; rationality; indivisibility; discreteness; actuarial fairness;
    All these keywords.

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • D1 - Microeconomics - - Household Behavior

    Statistics

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