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The effects of losses and event splitting on the Allais paradox

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Author Info
Bethany Weber
Abstract

The Allais Paradox, or common consequence effect, has been a standard challenge to normative theories of risky choice since its proposal over 60 years ago. However, neither its causes nor the conditions necessary to create the effect are well understood. Two experiments test the effects of losses and event splitting on the Allais Paradox. Experiment 1 found that the Allais Paradox occurs for both gain and mixed gambles and is reflected for loss gambles produced by reflection across the origin. Experiment 2 found that the Allais Paradox is eliminated by splitting the outcomes even when the probabilities used do not increase the salience of the common consequence. The results of Experiment 1 are consistent with Cumulative Prospect Theory, the current leading theory of risky choice. However, the results of Experiment 2 are problematic for Cumulative Prospect Theory and suggest that alternate explanations for the Allais Paradox must be sought.

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Publisher Info
Article provided by Society for Judgment and Decision Making in its journal Judgment and Decision Making.

Volume (Year): 2 (2007)
Issue (Month): (April)
Pages: 115-125
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Handle: RePEc:jdm:journl:v:2:y:2007:i::p:115-125

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Related research
Keywords: risk; Allais Paradox; certainty effect; preference reversals; mixed gambles; event splitting; Prospect Theory; Cumulative Prospect Theory.;

References listed on IDEAS
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  1. Starmer, Chris & Sugden, Robert, 1993. " Testing for Juxtaposition and Event-Splitting Effects," Journal of Risk and Uncertainty, Springer, vol. 6(3), pages 235-54, June.
  2. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
  3. Harless, David W., 1992. "Predictions about indifference curves inside the unit triangle : A test of variants of expected utility theory," Journal of Economic Behavior & Organization, Elsevier, vol. 18(3), pages 391-414, August. [Downloadable!] (restricted)
  4. Machina, Mark J, 1982. ""Expected Utility" Analysis without the Independence Axiom," Econometrica, Econometric Society, vol. 50(2), pages 277-323, March. [Downloadable!] (restricted)
  5. Conlisk, John, 1989. "Three Variants on the Allais Example," American Economic Review, American Economic Association, vol. 79(3), pages 392-407, June. [Downloadable!] (restricted)
  6. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-91, March. [Downloadable!] (restricted)
  7. Carlin, Paul S., 1990. "Is the Allais paradox robust to a seemingly trivial change of frame?," Economics Letters, Elsevier, vol. 34(3), pages 241-244, November. [Downloadable!] (restricted)
  8. Neilson, William S., 1992. "Some mixed results on boundary effects," Economics Letters, Elsevier, vol. 39(3), pages 275-278, July. [Downloadable!] (restricted)
  9. Humphrey, Steven J., 2000. "The common consequence effect: testing a unified explanation of recent mixed evidence," Journal of Economic Behavior & Organization, Elsevier, vol. 41(3), pages 239-262, March. [Downloadable!] (restricted)
  10. Humphrey, Steven J., 1998. "More mixed results on boundary effects," Economics Letters, Elsevier, vol. 61(1), pages 79-84, October. [Downloadable!] (restricted)
  11. John Payne, 2005. "It is Whether You Win or Lose: The Importance of the Overall Probabilities of Winning or Losing in Risky Choice," Journal of Risk and Uncertainty, Springer, vol. 30(1), pages 5-19, January. [Downloadable!] (restricted)
  12. Starmer, Chris & Sugden, Robert, 1991. "Does the Random-Lottery Incentive System Elicit True Preferences? An Experimental Investigation," American Economic Review, American Economic Association, vol. 81(4), pages 971-78, September. [Downloadable!] (restricted)
  13. Starmer, Chris, 1992. "Testing New Theories of Choice under Uncertainty Using the Common Consequence Effect," Review of Economic Studies, Blackwell Publishing, vol. 59(4), pages 813-30, October. [Downloadable!] (restricted)
  14. Camerer, Colin F, 1989. " An Experimental Test of Several Generalized Utility Theories," Journal of Risk and Uncertainty, Springer, vol. 2(1), pages 61-104, April.
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