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Prevent or Cure? Trading in the Face of Skewed Binary Lotteries

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  • Julien Jacob
  • Marielle Brunette
  • Louis Eeckhoudt

Abstract

We analyze the choice of a risk-averse decision maker who faces two lotteries that exhibit a trade-off between a reduction in the probability of a loss occurring and its magnitude. We make a theoretical analysis with skewed binary lotteries: lottery LA is associated with a lower magnitude and a higher probability of a loss occurring than lottery LB. We show that any risk-averse decision maker will prefer LA to LB when the expected gain of LA is higher than or equal to the expected gain of LB. However, in the opposite case, additional assumptions on individuals' prudence are required. We experimentally test our theoretical predictions, and provide applications and policy recommendations.

Suggested Citation

  • Julien Jacob & Marielle Brunette & Louis Eeckhoudt, 2022. "Prevent or Cure? Trading in the Face of Skewed Binary Lotteries," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 178(2), pages 130-169.
    • Handle: RePEc:mhr:jinste:urn:doi:10.1628/jite-2022-0009
    DOI: 10.1628/jite-2022-0009
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    More about this item

    Keywords

    skewed risk; binary lotteries; prudence; temperance; skewed risk;
    All these keywords.

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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