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Large Compound Lotteries

Author

Listed:
  • Zvi Safra

    (Warwick Business School)

  • Uzi Segal

    (Boston College)

Abstract

Extending preferences over simple lotteries to compound (two-stage) lotteries can be done using two different methods: (1) using the Re- duction of compound lotteries axiom, under which probabilities of the two stages are multiplied; (2) using the compound independence ax- iom, under which each second-stage lottery is replaced by its certainty equivalent. Except for expected utility preferences, the rankings in- duced by the two methods are always in disagreement and deciding on which method to use is not straightforward. Moreover, sometimes each of the two methods may seem to violate some kind of first order stochastic dominance. In this paper we demonstrate that, under some conditions, the disagreement disappears in the limit and that for (al- most) any pair of compound lotteries, the two methods agree if the lotteries are replicated sufficiently many times.

Suggested Citation

  • Zvi Safra & Uzi Segal, 2021. "Large Compound Lotteries," Boston College Working Papers in Economics 1057, Boston College Department of Economics, revised 01 Aug 2023.
    • Handle: RePEc:boc:bocoec:1057
    as

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    References listed on IDEAS

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    More about this item

    Keywords

    Reduction of compound lotteries axiom; compound independence axiom; duplicated lotteries;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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