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Is There A Plausible Theory for Risky Decisions?

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Author Info

  • James C. Cox
  • Vjollca Sadiraj
  • Bodo Vogt
  • Utteeyo Dasgupta

Abstract

A large literature is concerned with analysis and empirical application of theories of decision making for environments with risky outcomes. Expected value theory has been known for centuries to be subject to critique by St. Petersburg paradox arguments. More recently, theories of risk aversion have been critiqued with calibration arguments applied to concave payoff transformations. This paper extends the calibration critique to decision theories that represent risk aversion solely with transformation of probabilities. Testable calibration propositions are derived that apply to four representative decision theories: expected utility theory, cumulative prospect theory, rank-dependent expected utility theory, and dual expected utility theory. Heretofore, calibration critiques of theories of risk aversion have been based solely on thought experiments. This paper reports real experiments that provide data on the relevance of the calibration critiques to evaluating the plausibility of theories of risk aversion. The paper also discusses implications of the data for (original) prospect theory with editing of reference payoffs and for the new dual-self model of impulse control. In addition, the paper reports an experiment with a truncated St. Petersburg bet that adds to data inconsistent with risk neutrality.

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File URL: http://excen.gsu.edu/workingpapers/GSU_EXCEN_WP_2007-05.pdf
File Function: First version, 2007
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File URL: http://excen.gsu.edu/workingpapers/GSU_EXCEN_WP_2008-04.pdf
File Function: Revised version, 2008
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File URL: http://excen.gsu.edu/workingpapers/GSU_EXCEN_WP_2010-06.pdf
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File URL: http://excen.gsu.edu/workingpapers/GSU_EXCEN_WP_2012-09.pdf
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Bibliographic Info

Paper provided by Experimental Economics Center, Andrew Young School of Policy Studies, Georgia State University in its series Experimental Economics Center Working Paper Series with number 2007-05.

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Length: 40
Date of creation: Jun 2007
Date of revision: Apr 2008
Handle: RePEc:exc:wpaper:2007-05

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Cited by:
  1. Li, Minqiang, 2013. "On Aumann and Serrano's Economic Index of Risk," MPRA Paper 47466, University Library of Munich, Germany.
  2. Eike B. Kroll & Bodo Vogt, 2009. "The St. Petersburg Paradox despite risk-seeking preferences: An experimental study," FEMM Working Papers 09004, Otto-von-Guericke University Magdeburg, Faculty of Economics and Management.
  3. Jungmin Lee & Cary Deck & Javier Reyes & Chris Rosen, 2008. "Measuring Risk Attitudes Controlling for Personality Traits," Working Papers 0801, Florida International University, Department of Economics.
  4. James C. Cox & Vjollca Sadiraj, 2011. "Risk Aversion as Attitude towards Probabilities: A Paradox," Experimental Economics Center Working Paper Series 2011-10, Experimental Economics Center, Andrew Young School of Policy Studies, Georgia State University.
  5. Tibor Neugebauer, 2010. "Moral Impossibility in the Petersburg Paradox : A Literature Survey and Experimental Evidence," LSF Research Working Paper Series 10-14, Luxembourg School of Finance, University of Luxembourg.

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