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Risk Aversion as Attitude towards Probabilities: A Paradox

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  • James C. Cox
  • Vjollca Sadiraj

Abstract

Theories of decision under risk that challenge expected utility theory model risk attitudes at least partly with transformation of probabilities. We explain how attributing risk aversion (partly or wholly) to attitude towards probabilities, can produce extreme probability distortions that imply paradoxical risk aversion.

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File URL: http://excen.gsu.edu/workingpapers/GSU_EXCEN_WP_2011-10.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 2011-10.

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Length: 20
Date of creation: Jun 2011
Date of revision:
Handle: RePEc:exc:wpaper:2011-10

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Related research

Keywords: risk aversion; probability transformation; calibration; reference dependence; loss aversion;

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References

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  1. Matthew Rabin, 2001. "Risk Aversion and Expected Utility Theory: A Calibration Theorem," Levine's Working Paper Archive 7667, David K. Levine.
  2. James C. Cox & Vjollca Sadiraj & Bodo Vogt & Utteeyo Dasgupta, 2007. "Is There A Plausible Theory for Risky Decisions?," Experimental Economics Center Working Paper Series 2007-05, Experimental Economics Center, Andrew Young School of Policy Studies, Georgia State University, revised Apr 2008.
  3. Conlisk, John, 1989. "Three Variants on the Allais Example," American Economic Review, American Economic Association, vol. 79(3), pages 392-407, June.
  4. Quiggin, John, 1982. "A theory of anticipated utility," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 323-343, December.
  5. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  6. Handa, Jagdish, 1977. "Risk, Probabilities, and a New Theory of Cardinal Utility," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 97-122, February.
  7. Machina, Mark J, 1987. "Choice under Uncertainty: Problems Solved and Unsolved," Journal of Economic Perspectives, American Economic Association, vol. 1(1), pages 121-54, Summer.
  8. Cubitt, Robin P & Starmer, Chris & Sugden, Robert, 1998. "Dynamic Choice and the Common Ratio Effect: An Experimental Investigation," Economic Journal, Royal Economic Society, vol. 108(450), pages 1362-80, September.
  9. 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.
  10. James C. Cox & Vjollca Sadiraj & Ulrich Schmidt, 2011. "Paradoxes and Mechanisms for Choice under Risk," Kiel Working Papers 1712, Kiel Institute for the World Economy.
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