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Uncertainty Equivalents: Testing the Limits of the Independence Axiom

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  • James Andreoni
  • Charles Sprenger

Abstract

There is convincing experimental evidence that Expected Utility fails, but when does it fail, how severely, and for what fraction of subjects? We explore these questions using a novel measure we call the uncertainty equivalent. We find Expected Utility performs well away from certainty, but fails near certainty for about 40% of subjects. Comparing non-Expected Utility theories, we strongly reject Prospect Theory probability weighting, we support disappointment aversion if amended to allow violations of stochastic dominance, but find the u-v model of a direct preference for certainty the most parsimonious approach.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17342.

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Date of creation: Aug 2011
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Handle: RePEc:nbr:nberwo:17342

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  7. Han Bleichrodt & José María Abellán-Perpiñan & JoséLuis Pinto & Ildefonso Méndez-Martínez, 2005. "Resolving inconsistencies in utility measurement under risk: Tests of generalizations of expected utility," Economics Working Papers 798, Department of Economics and Business, Universitat Pompeu Fabra.
  8. John List & David Reiley, 2008. "Field experiments," Artefactual Field Experiments 00091, The Field Experiments Website.
  9. Oliver, Adam, 2007. "A Qualitative Analysis Of The Lottery Equivalents Method," Economics and Philosophy, Cambridge University Press, vol. 23(02), pages 185-204, July.
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  12. Booij, Adam S. & van de Kuilen, Gijs, 2009. "A parameter-free analysis of the utility of money for the general population under prospect theory," Journal of Economic Psychology, Elsevier, Elsevier, vol. 30(4), pages 651-666, August.
  13. Booij, Adam S. & van Praag, Bernard M. S. & van de Kuilen, Gijs, 2009. "A Parametric Analysis of Prospect Theory's Functionals for the General Population," IZA Discussion Papers 4117, Institute for the Study of Labor (IZA).
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  15. Ondřej Rydval & Andreas Ortmann & Sasha Prokosheva & Ralph Hertwig, 2009. "How certain is the uncertainty effect?," Experimental Economics, Springer, Springer, vol. 12(4), pages 473-487, December.
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  17. Quiggin, John, 1982. "A theory of anticipated utility," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 3(4), pages 323-343, December.
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Cited by:
  1. Fafchamps, Marcel & Kebede, Bereket & Zizzo, Daniel John, 2013. "Keep Up With the Winners: Experimental Evidence on Risk Taking, Asset Integration, and Peer Effects," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9714, C.E.P.R. Discussion Papers.
  2. Dwenger, Nadja & Kübler, Dorothea & Weizsäcker, Georg, 2014. "Flipping a coin: Theory and evidence," Discussion Papers, Research Unit: Market Behavior SP II 2013-201r, Social Science Research Center Berlin (WZB).

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