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Rationality on the Rise: Why Relative Risk Aversion Increases with Stake Size

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  • Helga Fehr-Duda

    ()
    (Institute of Economic Research, Swiss Federal Institute of Technology Zurich)

  • Adrian Bruhin

    ()
    (Socioeconomic Institute, University of Zurich)

  • Thomas Epper

    ()
    (Institute of Economic Research, Swiss Federal Institute of Technology Zurich)

  • Renate Schubert

    ()
    (Institute of Economic Research, Swiss Federal Institute of Technology Zurich)

Abstract

How does risk tolerance vary with stake size? This important question cannot be adequately answered if framing effects, nonlinear probability weighting, and heterogeneity of preference types are neglected. We show that, contrary to gains, no coherent change in relative risk aversion is observed for losses. The increase in relative risk aversion over gains cannot be captured by the curvature of the utility function. It is driven predominantly by a change in probability weighting of a majority group of individuals who exhibit more rational probability weighting at high stakes. These results not only challenge expected utility theory, but also prospect theory.

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File URL: http://www.soi.uzh.ch/research/wp/2007/wp0708.pdf
File Function: Revised version, 2008
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Bibliographic Info

Paper provided by Socioeconomic Institute - University of Zurich in its series SOI - Working Papers with number 0708.

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Length: 33 pages
Date of creation: Jul 2007
Date of revision: Feb 2008
Publication status: published in Journal of Risk and Uncertainty 40(2), pp. 147-180, 2010
Handle: RePEc:soz:wpaper:0708

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Keywords: Risk Aversion; Stake-Size Effect; Prospect Theory; Latent Heterogeneity;

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