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Anomalies: Risk Aversion

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  • Matthew Rabin
  • Richard H. Thaler

Abstract

Economists ubiquitously employ a simple and elegant explanation for risk aversion: It derives from the concavity of the utility-of-wealth function within the expected-utility framework. We show that this explanation is not plausible in most applications, since anything more than economically negligible risk aversion over moderate stakes requires a utility-of-wealth function that is so concave that it predicts absurdly severe risk aversion over very large stakes. We present examples of how the expected-utility framework has misled economists, and why we believe a better explanation for risk aversion must incorporate loss aversion and mental accounting.

Suggested Citation

  • Matthew Rabin & Richard H. Thaler, 2001. "Anomalies: Risk Aversion," Journal of Economic Perspectives, American Economic Association, vol. 15(1), pages 219-232, Winter.
    • Handle: RePEc:aea:jecper:v:15:y:2001:i:1:p:219-232
    Note: DOI: 10.1257/jep.15.1.219
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    File URL: http://www.aeaweb.org/articles.php?doi=10.1257/jep.15.1.219
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    References listed on IDEAS

    as
    1. Matthew Rabin., 2000. "Diminishing Marginal Utility of Wealth Cannot Explain Risk Aversion," Economics Working Papers E00-287, University of California at Berkeley.
    2. Matthew Rabin, 2000. "Risk Aversion and Expected-Utility Theory: A Calibration Theorem," Econometrica, Econometric Society, vol. 68(5), pages 1281-1292, September.
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    JEL classification:

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

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