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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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    References listed on IDEAS

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    1. Rabin, Matthew, 2000. "Diminishing Marginal Utility of Wealth Cannot Explain Risk Aversion," Department of Economics, Working Paper Series qt61d7b4pg, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
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    5. Shlomo Benartzi & Richard H. Thaler, 1995. "Myopic Loss Aversion and the Equity Premium Puzzle," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 73-92.
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    JEL classification:

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

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