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Anomalies: Risk Aversion

  • Matthew Rabin
  • Richard H. Thaler

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.

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Article provided by American Economic Association in its journal Journal of Economic Perspectives.

Volume (Year): 15 (2001)
Issue (Month): 1 (Winter)
Pages: 219-232

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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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  1. Uri Gneezy & Jan Potters, 1997. "An Experiment on Risk Taking and Evaluation Periods," The Quarterly Journal of Economics, Oxford University Press, vol. 112(2), pages 631-645.
  2. De Long, J Bradford, et al, 1991. "The Survival of Noise Traders in Financial Markets," The Journal of Business, University of Chicago Press, vol. 64(1), pages 1-19, January.
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  8. Matthew Rabin., 2000. "Diminishing Marginal Utility of Wealth Cannot Explain Risk Aversion," Economics Working Papers E00-287, University of California at Berkeley.
  9. Uzi Segal & Avia Spivak, 1988. "First Order Versus Second Order Risk Aversion," UCLA Economics Working Papers 540, UCLA Department of Economics.
  10. 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.
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  12. Daniel Kahneman & Jack L. Knetsch & Richard H. Thaler, 1991. "Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias," Journal of Economic Perspectives, American Economic Association, vol. 5(1), pages 193-206, Winter.
  13. Graham Loomes & Uzi Segal, . "Observing Different Orders of Risk Aversion," Discussion Papers 92/5, Department of Economics, University of York.
  14. Harry Markowitz, 1952. "The Utility of Wealth," Journal of Political Economy, University of Chicago Press, vol. 60, pages 151.
  15. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  16. Richard H. Thaler & Amos Tversky & Daniel Kahneman & Alan Schwartz, 1997. "The Effect of Myopia and Loss Aversion on Risk Taking: An Experimental Test," The Quarterly Journal of Economics, Oxford University Press, vol. 112(2), pages 647-661.
  17. Daniel Kahneman & Dan Lovallo, 1993. "Timid Choices and Bold Forecasts: A Cognitive Perspective on Risk Taking," Management Science, INFORMS, vol. 39(1), pages 17-31, January.
  18. Harless, David W & Camerer, Colin F, 1994. "The Predictive Utility of Generalized Expected Utility Theories," Econometrica, Econometric Society, vol. 62(6), pages 1251-89, November.
  19. Cubitt, Robin P. & Sugden, Robert, 2001. "On Money Pumps," Games and Economic Behavior, Elsevier, vol. 37(1), pages 121-160, October.
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