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Rejecting small gambles under expected utility

  • Palacios-Huerta, Ignacio
  • Serrano, Roberto

This paper contributes to an important recent debate around expected utility and risk aversion. Rejecting a gamble over a given range of wealth levels imposes a lower bound on risk aversion. Using this lower bound and empirical evidence on the range of the risk aversion coefficient, we calibrate the relationship between risk attitudes over small-stakes and large-stakes gambles. We find that rejecting small gambles is consistent with expected utility, contrary to a recent literature that concludes that expected utility is fundamentally unfit to explain decisions under uncertainty. Paradoxical behavior is only obtained when calibrations are made in a region of the parameter space that is not empirically relevant.

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Article provided by Elsevier in its journal Economics Letters.

Volume (Year): 91 (2006)
Issue (Month): 2 (May)
Pages: 250-259

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Handle: RePEc:eee:ecolet:v:91:y:2006:i:2:p:250-259
Contact details of provider: Web page: http://www.elsevier.com/locate/ecolet

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