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Rationality on the rise: Why relative risk aversion increases with stake size

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  • Helga Fehr-Duda

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  • Adrian Bruhin
  • Thomas Epper
  • Renate Schubert

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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Suggested Citation

  • Helga Fehr-Duda & Adrian Bruhin & Thomas Epper & Renate Schubert, 2010. "Rationality on the rise: Why relative risk aversion increases with stake size," Journal of Risk and Uncertainty, Springer, vol. 40(2), pages 147-180, April.
  • Handle: RePEc:kap:jrisku:v:40:y:2010:i:2:p:147-180
    DOI: 10.1007/s11166-010-9090-0
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    Keywords

    Stake effects; Prospect theory; Expected utility theory; Risk aversion; D81; C91;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior

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