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Background risk and small-stakes risk aversion

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  • Xiaosheng Mu
  • Luciano Pomatto
  • Philipp Strack
  • Omer Tamuz

Abstract

We show that under plausible levels of background risk, no theory of choice under risk -- such as expected utility theory, prospect theory, or rank dependent utility -- can simultaneously satisfy the following three economic postulates: (i) Decision makers are risk-averse over small gambles, (ii) they respect stochastic dominance, and (iii) they account for background risk.

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  • Xiaosheng Mu & Luciano Pomatto & Philipp Strack & Omer Tamuz, 2020. "Background risk and small-stakes risk aversion," Papers 2010.08033, arXiv.org, revised Mar 2021.
    • Handle: RePEc:arx:papers:2010.08033
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