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Small- and Large-Stakes Risk Aversion: Implications of Concavity Calibration for Decision Theory

  • James C. Cox
  • Vjollca Sadiraj

A growing literature reports the conclusions that: (a) expected utility theory does not provide a plausible theory of risk aversion for both small-stakes and large-stakes gambles; and (b) this decision theory should be replaced with an alternative theory characterized by loss aversion. This paper explains that the arguments in previous literature fail to support these conclusions. Either concavity calibration has no general implication for expected utility theory or it has problematic implications for all decision theories that involve concave transformations (utility or value functions) of positive money payoffs, which makes loss aversion irrelevant to the argument

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File URL: http://excen.gsu.edu/workingpapers/GSU_EXCEN_WP_2006-03.pdf
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Paper provided by Experimental Economics Center, Andrew Young School of Policy Studies, Georgia State University in its series Experimental Economics Center Working Paper Series with number 2006-03.

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Handle: RePEc:exc:wpaper:2006-03
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  1. William Vickrey, 1961. "Counterspeculation, Auctions, And Competitive Sealed Tenders," Journal of Finance, American Finance Association, vol. 16(1), pages 8-37, 03.
  2. Matthews, Steven A., 1983. "Selling to risk averse buyers with unobservable tastes," Journal of Economic Theory, Elsevier, vol. 30(2), pages 370-400, August.
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  4. Palacios-Huerta, Ignacio & Serrano, Roberto, 2006. "Rejecting small gambles under expected utility," Economics Letters, Elsevier, vol. 91(2), pages 250-259, May.
  5. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
  6. Matthew Rabin, 2001. "Risk Aversion and Expected Utility Theory: A Calibration Theorem," Levine's Working Paper Archive 7667, David K. Levine.
  7. Cox, James C. & Smith, Vernon L. & Walker, James M., 1982. "Auction market theory of heterogeneous bidders," Economics Letters, Elsevier, vol. 9(4), pages 319-325.
  8. Ariel Rubinstein, 2004. "Dilemmas of an Economic Theorist," Econometric Society 2004 North American Summer Meetings 661, Econometric Society.
  9. Riley, John G & Samuelson, William F, 1981. "Optimal Auctions," American Economic Review, American Economic Association, vol. 71(3), pages 381-92, June.
  10. Holt, Charles A, Jr, 1980. "Competitive Bidding for Contracts under Alternative Auction Procedures," Journal of Political Economy, University of Chicago Press, vol. 88(3), pages 433-45, June.
  11. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  12. Yaari, Menahem E, 1987. "The Dual Theory of Choice under Risk," Econometrica, Econometric Society, vol. 55(1), pages 95-115, January.
  13. Matthew Rabin & Richard H. Thaler, 2001. "Anomalies: Risk Aversion," Journal of Economic Perspectives, American Economic Association, vol. 15(1), pages 219-232, Winter.
  14. Colin Camerer & Richard H. Thaler, 2003. "In Honor of Matthew Rabin: Winner of the John Bates Clark Medal," Journal of Economic Perspectives, American Economic Association, vol. 17(3), pages 159-176, Summer.
  15. J. Riley & E. Maskin, 1981. "Optimal Auctions with Risk Averse Buyers," Working papers 311, Massachusetts Institute of Technology (MIT), Department of Economics.
  16. Harris, Milton & Raviv, Artur, 1981. "Allocation Mechanisms and the Design of Auctions," Econometrica, Econometric Society, vol. 49(6), pages 1477-99, November.
  17. Moore, John, 1984. "Global Incentive Constraints in Auction Design," Econometrica, Econometric Society, vol. 52(6), pages 1523-35, November.
  18. Daniel Kahneman, 2003. "A Psychological Perspective on Economics," American Economic Review, American Economic Association, vol. 93(2), pages 162-168, May.
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