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Is There A Plausible Theory for Risky Decisions?

Author

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  • James C. Cox
  • Vjollca Sadiraj
  • Bodo Vogt
  • Utteeyo Dasgupta

Abstract

A large literature is concerned with analysis and empirical application of theories of decision making for environments with risky outcomes. Expected value theory has been known for centuries to be subject to critique by St. Petersburg paradox arguments. More recently, theories of risk aversion have been critiqued with calibration arguments applied to concave payoff transformations. This paper extends the calibration critique to decision theories that represent risk aversion solely with transformation of probabilities. Testable calibration propositions are derived that apply to four representative decision theories: expected utility theory, cumulative prospect theory, rank-dependent expected utility theory, and dual expected utility theory. Heretofore, calibration critiques of theories of risk aversion have been based solely on thought experiments. This paper reports real experiments that provide data on the relevance of the calibration critiques to evaluating the plausibility of theories of risk aversion. The paper also discusses implications of the data for (original) prospect theory with editing of reference payoffs and for the new dual-self model of impulse control. In addition, the paper reports an experiment with a truncated St. Petersburg bet that adds to data inconsistent with risk neutrality.

Suggested Citation

  • James C. Cox & Vjollca Sadiraj & Bodo Vogt & Utteeyo Dasgupta, 2007. "Is There A Plausible Theory for Risky Decisions?," Experimental Economics Center Working Paper Series 2007-05, Experimental Economics Center, Andrew Young School of Policy Studies, Georgia State University, revised Jul 2010.
  • Handle: RePEc:exc:wpaper:2007-05
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    File URL: http://excen.gsu.edu/workingpapers/GSU_EXCEN_WP_2007-05.pdf
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    File URL: http://excen.gsu.edu/workingpapers/GSU_EXCEN_WP_2008-04.pdf
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    File URL: http://excen.gsu.edu/workingpapers/GSU_EXCEN_WP_2010-06.pdf
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    File URL: http://excen.gsu.edu/workingpapers/GSU_EXCEN_WP_2012-09.pdf
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    Citations

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    Cited by:

    1. Tibor Neugebauer, 2010. "Moral Impossibility in the Petersburg Paradox : A Literature Survey and Experimental Evidence," LSF Research Working Paper Series 10-14, Luxembourg School of Finance, University of Luxembourg.
    2. Minqiang Li, 2014. "On Aumann and Serrano’s economic index of risk," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 55(2), pages 415-437, February.
    3. Riedl Arno, 2012. "Experimental Economics: Economic and Game Theoretic Principles in Experimental Research in the Social Sciences," Research Memorandum 001, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
    4. Eike B. Kroll & Bodo Vogt, 2009. "The St. Petersburg Paradox despite risk-seeking preferences: An experimental study," FEMM Working Papers 09004, Otto-von-Guericke University Magdeburg, Faculty of Economics and Management.
    5. James C. Cox & Vjollca Sadiraj, 2011. "Risk Aversion as Attitude towards Probabilities: A Paradox," Experimental Economics Center Working Paper Series 2011-10, Experimental Economics Center, Andrew Young School of Policy Studies, Georgia State University.

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