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Probabilistic Risk Attitudes and Local Risk Aversion: a Paradox

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  • Vjollca Sadiraj

Abstract

Prominent theories of decision under risk that challenge expected utility theory model risk attitudes at least partly with transformation of probabilities. This paper shows how attributing local risk aversion (partly or wholly) to attitudes towards probabilities can produce extreme probability distortions that imply paradoxical risk aversion.

Suggested Citation

  • Vjollca Sadiraj, 2012. "Probabilistic Risk Attitudes and Local Risk Aversion: a Paradox," Experimental Economics Center Working Paper Series 2012-07, Experimental Economics Center, Andrew Young School of Policy Studies, Georgia State University.
  • Handle: RePEc:exc:wpaper:2012-07
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    File URL: http://excen.gsu.edu/workingpapers/GSU_EXCEN_WP_2012-07.pdf
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    References listed on IDEAS

    as
    1. Yaari, Menahem E, 1987. "The Dual Theory of Choice under Risk," Econometrica, Econometric Society, vol. 55(1), pages 95-115, January.
    2. Mohammed Abdellaoui & Han Bleichrodt & Olivier L’Haridon, 2008. "A tractable method to measure utility and loss aversion under prospect theory," Journal of Risk and Uncertainty, Springer, vol. 36(3), pages 245-266, June.
    3. 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.
    4. Handa, Jagdish, 1977. "Risk, Probabilities, and a New Theory of Cardinal Utility," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 97-122, February.
    5. Matthew Rabin, 2000. "Risk Aversion and Expected-Utility Theory: A Calibration Theorem," Econometrica, Econometric Society, vol. 68(5), pages 1281-1292, September.
    6. Quiggin, John, 1982. "A theory of anticipated utility," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 323-343, December.
    7. Chris Starmer, 2000. "Developments in Non-expected Utility Theory: The Hunt for a Descriptive Theory of Choice under Risk," Journal of Economic Literature, American Economic Association, vol. 38(2), pages 332-382, June.
    8. Wakker,Peter P., 2010. "Prospect Theory," Cambridge Books, Cambridge University Press, number 9780521765015.
    9. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-291, March.
    10. James Cox & Vjollca Sadiraj & Bodo Vogt & Utteeyo Dasgupta, 2013. "Is there a plausible theory for decision under risk? A dual calibration critique," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 54(2), pages 305-333, October.
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    Cited by:

    1. repec:kap:theord:v:82:y:2017:i:4:d:10.1007_s11238-016-9581-9 is not listed on IDEAS
    2. Steffen Andersen & James C. Cox & Glenn W. Harrison & Morten Lau & Elisabet E. Rutstroem & Vjollca Sadiraj, 2011. "Asset Integration and Attitudes to Risk: Theory and Evidence," Working Papers 2011_10, Durham University Business School.
    3. Amedeo Piolatto & Matthew D. Rablen, 2017. "Prospect theory and tax evasion: a reconsideration of the Yitzhaki puzzle," Theory and Decision, Springer, vol. 82(4), pages 543-565, April.

    More about this item

    Keywords

    risk aversion; probability transformation; calibration;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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