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Can expected utility theory explain gambling?

Listed author(s):
  • Lisa Farrell
  • Roger Hartley
Registered author(s):

    We investigate the ability of expected utility theory to account for simultaneous gambling and insurance. Contrary to a previous claim that borrowing and lending in perfect capital markets removes the demand for gambles, we show expected utility theory with nonconcave utility functions can explain gambling. When the rates of interest and time preference are equal, agents seek to gamble unless income falls in a finite set of values. When they differ, there is a range of incomes where gambles are desired. Different borrowing and lending rates can account for persistent gambling provided the rates span the rate of time preference.

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    File URL: http://hdl.handle.net/10197/539
    File Function: Open Access version, 2002
    Download Restriction: no

    Paper provided by School of Economics, University College Dublin in its series Open Access publications with number 10197/539.

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    Length: 12 pages
    Date of creation: Jun 2002
    Publication status: Published in: American Economic Review, 92(3) 2002-06
    Handle: RePEc:ucn:oapubs:10197/539
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    UCD, Belfield, Dublin 4

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    Web page: http://www.ucd.ie/economics

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    1. Dowell, Richard S & McLaren, Keith R, 1986. "An Intertemporal Analysis of the Interdependence between Risk Preference, Retirement, and Work Rate Decisions," Journal of Political Economy, University of Chicago Press, vol. 94(3), pages 667-682, June.
    2. Bailey, Martin J & Olson, Mancur & Wonnacott, Paul, 1980. "The Marginal Utility of Income Does not Increase: Borrowing, Lending, and Friedman-Savage Gambles," American Economic Review, American Economic Association, vol. 70(3), pages 372-379, June.
    3. Becker, Gary S & Murphy, Kevin M, 1988. "A Theory of Rational Addiction," Journal of Political Economy, University of Chicago Press, vol. 96(4), pages 675-700, August.
    4. Milton Friedman & L. J. Savage, 1948. "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, University of Chicago Press, vol. 56, pages 279-279.
    5. Conlisk, John, 1993. "The Utility of Gambling," Journal of Risk and Uncertainty, Springer, vol. 6(3), pages 255-275, June.
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