Anomalies: Risk Aversion
Matthew Rabin,Richard H. Thaler +1 more
TL;DR: The authors show that risk aversion is not plausible in most applications, since anything more than economically negligible risk aversion over moderate stakes requires a utility-of-wealth function that is so concave that it predicts absurdly severe risk aversion for very large stakes.
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Abstract: Economists ubiquitously employ a simple and elegant explanation for risk aversion: It derives from the concavity of the utility-of-wealth function within the expected-utility framework. We show that this explanation is not plausible in most applications, since anything more than economically negligible risk aversion over moderate stakes requires a utility-of-wealth function that is so concave that it predicts absurdly severe risk aversion over very large stakes. We present examples of how the expected-utility framework has misled economists, and why we believe a better explanation for risk aversion must incorporate loss aversion and mental accounting.
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Citations
Time Discounting and Time Preference: A Critical Review
TL;DR: In this paper, the authors discuss the discounted utility (DU) model, its historical development, underlying assumptions, and "anomalies" -the empirical regularities that are inconsistent with its theoretical predictions.
The Endowment Effect, Loss Aversion, and Status Quo Bias
Daniel Kahneman,Jack L. Knetsch,Richard H. Thaler +2 more
- 01 Jan 2016
TL;DR: Most behavior can be explained by assuming that agents have stable, well-defined preferences and make rational choices consistent with those preferences in markets that (eventually) clear as discussed by the authors, but this assumption requires implausible assumptions.
Psychology and Economics: Evidence from the Field
TL;DR: The authors survey the empirical evidence from the field on three classes of deviations from the standard model: nonstandard prefer- ences, nonstandard beliefs, and nonstandard decision making, and present evidence on overcon- fidence, on the law of small numbers and on projection bias.
Managerial Optimism and Corporate Finance
TL;DR: In this article, the authors explore the implications of a single specification of managerial irrationality in a simple model of corporate finance and establish an underinvestmentoverinvestment tradeoff related to free cash flow without invoking asymmetric information or rational agency costs.
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Who is ‘behavioral’? cognitive ability and anomalous preferences
TL;DR: This article found that small-stakes risk aversion and short-run discounting are less common among those with higher standardized test scores in Chilean high-school students with similar schooling backgrounds and found some evidence that elementary-school GPA is predictive of preferences measured at the end of high school.
References
The Framing of Decisions and the Psychology of Choice
Amos Tversky,Daniel Kahneman +1 more
TL;DR: The psychological principles that govern the perception of decision problems and the evaluation of probabilities and outcomes produce predictable shifts of preference when the same problem is framed in different ways.
Time Discounting and Time Preference: A Critical Review
TL;DR: In this paper, the authors discuss the discounted utility (DU) model, its historical development, underlying assumptions, and "anomalies" -the empirical regularities that are inconsistent with its theoretical predictions.
Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias
TL;DR: A wine-loving economist we know purchased some nice Bordeaux wines years ago at low prices as discussed by the authors, but would neither be willing to sell the wine at the auction price nor buy an additional bottle at that price.
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