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Is there a plausible theory of decision making under risk?

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Published on Sep 23, 2008

Jim Cox from Georgia State, a visiting Erskine Fellow in the Economics Department this year ...and Maros' PhD supervisor!!... presented a stimulating seminar on theories of decision making under risk. The basic question Jim asks (and answers) is whether new and old theories of decision making under uncertain are plausible? Contemporary theories of decision making under risk, from Expected Utility theory to Prospect Theory, basically transform money payoffs or probabilities, or both, in some non linear way. When calibrated to rationalize patterns of observed choices on realistic but relatively small stakes gambles ALL of these theories are shown to have implausible implications for risk taking on larger domains of wealth. How is "implausibility" operationalized? Well..check out Jim's seminar for details !! A sneak preview: consider a 50/50 coin toss paying paying nothing or 1 million dollars . Where credibility isn't an issue...eg forget your average experimenter's budget and go to a roulette wheel at a commercial casino with a sufficient stock of of available wealth and reputation...so you do expect they will pay out ...would you really prefer $100 for sure to that 50/50 gamble? With a clever use of compound 50/50 gambles and restrictions implied by concavity and additively separable functionals Jim and his co-aithours show that plausible styles of risk aversion in small stakes gamble imply precisely this kind of implausible behaviour for large stakes.
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