Utility Theory and Participation in Unfair Lotteries
Patel Nitin R and
Subrahmanyam M G
No WP1977-12-01_00262, IIMA Working Papers from Indian Institute of Management Ahmedabad, Research and Publication Department
Two alternative explanations have been proposed earlier to rationalize the participation of risk averse individuals in unfair lotteries within the framework of the von Neumann-Morgenstern expected utility hypothesis. One relies on the “thrill of gambling” while the other postulates that individuals have utility functions that are initially convex and become concave for larger values of wealth. In this paper, we provide a more complete explanation that is consistent with consumer choice theory. The underlying assumption is that certain commodities mainly luxuries are available only in “lumpy” amounts. It is shown that the indivisibility of high value commodities creates situations where individuals participate in unfair lotteries and yet are behaving consistently with the expected utility maxim.
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