Prevent or Cure? Trading in the Face of Skewed Binary Lotteries

Julien Jacob, Marielle Brunette () and Louis Eeckhoudt

Journal of Institutional and Theoretical Economics (JITE), 2022, vol. 178, issue 2, 130-169

Abstract: We analyze the choice of a risk-averse decision maker who faces two lotteries that exhibit a trade-off between a reduction in the probability of a loss occurring and its magnitude. We make a theoretical analysis with skewed binary lotteries: lottery LA is associated with a lower magnitude and a higher probability of a loss occurring than lottery LB. We show that any risk-averse decision maker will prefer LA to LB when the expected gain of LA is higher than or equal to the expected gain of LB. However, in the opposite case, additional assumptions on individuals' prudence are required. We experimentally test our theoretical predictions, and provide applications and policy recommendations.

Keywords: skewed risk; binary lotteries; prudence; temperance; skewed risk (search for similar items in EconPapers)
JEL-codes: C91 D81 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1628/jite-2022-0009

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