Approximate optimality and the risk/reward tradeoff given repeated gambles

Zengjing Chen (), Larry G. Epstein () and Guodong Zhang ()
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Zengjing Chen: Shandong University
Larry G. Epstein: McGill University
Guodong Zhang: Shandong University

Economic Theory, 2025, vol. 79, issue 4, No 8, 1381 pages

Abstract: Abstract This paper studies a sequential decision problem where payoff distributions are known and where the riskiness of payoffs matters. Equivalently, it studies sequential choice from a repeated set of independent lotteries. The decision-maker is assumed to pursue strategies that are approximately optimal for large horizons. By exploiting the tractability afforded by asymptotics, conditions are derived characterizing when specialization in one action or lottery throughout is asymptotically optimal and when optimality requires intertemporal diversification. The key is the constancy or variability of risk attitude, that is, the decision-maker’s risk/reward tradeoff.

Keywords: Risk/reward tradeoff; Large-horizon approximations; Central limit theorem; Repeated gambles; Diversification; Multi-armed bandit (search for similar items in EconPapers)
JEL-codes: C02 D81 (search for similar items in EconPapers)
Date: 2025
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DOI: 10.1007/s00199-024-01614-4

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