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Probability Premium and Attitude Towards Probability

Louis R. Eeckhoudt and Roger Laeven ()

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Abstract: Employing a generalized definition of Pratt (1964) and Arrow's (1965, 1971) probability premium, we introduce a new concept of attitude towards probability. We illustrate in a problem of risk sharing that whether attitude towards probability is a first-order or second-order phenomenon has important economic applications. By developing a local approximation to the probability premium, we show that the canonical rank-dependent utility model usually exhibits attitude towards probability of first order, whereas under the dual theory with smooth probability weighting functions attitude towards probability is a second-order trait.

Date: 2021-04
New Economics Papers: this item is included in nep-rmg and nep-upt
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