Large Compound Lotteries

Zvi Safra () and Uzi Segal
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Zvi Safra: Warwick Business School

No 1057, Boston College Working Papers in Economics from Boston College Department of Economics

Abstract: Extending preferences over simple lotteries to compound (two-stage) lotteries can be done using two different methods: (1) using the Re- duction of compound lotteries axiom, under which probabilities of the two stages are multiplied; (2) using the compound independence ax- iom, under which each second-stage lottery is replaced by its certainty equivalent. Except for expected utility preferences, the rankings in- duced by the two methods are always in disagreement and deciding on which method to use is not straightforward. Moreover, sometimes each of the two methods may seem to violate some kind of first order stochastic dominance. In this paper we demonstrate that, under some conditions, the disagreement disappears in the limit and that for (al- most) any pair of compound lotteries, the two methods agree if the lotteries are replicated sufficiently many times.

Keywords: Reduction of compound lotteries axiom; compound independence axiom; duplicated lotteries (search for similar items in EconPapers)
JEL-codes: D81 (search for similar items in EconPapers)
Date: 2021-04-28, Revised 2023-08-01
New Economics Papers: this item is included in nep-upt
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