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

Julien Jacob (), Marielle Brunette () and Louis Eeckhoudt
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Julien Jacob: BETA - Bureau d'Économie Théorique et Appliquée - AgroParisTech - UNISTRA - Université de Strasbourg - Université de Haute-Alsace (UHA) - Université de Haute-Alsace (UHA) Mulhouse - Colmar - UL - Université de Lorraine - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, UNISTRA FSEG - Université de Strasbourg - Faculté des sciences économiques et de gestion - UNISTRA - Université de Strasbourg
Marielle Brunette: BETA - Bureau d'Économie Théorique et Appliquée - AgroParisTech - UNISTRA - Université de Strasbourg - Université de Haute-Alsace (UHA) - Université de Haute-Alsace (UHA) Mulhouse - Colmar - UL - Université de Lorraine - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, AgroParisTech, CEC - Chaire Economie du Climat - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres
Louis Eeckhoudt: IESEG School of Management Lille

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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 (L) over tilde (A) is associated with a lower magnitude and a higher probability of a loss occurring than lottery (L) over tilde (B). We show that any risk-averse decision maker will prefer (L) over tilde (A) to (L) over tilde (B) when the expected gain of (L) over tilde (A) is higher than or equal to the expected gain of (L) over tilde (B). 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 (search for similar items in EconPapers)
Date: 2022
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Published in Journal of Institutional and Theoretical Economics, 2022, 178 (2), pp.130-169. ⟨10.1628/jite-2022-0009⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-04174322

DOI: 10.1628/jite-2022-0009

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