Background Risk and Small-Stakes Risk Aversion
Xiaosheng Mu,
Luciano Pomatto,
Philipp Strack and
Omer Tamuz
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Xiaosheng Mu: Princeton University
Luciano Pomatto: Caltech
Philipp Strack: Yale University
Omer Tamuz: Caltech
Working Papers from Princeton University. Economics Department.
Abstract:
Building on Pomatto, Strack, and Tamuz (2020), we identify a tight condition for when background risk can induce first-order stochastic dominance. Using this condition, we show that under plausible levels of background risk, no theory of choice under risk can simultaneously satisfy the following three economic postulates: (i) Decision makers are risk-averse over small gambles, (ii) their preferences respect stochastic dominance, and (iii) they account for background risk. This impossibility result applies to expected utility theory, prospect theory, rank dependent utility and many other models.
Keywords: risk; theories of choice (search for similar items in EconPapers)
JEL-codes: D81 (search for similar items in EconPapers)
Date: 2023-08
New Economics Papers: this item is included in nep-cwa, nep-ore, nep-rmg and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:pri:econom:2021-26
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