Anomalies: Risk Aversion

Economists ubiquitously employ a simple and elegant explanation for risk aversion: It derives from the concavity of the utility-of-wealth function within the expected-utility framework. We show that this explanation is not plausible in most applications, since anything more than economically negligi...

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Bibliographic Details
Published inThe Journal of economic perspectives Vol. 15; no. 1; pp. 219 - 232
Main Authors Rabin, Matthew, Thaler, Richard H.
Format Journal Article
LanguageEnglish
Published Nashville American Economic Association 2001
Subjects
Attitudes
Betting
Decision theory
Diminishing marginal utility
Economic theory
Economists
Expected utility
Features
Financial risk
Insurance policies
Loss aversion
Marginal utility
Preferences
Pumps
Rational expectations
Rationalization
Risk
Risk aversion
Utility functions
Utility theory
Wealth
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Summary:Economists ubiquitously employ a simple and elegant explanation for risk aversion: It derives from the concavity of the utility-of-wealth function within the expected-utility framework. We show that this explanation is not plausible in most applications, since anything more than economically negligible risk aversion over moderate stakes requires a utility-of-wealth function that is so concave that it predicts absurdly severe risk aversion over very large stakes. We present examples of how the expected-utility framework has misled economists, and why we believe a better explanation for risk aversion must incorporate loss aversion and mental accounting.
Bibliography:ObjectType-Article-2
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ISSN:0895-3309
1944-7965
DOI:10.1257/jep.15.1.219