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Alternation bias and reduction in St. Petersburg gambles

Author

Listed:
  • Kim Kaivanto
  • Eike Kroll
Abstract
Reduction of compound lotteries is implicit both in the statement of the St. Petersburg Paradox and in its resolution by Expected Utility (EU).We report three real-money choice experiments between truncated compound-form St. Petersburg gambles and their reduced-form equivalents. The first tests for differences in elicited Certainty Equivalents. The second develops the distinction between ‘weak-form’ and ‘strong-form’ rejection of Reduction, as well as a novel experimental task that verifiably implements Vernon Smith’s dominance precept. The third experiment checks for robustness against range and increment manipulation. In all three experiments the null hypothesis of Reduction is rejected, with systematic deprecation of the compound form in favor of the reduced form. This is consistent with the predictions of alternation bias. Together these experiments offer evidence that the Reduction assumption may have limited descriptive validity in modelling St. Petersburg gambles, whether by EU or non-EU theories.

Suggested Citation

  • Kim Kaivanto & Eike Kroll, 2014. "Alternation bias and reduction in St. Petersburg gambles," Working Papers 65600286, Lancaster University Management School, Economics Department.
    • Handle: RePEc:lan:wpaper:65600286
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    More about this item

    Keywords

    St. Petersburg Paradox; reduction axiom; alternation bias; dominance precept; law of small numbers; test of indifference;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior

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