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Another Solution for Allais Paradox: Preference Imprecision, Dispersion and Pessimism

Author

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  • Bayrak, Oben
Abstract
Although there are alternative models which can explain the Allais paradox with non-standard preferences, they do not take the emerging evidence on preference imprecision into account. The imprecision is so far incorporated into these models by adding a stochastic specification implying the errors that subjects make. However, there is also the inherent part of the preference imprecision which does not diminish with experience provided in repeated experiments and these stochastic specifications cannot explain a significant portion of the observed behavior in experiments. Moreover, evidence on imprecision suggests that subjects exhibit higher imprecision for a lottery with a higher variance. This paper presents a new model for decision under risk which takes into account the findings of the literature. Looking at the indifference curves predicted by the new model, the new model acts like a mixture of Expected Utility Theory and Rank Dependent Utility Theory depending on which part of the probability triangle the lottery is located.

Suggested Citation

  • Bayrak, Oben, 2016. "Another Solution for Allais Paradox: Preference Imprecision, Dispersion and Pessimism," MPRA Paper 71780, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:71780
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    File URL: https://mpra.ub.uni-muenchen.de/71780/1/MPRA_paper_71780.pdf
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    References listed on IDEAS

    as
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    3. Oben K Bayrak & Bengt Kriström, 2016. "Is there a valuation gap? The case of interval valuations," Economics Bulletin, AccessEcon, vol. 36(1), pages 218-236.
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    More about this item

    Keywords

    Allais Paradox; Independence Axiom; Preference Imprecision; Anomalies; Decision Theory; Decision under Risk and Uncertainty; Alternative Models;
    All these keywords.

    JEL classification:

    • A1 - General Economics and Teaching - - General Economics
    • A10 - General Economics and Teaching - - General Economics - - - General
    • B0 - Schools of Economic Thought and Methodology - - General
    • C0 - Mathematical and Quantitative Methods - - General
    • C9 - Mathematical and Quantitative Methods - - Design of Experiments
    • D0 - Microeconomics - - General
    • D00 - Microeconomics - - General - - - General
    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • D02 - Microeconomics - - General - - - Institutions: Design, Formation, Operations, and Impact
    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D04 - Microeconomics - - General - - - Microeconomic Policy: Formulation; Implementation; Evaluation
    • D10 - Microeconomics - - Household Behavior - - - General
    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D89 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Other
    • G0 - Financial Economics - - General
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles

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