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Rubinstein2005-page126

Rubinstein2005-page126 - prize(chose(2 while in the second...

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October 21, 2005 12:18 master Sheet number 124 Page number 108 108 Lecture Nine Figure 9.4 1 is more risk averse than 2. You have \$2000 in your bank account. You have to choose between 1. a sure loss of \$500 and 2. a lottery in which you lose \$1000 with probability 1 / 2 and lose 0 with probability 1 / 2. What is your choice? Now assume that you have \$1000 in your account and that you have to choose between 3. a certain gain of \$500 and 4. a lottery in which you win \$1000 with probability 1 / 2 and win 0 with probability 1 / 2. What is your choice? In the first case, most people preferred the lottery to the certain
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Unformatted text preview: prize (chose (2)), while in the second case most people preferred the sure prize (chose (3)). Such a preference does not conﬂict with expected utility theory if we interpret a prize to reﬂect a “monetary change.” However, if we assume that the decision maker takes the ﬁnal wealth levels to be his prizes, we have a problem: in terms of ﬁnal wealth levels, both choices can be presented as being between a sure prize of \$1500 and a lottery that yields \$2000 or \$1000 with probability 1 / 2 each....
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