Background risk and small-stakes risk aversion

15 Oct 2020  ·  Xiaosheng Mu, Luciano Pomatto, Philipp Strack, Omer Tamuz ·

We show that under plausible levels of background risk, no theory of choice under risk -- such as expected utility theory, prospect theory, or rank dependent utility -- can simultaneously satisfy the following three economic postulates: (i) Decision makers are risk-averse over small gambles, (ii) they respect stochastic dominance, and (iii) they account for background risk.

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