Comments on the Risk and Time Preferences in Economics

Abstract

I heard about Rabin’s calibration result from Daniel Kahneman and, like him, I was impressed. Part of the reason is that it does not rely on experiments. It relies instead on a mental experiment and rings true without the need to be verified. I rushed to add the material to the lecture notes for my graduate micro-economics course. My comments there were in the spirit of Rabin’s criticism of expected utility theory: “What conclusion should we derive from this observation? Do we economists take our own findings seriously?” However, unlike Rabin, I wrote the comments with question marks and the conclusion I drew was quite different from that of Rabin (2001) and Rabin and Thaler (2001). I still include Rabin’s material in my lectures but not as a criticism of expected utility theory but as a demonstration of the problems associated with applying expected utility theory in mainstream economics. Let us review Rabin’s argument: A decision-maker rejects, at all levels of wealth (or at a certain interval, such as �0,$4000�), the lottery 0.5��10 � � 0.5��11�. The existence of such decision makers is plausible. If a decision maker behaves according to expected utility theory and is risk averse, his vNM utility function, u, satisfies

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