Expected utility: a defense

Abstract

In recent papers Matthew Rabin and Richard H. Thaler have argued that expected utility theory generates implausible predictions about individuals' attitudes toward small vs. large risks. Specifically, these authors argued that expected utility theory, plus the assertion that individuals reject small risks that are actuarially unfavorable, implies that agents should reject large risks which in fact they would accept. In this paper we question the presumption that the small risks are in fact rejected: they have risk-return characteristics that are superior to those of the daily returns on common stocks, which individuals generally find acceptable.

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