Resolving Rabin’s Paradox
Controversies and confusions have arisen as to whether Rabin’s classical paradox truly violates expected utility and, more generally, reference dependence, partly due to different terminologies in different fields. The specific causes of expected utility's unacceptable conclusions under Rabin's paradox have not been parsed either. By providing the proper theoretical model, we resolve the confusions and make it possible to identify the causes of this long-standing paradox. Further, through use of proper experimental stimuli, we make it possible to test the empirical relevance of these causes. Based on indirect (excluding all other causes) and direct evidence, we identify violations of reference independence as the true culprit. Thus, Rabin’s paradox provides not only the negative implication that expected utility is violated but also a positive message: it underscores the importance of reference dependence.
|Keywords||Rabin’s paradox, reference dependence, loss aversion, prospect theory|
|JEL||Laboratory, Individual Behavior (jel C91), Criteria for Decision-Making under Risk and Uncertainty (jel D81)|
|Journal||Journal of Risk and Uncertainty|
Bleichrodt, H, Doctor, J.N, Gao, Y, Li, C, Meeker, D., & Wakker, P.P. (2019). Resolving Rabin’s Paradox. Journal of Risk and Uncertainty, in press. Retrieved from http://hdl.handle.net/1765/119934