Resolving Rabin’s paradox
We present a theoretical model of Rabin’s famous calibration paradox that resolves confusions in the literature and that makes it possible to identify the causes of the paradox. Using suitable experimental stimuli, we show that the paradox truly violates expected utility and that it is caused by reference dependence. Rabin already showed that utility curvature alone cannot explain his paradox. We, more strongly, do not find any contribution of utility curvature to the explanation of the paradox. We find no contribution of probability weighting either. We conclude that Rabin’s paradox underscores the importance of reference dependence.
|Loss aversion, Prospect theory, Rabin’s paradox, Reference dependence|
|Criteria for Decision-Making under Risk and Uncertainty (jel D81), Behavioral Economics; Underlying Principles (jel D03), Laboratory, Individual Behavior (jel C91)|
|Journal of Risk and Uncertainty|
|Organisation||Erasmus School of Economics|
Bleichrodt, H, Doctor, J.N, Gao, Y, Li, C, Meeker, D. (Daniella), & Wakker, P.P. (2020). Resolving Rabin’s paradox. Journal of Risk and Uncertainty. doi:10.1007/s11166-019-09318-0