NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Ziang Li

Department of Economics
Princeton University
Julis Romo Rabinowitz Building
Princeton, NJ 08544

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Institutional Affiliation: Princeton University

NBER Working Papers and Publications

August 2018Cognitive Imprecision and Small-Stakes Risk Aversion
with Mel Win Khaw, Michael Woodford: w24978
Observed choices between risky lotteries are difficult to reconcile with expected utility maximization, both because subjects appear to be too risk averse with regard to small gambles for this to be explained by diminishing marginal utility of wealth, as stressed by Rabin (2000), and because subjects' responses involve a random element. We propose a unified explanation for both anomalies, similar to the explanation given for related phenomena in the case of perceptual judgments: they result from judgments based on imprecise (and noisy) mental representations of the decision situation. In this model, risk aversion results from a sort of perceptual bias — but one that represents an optimal decision rule, given the imprecision of the mental representation of the situation. We propose a quanti...
March 2017Risk Aversion as a Perceptual Bias
with Mel Win Khaw, Michael Woodford: w23294
The theory of expected utility maximization (EUM) explains risk aversion as due to diminishing marginal utility of wealth. However, observed choices between risky lotteries are difficult to reconcile with EUM: for example, in the laboratory, subjects' responses on individual trials involve a random element, and cannot be predicted purely from the terms offered; and subjects often appear to be too risk averse with regard to small gambles (while still accepting sufficiently favorable large gambles) to be consistent with any utility-of-wealth function. We propose a unified explanation for both anomalies, similar to the explanation given for related phenomena in the case of perceptual judgments: they result from judgments based on imprecise (and noisy) mental representation of the decision sit...
 
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