Buying and selling price for risky lotteries and expected utility theory with gambling wealth

Abstract

I analyze two expected utility models which abandon the consequentialist assumption of terminal wealth positions. In the expected utility of gambling wealth model, in which initial wealth is allowed to be small, I show that a large WTA/WTP gap is possible and the (Rabin in Econometrica, 68(5), [1281][1282][1283][1284][1285][1286][1287][1288][1289][1290][1291][1292] 2000) paradox may be resolved. Within the same model the classical preference reversal which allows arbitrage is not possible, whereas preference reversal (involving buying prices in place of selling prices), which does not allow arbitrage, is possible. In the expected utility of wealth changes model, in which there is no initial wealth, I show that both a WTA/WTP gap as well as the classical preference reversal are possible due to loss aversion, both in its general as well as some specific forms.Keywords Expected utility · Narrow framing · Rabin (2000) paradox · Preference reversal · WTA/WTP disparity · Buying and selling price for a lotteryWillingness to accept (WTA) or selling price for a lottery is a minimal sure amount of money which a person is willing to accept to forego the right to play the lottery. Willingness to pay (WTP) or buying price for a lottery, on the other hand, is a maximal sure amount of money which a person is willing to pay in order to get the right to play the lottery. The disparity between willingness to pay and willingness to accept is a well-known phenomenon that arises in experimental settings. There is a large body of evidence starting with Knetsch and Sinden (1984) and Thaler (1980) that WTA is much higher than WTP for many types of goods. Horowitz and McConnell (2002)

Risk awareness and complexity in students’ gambling

“…In this world gambling is an anomaly to be explained. Some works have explored the possibility that gambling is associated to a specific "utility", though its compatibility with rational behaviour remains in doubt (Conlisk, 1993;Diecidue et al, 2004;Lewandowski, 2014), A lot of empirical research has increasingly provided evidence that individuals sometimes decide against their own long-term self-interest and gambling is a flawless example of this behavior, since "the dealer always wins" (Dassen et al, 2015;Gainsbury et al, 2018).…”

What explains observed reluctance to trade? A comprehensive literature review

“…Finally, in a new addition to the ever-growing stack of theoretical explanations, Lewandowski (2014) challenged the predictive value of the basic tenet of consequentialism that assumes that individuals make choices conditional on their total wealth. In most experiments, subjects are asked to report valuations for lotteries with small values relative to total wealth.…”