We don’t need loss aversion to explain a person’s decision to reject a 50:50 bet to win $110 or lose $100. That is just risk aversion as in expected utility theory.
Rabin’s argument starts with a simple bet: suppose you are offered a 50:50 bet to win $110 or lose $100, and you turn it down. Suppose further that you would reject this bet no matter what your wealth (this is an assumption we will turn to in more detail later). What can you infer about your response to other bets?
I would have highlighted the detail about needing to reject the bet at any wealth level for the argument to apply. I believe that making it a footnote was a mistake which makes the rest of the post much harder to follow because it’s very easy to miss a key underlying assumption.
You do not need to reject the bet at every wealth level. The point is that over the domain that you do reject the bet, your (hypothetical) marginal utility of money would be decreasing at least as fast as the derived exponential (on average).
Could that domain not just be really small, such that the ratio of outcomes you’d accept the bet at get closer and closer to 1? It seems like the premise that the discounting rate stays constant over a large interval (so we get the extreme effects from exponential discounting) is doing the work in your argument, but I don’t see how it’s substantiated.
Yeah, this is a good point. In the mathematical argument it simply has to be assumed as an input that the response is the same over at least a several-thousand-dollar span. But does that seem to bear out in the data about real humans? I think so. If you have a bunch of people who exhibit similar apparent risk aversion, spread out over a variety of wealths and dispositions, it seems like it would be a miracle for them to all be just below the level of wealth where they’d change their minds.
I like how Jason Collins frames it:
Rabin’s argument starts with a simple bet: suppose you are offered a 50:50 bet to win $110 or lose $100, and you turn it down. Suppose further that you would reject this bet no matter what your wealth (this is an assumption we will turn to in more detail later). What can you infer about your response to other bets?
I would have highlighted the detail about needing to reject the bet at any wealth level for the argument to apply. I believe that making it a footnote was a mistake which makes the rest of the post much harder to follow because it’s very easy to miss a key underlying assumption.
You do not need to reject the bet at every wealth level. The point is that over the domain that you do reject the bet, your (hypothetical) marginal utility of money would be decreasing at least as fast as the derived exponential (on average).
Could that domain not just be really small, such that the ratio of outcomes you’d accept the bet at get closer and closer to 1? It seems like the premise that the discounting rate stays constant over a large interval (so we get the extreme effects from exponential discounting) is doing the work in your argument, but I don’t see how it’s substantiated.
Yeah, this is a good point. In the mathematical argument it simply has to be assumed as an input that the response is the same over at least a several-thousand-dollar span. But does that seem to bear out in the data about real humans? I think so. If you have a bunch of people who exhibit similar apparent risk aversion, spread out over a variety of wealths and dispositions, it seems like it would be a miracle for them to all be just below the level of wealth where they’d change their minds.
Yeah, I guess you can get away with a weaker assumption. But it’s an important enough assumption that it should be stated.