At the scale of living room bets, risk aversion is not a factor
You’re right about this strictly speaking, but liquidity constraints can result in the same practical outcome as risk aversion, and these are definitely relevant “on the margin”. I could be willing to take a $10 - $500 bet in the abstract, but if that requires me to borrow the $500 should I lose (for an extra $300 cost, say), it’s no longer rational for me to take that side of the bet! It would have to be a $10 - $200 bet or something, but obviously that creates a bid-ask spread which translates to an “imprecise” elicitation of probabilities. The ‘proper’ fix is to make the stakes small enough that liquidity too becomes a negligible factor—but a 5¢ - $2.5 bet is, um, not very exciting, and fixed transaction costs might make the bet infeasible again!
Good point. Though if I were betting against you, I’d just offer you to pay the $500 sometime in the next month or three. It’s the same as borrowing money, but the cost is low enough that the bid-ask spread should stay small.
You’re right about this strictly speaking, but liquidity constraints can result in the same practical outcome as risk aversion, and these are definitely relevant “on the margin”. I could be willing to take a $10 - $500 bet in the abstract, but if that requires me to borrow the $500 should I lose (for an extra $300 cost, say), it’s no longer rational for me to take that side of the bet! It would have to be a $10 - $200 bet or something, but obviously that creates a bid-ask spread which translates to an “imprecise” elicitation of probabilities. The ‘proper’ fix is to make the stakes small enough that liquidity too becomes a negligible factor—but a 5¢ - $2.5 bet is, um, not very exciting, and fixed transaction costs might make the bet infeasible again!
Good point. Though if I were betting against you, I’d just offer you to pay the $500 sometime in the next month or three. It’s the same as borrowing money, but the cost is low enough that the bid-ask spread should stay small.