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Pre-Decision Side-Bet Sequences

Research output: Working paper

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Pre-Decision Side-Bet Sequences. / Kaivanto, Kim Kaleva; Peel, David Alan.
Lancaster: Lancaster University, Department of Economics, 2017. (Economics Working Paper Series).

Research output: Working paper

Harvard

Kaivanto, KK & Peel, DA 2017 'Pre-Decision Side-Bet Sequences' Economics Working Paper Series, Lancaster University, Department of Economics, Lancaster.

APA

Kaivanto, K. K., & Peel, D. A. (2017). Pre-Decision Side-Bet Sequences. (Economics Working Paper Series). Lancaster University, Department of Economics.

Vancouver

Kaivanto KK, Peel DA. Pre-Decision Side-Bet Sequences. Lancaster: Lancaster University, Department of Economics. 2017 Apr. (Economics Working Paper Series).

Author

Kaivanto, Kim Kaleva ; Peel, David Alan. / Pre-Decision Side-Bet Sequences. Lancaster : Lancaster University, Department of Economics, 2017. (Economics Working Paper Series).

Bibtex

@techreport{c3dc877cdef44a5d98765a69e02905b4,
title = "Pre-Decision Side-Bet Sequences",
abstract = "Risk-averse Expected Utility (EU) decision makers with wealth-dependent utility functions may find themselves indifferent between accepting and rejecting an indivisible risky prospect. Bell (1988) showed that under these circumstances it is EU-enhancing for the decision maker to engage in a pre-decision side bet, accepting the indivisible risky prospect conditional upon winning the side bet. The side bet places the decision maker on the convex hull between the initial-wealth utility function and the utility function with risky-prospect-augmented wealth. We show that decision makers restricted to actuarially unfair side bets engage in a sequence of individually EU-enhancing side bets. This occurs because optimal stake size is modest for actuarially unfair side bets, whereby wealth remains within the interval of interim convexity upon losing the side bet. As optimal stake size falls strongly with each successive side-bet round, wealth remains within the interval of interim convexity. The EU enhancement conferredby each successive round is also strongly diminishing. Hence the side-bet sequence is eventually truncated when no further EU enhancement is available.",
keywords = "Expected Utility, risk aversion, side bets, rationality, indivisibility, discreteness, actuarial fairness",
author = "Kaivanto, {Kim Kaleva} and Peel, {David Alan}",
year = "2017",
month = apr,
language = "English",
series = "Economics Working Paper Series",
publisher = "Lancaster University, Department of Economics",
type = "WorkingPaper",
institution = "Lancaster University, Department of Economics",

}

RIS

TY - UNPB

T1 - Pre-Decision Side-Bet Sequences

AU - Kaivanto, Kim Kaleva

AU - Peel, David Alan

PY - 2017/4

Y1 - 2017/4

N2 - Risk-averse Expected Utility (EU) decision makers with wealth-dependent utility functions may find themselves indifferent between accepting and rejecting an indivisible risky prospect. Bell (1988) showed that under these circumstances it is EU-enhancing for the decision maker to engage in a pre-decision side bet, accepting the indivisible risky prospect conditional upon winning the side bet. The side bet places the decision maker on the convex hull between the initial-wealth utility function and the utility function with risky-prospect-augmented wealth. We show that decision makers restricted to actuarially unfair side bets engage in a sequence of individually EU-enhancing side bets. This occurs because optimal stake size is modest for actuarially unfair side bets, whereby wealth remains within the interval of interim convexity upon losing the side bet. As optimal stake size falls strongly with each successive side-bet round, wealth remains within the interval of interim convexity. The EU enhancement conferredby each successive round is also strongly diminishing. Hence the side-bet sequence is eventually truncated when no further EU enhancement is available.

AB - Risk-averse Expected Utility (EU) decision makers with wealth-dependent utility functions may find themselves indifferent between accepting and rejecting an indivisible risky prospect. Bell (1988) showed that under these circumstances it is EU-enhancing for the decision maker to engage in a pre-decision side bet, accepting the indivisible risky prospect conditional upon winning the side bet. The side bet places the decision maker on the convex hull between the initial-wealth utility function and the utility function with risky-prospect-augmented wealth. We show that decision makers restricted to actuarially unfair side bets engage in a sequence of individually EU-enhancing side bets. This occurs because optimal stake size is modest for actuarially unfair side bets, whereby wealth remains within the interval of interim convexity upon losing the side bet. As optimal stake size falls strongly with each successive side-bet round, wealth remains within the interval of interim convexity. The EU enhancement conferredby each successive round is also strongly diminishing. Hence the side-bet sequence is eventually truncated when no further EU enhancement is available.

KW - Expected Utility

KW - risk aversion

KW - side bets

KW - rationality

KW - indivisibility

KW - discreteness

KW - actuarial fairness

M3 - Working paper

T3 - Economics Working Paper Series

BT - Pre-Decision Side-Bet Sequences

PB - Lancaster University, Department of Economics

CY - Lancaster

ER -