RISK AVERSION AND EXPECTED UTILITY THEORY: AN EXPERIMENT WITH LARGE AND SMALL STAKES

We employ a novel data set to estimate a structural econometric model of the decisions under risk of players in a game show where lotteries present payoffs in excess of half a million dollars. The decisions under risk of players in the presence of large payoffs allow us to estimate the parameters of the curvature of the von NeumannMorgenstern utility functionnot only locally, as in previous studies in the literature, but also globally. Our estimates of relative risk aversion indicate that a constant relative risk aversion parameter of about 1 captures the average of the sample population. We also find that individuals are practically risk neutral at small stakes and risk averse at large stakesa necessary condition, according to Rabins calibration theorem, for expected utility to provide a unified account of individuals attitudes toward risk. Finally, we show that for lotteries characterized by substantial stakes, nonexpected utility theories fit the data equally as well as expected utility theory.