Now You See It, Now You Don’t: How to Make the Allais Paradox Appear, Disappear, or Reverse
25 Pages Posted: 6 Jul 2015
Date Written: June 23, 2015
Abstract
The Allais Paradox, or Common Consequence Effect to be precise, is one of the most well-known behavioral regularities in individual decision making under risk. A common perception in the literature, which motivated the development of numerous generalized non‐expected utility theories, is that the Allais Paradox is a robust empirical finding. We argue that such a perception does not accurately reflect the experimental evidence on the Allais Paradox and show how specific choices of parameters can make it appear, disappear, or reverse. For example, our results suggest that the Allais Paradox is likely to disappear when lotteries involve relatively small outcomes under real financial incentives and probability distributions are described as compound lotteries or in a frequency format (rather than as reduced‐form simple lotteries). We also find that the Allais Paradox is likely to get reversed when lotteries are designed with an even division of the probability mass between the lowest and the highest outcomes.
Keywords: Decision under risk, the Allais Paradox, Common Consequence Effect, Expected Utility, Fanning‐out, Experimental Practices
JEL Classification: D01, D81
Suggested Citation: Suggested Citation