Rationality on the Rise: Why Relative Risk Aversion Increases with Stake Size

Working Paper No. 413

34 Pages Posted: 9 Jun 2009

See all articles by Helga Fehr-Duda

Helga Fehr-Duda

ETH Zürich - Center for Economic Research

Adrian Bruhin

ETH Zürich - CER-ETH - Center of Economic Research at ETH Zurich

Thomas Epper

CNRS - Lille Economics & Managment - UMR 9221; Catholic University of Lille - IESEG School of Management

Date Written: May 2009

Abstract

How does risk tolerance vary with stake size? This important question cannot be adequately answered if framing effects, nonlinear probability weighting, and heterogeneity of preference types are neglected. We show that the increase in relative risk aversion over gains cannot be captured by the curvature of the utility function. It is driven predominantly by a change in probability weighting of a majority group of individuals who exhibit more rational probability weighting at high stakes. Contrary to gains, no coherent change in relative risk aversion is observed for losses. These results not only challenge expected utility theory, but also prospect theory.

Suggested Citation

Fehr-Duda, Helga and Bruhin, Adrian and Epper, Thomas, Rationality on the Rise: Why Relative Risk Aversion Increases with Stake Size (May 2009). Working Paper No. 413, Available at SSRN: https://ssrn.com/abstract=1416008 or http://dx.doi.org/10.2139/ssrn.1416008

Helga Fehr-Duda (Contact Author)

ETH Zürich - Center for Economic Research ( email )

Weinbergstr. 35
Zurich 8092
Switzerland

Adrian Bruhin

ETH Zürich - CER-ETH - Center of Economic Research at ETH Zurich ( email )

Zürichbergstrasse 18
Zurich, 8092
Switzerland

Thomas Epper

CNRS - Lille Economics & Managment - UMR 9221 ( email )

Lille
France

Catholic University of Lille - IESEG School of Management ( email )

Socle de la Grande Arche
1 Parvis de la Defense
Puteaux, Paris 92800
France

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