An Approximate Dual-Self Model and Paradoxes of Choice Under Risk
FRB of St. Louis Working Paper No. 2012-034A
Posted: 19 Sep 2012
Date Written: August 1, 2012
We derive a simplified version of the model of Fudenberg and Levine [2006, 2011] and show how this approximate model is useful in explaining choice under risk. We show that in the simple case of three outcomes, the model can generate indifference curves that “fan out” in the Marshack-Machina triangle, and thus can explain the well-known Allais and common ratio paradoxes that models such as prospect theory and regret theory are designed to capture. At the same time, our model is consistent with modern macroeconomic theory and evidence and generates predictions across a much wider set of domains than these models.
Keywords: common ratio effect, dual-self process, Allais paradox, self-control
JEL Classification: D01, D03
Suggested Citation: Suggested Citation