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A Context-Dependent Model of the Gambling Effect

Erasmus University, iMTA/iBMG, P.O. Box 1738, 3000 DR Rotterdam, The Netherlands
University of Southern Denmark, Department of Economics, Campusvej 55, 5230 Odense M, Denmark, and Christian Albrechts Universität, Kiel, Germany
Bleichrodt(bmg.eur.nl
us(bwl.uni-kiel.de

This paper presents a context-dependent theory of decision under risk. The relevant contextual factor is the presence of a riskless lottery in a preference comparison. The theory only deviates from expected utility if the set of options contains both riskless and risky lotteries. The main motivation for the theory is to explain the gambling effect. Contrary to previous theories of the gambling effect, the present theory is consistent with stochastic dominance. It can, however, violate transitivity. The theory allows for a decomposition of the interaction between risk aversion and gambling aversion and thereby extends the classical Arrow-Pratt measure of risk aversion.

Key Words: nonexpected utility; gambling effect; risk aversion; intransitivity
revision received: May 2, 2001;

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