Paying to improve your chances: Gambling or insurance? |
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Authors: | Martin McGuire John Pratt Richard Zeckhauser |
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Affiliation: | 1. Department of Economics, University of Maryland, 20742, College Park, MD 2. Harvard Business School, Soldiers Field Road, 02163, Boston, MA 3. Kennedy School of Government, Harvard University, 79 John F. Kennedy Street, 02138, Cambridge, MA
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Abstract: | Will a more risk-averse individual spend more or less to improve probabilities, say on marketing efforts that enhance the chance of a sale? For any two payoffs and starting probabilities, the answer is unfortunately indeterminate. However, interpreting gambling as increasing small chances of good outcomes and insurance as reducing small chances of bad outcomes, the more risk-averse individual will pay less (more) to gamble (insure). We find a critical switching probability that depends on the individuals and outcomes involved. If the good outcome is less (more) likely than this critical value, the expenditures represent gambling (insurance). |
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Keywords: | gambling insurance risk risk aversion probability shifting utility theory |
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