Social Sciences Brown Bag Seminar

Abstract: Many models of decision-making under uncertainty are motivated by two prominent deviations from expected utility (EU): the common consequence effect (CCE) and the common ratio effect (CRE). Both decision problems were originally proposed as thought experiments by Allais (1953), and later popularized by Kahneman & Tversky (1979). The apparent deviations from EU predictions in each problem have motivated a wide body of decision theories in risky choice.

Although the CRE and CCE both represent violations of the EU axiom of independence, they have been studied mostly independently, and using quite different experimental parameters. In fact, however, the two decision problems are closely related: If conducted at a common set of experimental parameters, the two problems would share three out of four possible options. Moreover, the connections between the two problems are relevant for assessing various non-EU models—i.e., different models predict specific patterns.

In this paper, we extend existing empirical tests by (i) explicitly recognizing the connection between the two decision problems; (ii) conducting a large number of experiments covering connected CRE and CCE problems at different experimental parameters; and (iii) implementing experiments using both paired choice tasks (for comparison to the prior literature) and paired valuation tasks (our preferred approach given the inferential challenges outlined in McGranaghan et al (2022)).

Our results provide important insights on the shape of risk preferences. We find small but significant CR preferences, but systematic reverse CC preferences. Through their connection, this pattern implies that individuals violate betweenness by preferring mixtures. These results are inconsistent with leading non-EU models, and we propose a model to rationalize these findings.

Co-author(s): Christina McGranaghan (University of Delaware), Kirby Nielsen (California Institute of Technology), Ted O'Donoghue (Cornell University), and Jason Somerville (Federal Reserve Bank of New York)