A Model of Casino Gambling
NBER Working Paper No. 14947
We show that prospect theory offers a rich theory of casino gambling, one that captures several features of actual gambling behavior. First, we demonstrate that, for a wide range of preference parameter values, a prospect theory agent would be willing to gamble in a casino even if the casino only offers bets with no skewness and with zero or negative expected value. Second, we show that the probability weighting embedded in prospect theory leads to a plausible time inconsistency: at the moment he enters a casino, the agent plans to follow one particular gambling strategy; but after he starts playing, he wants to switch to a different strategy. The model therefore predicts heterogeneity in gambling behavior: how a gambler behaves depends on whether he is aware of the time inconsistency; and, if he is aware of it, on whether he can commit in advance to his initial plan of action.