NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Uncertainty Equivalents: Testing the Limits of the Independence Axiom

James Andreoni, Charles Sprenger

NBER Working Paper No. 17342
Issued in August 2011
NBER Program(s):   PE

There is convincing experimental evidence that Expected Utility fails, but when does it fail, how severely, and for what fraction of subjects? We explore these questions using a novel measure we call the uncertainty equivalent. We find Expected Utility performs well away from certainty, but fails near certainty for about 40% of subjects. Comparing non-Expected Utility theories, we strongly reject Prospect Theory probability weighting, we support disappointment aversion if amended to allow violations of stochastic dominance, but find the u-v model of a direct preference for certainty the most parsimonious approach.

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Document Object Identifier (DOI): 10.3386/w17342

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