DATE

13 March 2025

TIME

02:00 pm - 03:30 pm

LOCATION

Room 205, Anthony B. Atkinson - Ground Floor | Maison des Sciences Humaines, 11 Porte des Sciences, Esch-sur-Alzette

The Allais Paradox and Bipolar Risk Preferences: The Separate Upside and Downside Risk Menus

Individuals' risk preferences are fundamental to understanding economic and financial equilibria, as well as empirical results. However, the analysis of different experimental results on risk preferences sometimes seems confusing to researchers, students, and practitioners.

To help disentangle risk preferences, subjects in a laboratory experiment are presented with a small set of paired lottery choices that can be used to analyze two related choice patterns:

1. Allais Paradox violations of expected utility, and
2. a switch from avoidance of downside risk (small probability of a relatively small payoff) to a preference for upside risk (small probability of a relatively large payoff).

A large majority of financially motivated subjects exhibit one or both of these patterns. In contrast, only a minority of subjects exhibit risk aversion in all choices or risk neutrality/seeking in all choices. The observed decisions follow the Bipolar Risk Preferences: Separate risk preferences for the Upside and the Downside Risk Menu, and are analyzed through the lens of prospect theory.

Finally, we offer the Separate Upside and Downside Risk Menu for easy application in new research.

Co-authored with Charles A. Holt