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Published March 4, 2021 | Submitted
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Background Risk and Small-Stakes Risk Aversion


We show that under plausible levels of background risk, no theory of choice under risk---such as expected utility theory, prospect theory, or rank dependent utility---can simultaneously satisfy the following three economic postulates: (i) Decision makers are risk-averse over small gambles, (ii) they respect stochastic dominance, and (iii) they account for background risk.

Additional Information

We want to thank Ned Augenblick, Nick Barberis, Sebastian Ebert, Armin Falk, Stefano DellaVigna, Paul Heidhues, Matthew Rabin, Todd Sarver, Charlie Sprenger and Juuso Välimäki for helpful comments and discussions. Xiaosheng Mu acknowledges the hospitality of Columbia University and the Cowles Foundation at Yale University, which hosted him during parts of this research. Omer Tamuz was supported by a grant from the Simons Foundation (#419427), by a BSF grant (#2018397) and by a Sloan fellowship.

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