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Risk aversion and the long run

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According to the dominant theory of rational choice in the face of risk and uncertainty, rationality demands that agents maximise expected utility. Critics argue, however, that this theory is not sufficiently permissive of attitudes to risk that are both common, and seem intuitively rational. The problem, according to Buchak (2013), is that for an agent to be risk averse with regard to a single good such as money, the utility function needs to display decreasing marginal utility with regard to that good. If the utility function is to capture the way in which the agent values the good, this means that the good has to be worth less to the agent, the more she has of it. However, intuitively it does not seem to be irrational to value a good in a linear way, and nevertheless be risk averse with regard to it. We often seem to display risk aversion because we want to avoid risk, not because we do not value the goods in question in a linear way. Expected utility theory does not allow for such an independent role for risk.

Several alternatives to expected utility theory, notably Buchak’s own risk-weighted expected utility (REU) theory, which builds on Quiggin’s (1982) rank dependent utility theory, allow for risk to matter independently from the shape of the utility function. This paper poses a challenge to such theories as normative theories of rational choice. I argue that theories like Buchak’s can only make sense of examples of ordinary risk aversion if the agents in question framed their decision problems too narrowly, and thus displayed a kind of practical irrationality. Once an agent takes account of the fact that any risky choice is only one in a long series of risky choices in her life, these alternatives can no longer account for ordinary cases of risk aversion. But since these are the very examples that motivate these theories in the first place, they lose much of their appeal as normative theories of rational choice.

This talk is part of the CamPoS (Cambridge Philosophy of Science) seminar series.

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