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Prospect-theory’s Diminishing Sensitivity Versus Economics’ Intrinsic Utility of Money: How the Introduction of the Euro can be Used to Disentangle the Two Empirically

Abstract

The introduction of the euro gave a unique opportunity to empirically disentangle two components of utility: intrinsic value, a rational component central in economics, and the numerosity effect (going by numbers while ignoring units), a descriptive and irrational component central in prospect theory and underlying the money illusion. We measured relative risk aversion in Belgium before and after the introduction of the euro, and could consider changes in intrinsic value while keeping numbers constant, and changes in numbers while keeping intrinsic value constant. Intrinsic value significantly affected risk aversion, and the numerosity effect did not. Our study is the first to confirm the classical hypothesis of increasing relative risk aversion while avoiding irrational distortions due to the numerosity effect.

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Wakker, P.P., Köbberling, V. & Schwieren, C. Prospect-theory’s Diminishing Sensitivity Versus Economics’ Intrinsic Utility of Money: How the Introduction of the Euro can be Used to Disentangle the Two Empirically. Theor Decis 63, 205–231 (2007). https://doi.org/10.1007/s11238-007-9040-8

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Keywords

  • utility
  • currency change
  • prospect theory
  • psychology of money
  • money illusion
  • relative risk aversion