Individual Choice from a Convex Lottery Set: Experimental Evidence
This paper is concerned with a simple pen-and-paper experiment on individual choice under risk, in which subjects choose a lottery from a convex set. In the reported experiment subjects face a choice of two risky lotteries and a degenerated one, and any linear combination of the three lotteries.1 The distinguishing features of the design are as follows: The two risky lotteries perfectly negatively correlate with each other, implying the existence of a riskless combination of these lotteries. Furthermore, as this riskless combination of the risky lotteries yields a greater payoff than the degenerated lottery, all lotteries in the interior of the convex set are strictly dominated. Finally, the efficient frontier of the convex set includes lotteries that involve a possible loss.
KeywordsIndividual choice under risk First order stochastic dominance Modern portfolio theory Prospect theory
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