People's choices between gambles reverse when a common outcome is added to both, which expected utility theory says cannot happen.
Allais put his pair of choices to an audience of economists in 1953, several of whom had helped build the theory, and most chose inconsistently. The pattern is the certainty effect: a sure thing is weighted more heavily than its probability warrants, so removing certainty from both options changes the ranking. Kahneman and Tversky built prospect theory on this result.
In practice
- A buyer pays far more for the warranty that removes the last one per cent of risk than for one that removes ten points in the middle.
- A gambler who refuses an even chance on his stake buys a lottery ticket with far worse odds.
- Standing
- Robust and repeatedly replicated. The dispute was never about the finding but about whether to call it irrationality or the wrong model of preference. Compare the Ellsberg paradox.
- Further reading
- Wikipedia
- Subject
- Decision-making & Reasoning
- Essay
- Paradoxes that broke theories, and sayings that outlived them