Risk Aversion and Catastrophic Risks: the Pill Experiment

TL;DR

This paper critiques expected utility theory's ability to explain decisions involving catastrophic risks, presenting experimental evidence and proposing a new utility function that better aligns with observed behaviors.

Contribution

It demonstrates the inadequacy of risk aversion models for catastrophic risks and introduces a new utility function aligned with experimental results.

Findings

Expected utility theory fails to explain choices involving catastrophic risks.

A new utility function better fits experimental data on catastrophic risk decisions.

Risk aversion does not account for observed decision patterns in pill experiment.

Abstract

This article focuses on the work of O. Chanel and G. Chichilnisky (2013) on the flaws of expected utility theory while assessing the value of life. Expected utility is a fundamental tool in decision theory. However, it does not fit with the experimental results when it comes to catastrophic outcomes ---see, for example, Chichilnisky (2009) for more details. In the experiments conducted by Olivier Chanel in 1998 and 2009, several subjects are ask to imagine they are presented 1 billion identical pills. They are paid \$220,000 to take and swallow one, knowing that one out of 1 billion is deadly. The objective of this article is to show that risk aversion phenomenon cannot explain the experimental results found. This is an additional reason why a new kind of utility function is necessary: the axioms proposed by Graciela Chichilnisky will be briefly presented, and it will be shown that it better fits with experiments than any risk aversion utility function.