Robust Testing Of the Allais Paradox By Paired Choices vs. Paired Valuations

TL;DR

This paper critiques valuation tests for the Allais paradox, advocates for a robust paired choice test, and demonstrates the persistence of the common ratio effect in experimental data.

Contribution

It introduces a strong paired choice test that remains unbiased under stochastic choice models and challenges previous findings based on valuation tests.

Findings

Valuation tests are biased and lack predictive power under standard models.

The strong paired choice test remains unbiased across stochastic choice models.

The common ratio effect is still prevalent in experimental data.

Abstract

McGranaghan, Nielsen, O'Donoghue, Somerville, and Sprenger [2024] show that standard paired choice tests for the common ratio effect are structurally biased when choice is stochastic, proposing valuation tests as a robust alternative. Using valuation tests, they find no systematic evidence for the common ratio effect, seemingly overturning much of the extant literature. We evaluate this conclusion in light of stochastic choice theory. We argue that valuation tests are inherently biased and lack predictive power under standard expected utility assumptions. In contrast, we advocate for a ``strong'' paired choice test, proving it remains robustly unbiased across common models of stochastic choice. Applying this strong test to existing experimental data, we find that the common ratio effect remains highly prevalent.