Risk .A Puzzle Involving Low Probability Events.
Choice. Option A: Win $5 for sure. Option B: Win $5,000 with odds of 1 in 1,000; else, win nothing.
In experiments, a majority of subjects choose option B.
This choice is puzzling because options A and B have the same expected payoff($5), but option B clearly involves greater risk.
If subjects are risk averse, they should pick option A.
Risk. A Puzzle Involving Aversion to Very Small Risks.
Choice. Option C: Win $1,010 with 50% probability. else, lose $1,000 with 50% probability. Option D: Win $10.10 with 50% probability; else, lose $10 with 50% probability. Most people would take neither option. However, standard economic theory shows that a risk- averse individual should always be willing to accept a sufficiently small share of any gamble that provides a positive expected payoff.