3 ms·

I have heard this argument before but I don't get it. Especially since evidence seems to show people generally have concave utility for money. (Under the assump

by kqr 3y ago

I have heard this argument before but I don't get it. Especially since evidence seems to show people generally have concave utility for money. (Under the assumption of concave utility, insurance is a better deal than it seems, but lotteries a worse deal than they seem -- even when one diversifies.) What is the exact shape of the convex utility function you theorise these people have? And what data supports that?

aleph_minus_one 3y ago
> (Under the assumption of concave utility, insurance is a better deal than it seems, but lotteries a worse deal than they seem -- even when one diversifies. Indemnity insurance and lotteries are actually symmetric to each other: indemnity insure is about preventing big losses in a rare event, and lotteries are about winning big in a rare event. The central difference is that the behaviour of people with respect to wins and losses is not symmetric, that is why insurance policies and lotteries are marketed quite differently. > What is the exact shape of the convex utility function you theorise these people have? And what data supports that? I am very sure that big lottery companies have data available to answer this question, but they won't make the data available. So I honestly admit that I don't know the answer, but I can propose an experiment how one might get a partial answer: Create some lottery offers, paying out, say, 1000, 10.000, 100.000, 1.000.000, 10.000.000 $ with probabilities such that the expected payout is 5 $ for each of them. Now sell/auction the lottery tickets and look what prices customers are willing to pay. This should give a rough idea how the utility function might look like.
- kqr 3y ago
  You mean the expected payout is -$5, right? Otherwise the rational person with decent means -- even with a very concave utility -- would pay near $5 for that ticket, and this would be a Kelly-correct investment. The discussion was specifically about negative-EV lotteries since those are the ones that require convex utility.
  - aleph_minus_one 3y ago
    > You mean the expected payout is -$5, right? No, 5$. The reason is that you sell/auction these lottery tickets. The price that the customer pays has to be subtracted from this payout (and this way the final payout very likely will become negative). But the price that the customer will pay in this experiment is not known beforehand, so the initial payout has to be positive.
    - kqr 3y ago
      Right, I'm dumb. Yeah, that sounds like a very exciting experiment! Now I just have to find someone to fund it...

by kqr 3y ago

aleph_minus_one 3y ago

> (Under the assumption of concave utility, insurance is a better deal than it seems, but lotteries a worse deal than they seem -- even when one diversifies. Indemnity insurance and lotteries are actually symmetric to each other: indemnity insure is about preventing big losses in a rare event, and lotteries are about winning big in a rare event. The central difference is that the behaviour of people with respect to wins and losses is not symmetric, that is why insurance policies and lotteries are marketed quite differently. > What is the exact shape of the convex utility function you theorise these people have? And what data supports that? I am very sure that big lottery companies have data available to answer this question, but they won't make the data available. So I honestly admit that I don't know the answer, but I can propose an experiment how one might get a partial answer: Create some lottery offers, paying out, say, 1000, 10.000, 100.000, 1.000.000, 10.000.000 $ with probabilities such that the expected payout is 5 $ for each of them. Now sell/auction the lottery tickets and look what prices customers are willing to pay. This should give a rough idea how the utility function might look like.

kqr 3y ago
You mean the expected payout is -$5, right? Otherwise the rational person with decent means -- even with a very concave utility -- would pay near $5 for that ticket, and this would be a Kelly-correct investment. The discussion was specifically about negative-EV lotteries since those are the ones that require convex utility.
- aleph_minus_one 3y ago
  > You mean the expected payout is -$5, right? No, 5$. The reason is that you sell/auction these lottery tickets. The price that the customer pays has to be subtracted from this payout (and this way the final payout very likely will become negative). But the price that the customer will pay in this experiment is not known beforehand, so the initial payout has to be positive.
  - kqr 3y ago
    Right, I'm dumb. Yeah, that sounds like a very exciting experiment! Now I just have to find someone to fund it...