Comment on Is risk aversion really irrational ?

Sat, 11 Feb 2012 14:01:40 GMT

A bottle of water can save my life if I am in desert. However, as long as I am not there (and there is no desert within 1000km from my home), I don't carry a bottle of water with me every time. In the desert, a bottle of water can have a very high utility. If you know you will go in one, buy a bottle of water. But standing in front of the shop (knowing you will be in a desert soon), the utility of a bottle of water is just a bit higher than the utility of the money to buy one (because you save the time to do so).

Scenario: Let's remove the time to buy a bottle, we are right next to a vending machine for water. A bottle costs 2€ there and the machine works perfectly. You know that you will be in a desert soon, the vending machine is you only way to get water and you are highly confident that you need one bottle to survive, and do not need more than one.

Example 1: You bought a bottle of water. Would you sell me this bottle for 5€? I am quite sure it would be the rational thing to do so and to buy a new bottle. This means that at the moment, 5€ have a utility which is a bit higher than a bottle of water.

Example 2: You don't have money and water. In this situation, 2€ have a really high utility for you - you would give me a lot to get 2€, similar to stuff you would give for one bottle of water.

Note that your utility for both money and water is highly nonlinear here. The second bottle of water could be useful, but it does not save your life. With 2€ (or a bottle of water), you would not accept any (reasonable) gamble with a risk of losing.

If you do not assign equivalent utility to money, you should rush to some shops and sell all your money.

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