Paying to Improve Your Chances: Gambling or Insurance?

Martin C. McGuire, John Pratt, and Richard Zeckhauser , Journal of Risk and Uncertainty 4(4) , 329-338 , December 1991.

Will a more risk-averse individual spend more or less to improve probabilities, say on marketing efforts that enhance the chance of a sale? For any two payoffs and starting probabilities, the answer is unfortunately indeterminate. However, interpreting gambling as increasing small chances of good outcomes and insurance as reducing small chances of bad outcomes, the more risk-averse individual will pay less (more) to gamble (insure). We find a critical switching probability that depends on the individuals and outcomes involved. If the good outcome is less (more) likely than this critical value, the expenditures represent gambling (insurance).

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