Working Paper: NBER ID: w14947
Authors: Nicholas C. Barberis
Abstract: We show that prospect theory offers a rich theory of casino gambling, one that captures several features of actual gambling behavior. First, we demonstrate that, for a wide range of preference parameter values, a prospect theory agent would be willing to gamble in a casino even if the casino only offers bets with no skewness and with zero or negative expected value. Second, we show that the probability weighting embedded in prospect theory leads to a plausible time inconsistency: at the moment he enters a casino, the agent plans to follow one particular gambling strategy; but after he starts playing, he wants to switch to a different strategy. The model therefore predicts heterogeneity in gambling behavior: how a gambler behaves depends on whether he is aware of the time inconsistency; and, if he is aware of it, on whether he can commit in advance to his initial plan of action.
Keywords: Casino Gambling; Prospect Theory; Behavioral Economics
JEL Codes: D03; D81
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| perceived skewness of outcomes (D30) | willingness to enter the casino (L83) |
| perceived utility from gambling (H27) | decision to enter the casino (L83) |
| awareness of time inconsistency (D15) | initial plan to gamble or exit the casino (H27) |
| accumulated gains or losses (G11) | switch strategies (C73) |
| decision-making process of different types of agents (D91) | behavior under various conditions (C99) |