Dynamic choice and the common ratio effect: An experimental investigation

Abstract

The common ratio effect is a well-attested violation of expected utility theory. This paper uses four principles of dynamic choice to characterise alternative theoretical strategies for explaining the effect. It reports an experiment which tests these principles and, by implication, several well-known accounts of the common ratio effect. Unlike previous work, the experimental design uses real financial incentives without presupposing any dynamic choice principles. We find violation of a principle of 'timing independence', which is part of most existing theories of dynamic choice We examine the implications of this finding for decision theory and economics.