Probabilistic Insurance and Anticipated Utility

Abstract

Kahneman and Tversky found that decision makers' reactions toward probabilistic insurance imply risk loving over the range of negative outcomes. This article proves that the probabilistic insurance phenomenon is consistent with risk aversion and a concave utility function, provided the decision maker satisfies the reduction of compound lotteries axiom or the independence axiom, but not both. This is demonstrated by using anticipated utility theory rather than expected utility theory.