Rationality crossovers

Abstract

Herein we further explore whether the power of arbitrage to induce people to exhibit more rational behavior extends to diverse decision-making tasks and stated valuation over preferences for gambles. We examine how arbitrage in a preference reversal setting affects behavior for the valuation of low probability food safety risks, the Allais Paradox, and the Ellsberg paradox. We design a three-stage experiment that elicits choices and values over gambles, with and without the experience of arbitrage. Our results suggest that a rationality crossover can exist – arbitrage in one setting can crossover to affect the choices in unrelated tasks. Stated values for safer food dropped by 20–50%, and the frequency of the Allais paradox is cut in half. People acted more rationally by reducing their stated value for a lottery, or if monetary adjustments are impossible they adjust their choice away from the lottery. Rationality crossovers have their predicted limits in that the frequency of the Ellsberg paradox, the most distinct decision environment, remained the same. We also found that the form of arbitrage as captured by stricter real marketlike experience or a weaker version of cheap-talk (i.e., hypothetical) arbitrage did not affect the results. This paper shows that arbitrage-induced rationality can transfer across contexts.