Toomas Hinnosaar (Collegio Carlo Alberto)

“On the impossibility of protecting risk-takers”

Abstract

Risk-neutral sellers can extract high profits from risk-loving buyers by selling them lotteries. To limit risk-taking, gambling is heavily regulated in most countries. I show that protecting risk-loving buyers is essentially impossible. Even if buyers are risk-loving only asymptotically, the seller can construct a nonrandom winner-pays auction that ensures unbounded profits. Buyers are asymptotically risk-loving, for example, when their preferences satisfy Savage’s axioms or they have cumulative prospect theory preferences. The profits are unbounded even if the seller cannot use any mechanism that resembles a lottery. Asymptotically risk-loving preferences are both sufficient and necessary for unbounded profits.