Allais Paradox
What is the Allais Paradox?
The Allais paradox illustrates how individuals often make decisions that violate expected utility theory, demonstrating inconsistencies in rational decision-making when faced with choices involving risk and uncertainty.
The Basic Idea
The Allais Paradox refers to a classic hypothetical choice problem in behavioral economics that exposes human irrationality. Daniel Kahneman offered a simplified version of the puzzle in his seminal book, Thinking, Fast and Slow
1:
Problem A: 61% chance to win $520,000 OR 63% chance to win $500,000
Problem B: 98% chance to win $520,000 OR 100% chance to win $500,000
If you haven’t already, take a moment to consider your own preferences for each problem… The majority of people choose the left-hand option for Problem A and the right-hand option for Problem B. As Kahneman put it: “If these were your preferences, you have just committed a logical sin and violated the rules of rational choice.” The irrationality stems from the willingness to take on an additional 2% risk in exchange for an extra $20,000 in potential winnings for one problem but not the other. Put differently, we are risk-seeking and choose the option with a greater expected value for Problem A but are risk-averse and choose the option with a lower expected value for Problem B, despite the possible outcomes being of equal value for both problems.
A theory is only as good as its assumptions.
- Maurice Allais
About the Authors
Dan Pilat
Dan is a Co-Founder and Managing Director at The Decision Lab. He is a bestselling author of Intention - a book he wrote with Wiley on the mindful application of behavioral science in organizations. Dan has a background in organizational decision making, with a BComm in Decision & Information Systems from McGill University. He has worked on enterprise-level behavioral architecture at TD Securities and BMO Capital Markets, where he advised management on the implementation of systems processing billions of dollars per week. Driven by an appetite for the latest in technology, Dan created a course on business intelligence and lectured at McGill University, and has applied behavioral science to topics such as augmented and virtual reality.
Dr. Sekoul Krastev
Sekoul is a Co-Founder and Managing Director at The Decision Lab. He is a bestselling author of Intention - a book he wrote with Wiley on the mindful application of behavioral science in organizations. A decision scientist with a PhD in Decision Neuroscience from McGill University, Sekoul's work has been featured in peer-reviewed journals and has been presented at conferences around the world. Sekoul previously advised management on innovation and engagement strategy at The Boston Consulting Group as well as on online media strategy at Google. He has a deep interest in the applications of behavioral science to new technology and has published on these topics in places such as the Huffington Post and Strategy & Business.
