Rationality Crossovers*

This paper explores whether the power of arbitrage to induce more rational behavior in market and nonmarket settings extends to diverse decision-making tasks 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 arbitrage in one setting can crossover to impact the choices in unrelated tasks. Stated values for safer food dropped by 20 to 50 percent, and the frequency of the Allais paradox is cut in half. People adjust their instinctual overreaction to risky lotteries by reducing their stated value for the lottery, or if monetary adjustments are impossible they adjust their choice away from the lottery. Rationality crossover has its limits, however, in that the frequency of the more distinct Ellsberg paradox, the most distinct decision environment, remained the same. We also found that the type of arbitrage, real market-like experience or a cheap-talk (i.e., hypothetical) version, did not affect the results. *The authors thank the USDA/ERS for financial support, and B. Cherry and C. Berry for their motivation. Thanks to Peter Bohm, Kate Johnson, and Dale Menkhaus for their helpful comments. **Cherry: Department of Economics, Appalachian State University, Boone, NC 28608-2051, [email protected]; Shogren: Department of Economics and Finance, University of Wyoming, Laramie, WY 82071-3985, [email protected].