Rationality and the Nature of the Market

Abstract

Abstract: We investigate the distribution of risk preferences and the frequency of expected utility violations along the gradient of market devel-opment. To do this, we collect experimental and survey data from a random sample of the population at four sites in Peru that differ in their level of competition and development. Similar to previous studies, we find that vio-lations of expected utility theory are frequent. More importantly, however, violations are far less frequent the more competitive the market is. Also, our study suggests that experience in trade is not always associated with fewer behavioral anomalies. For instance, wholesale traders in an oligopolistic mar-ket with many years of experience are more likely to violate expected utility theory than entrepreneurs in an adjacent market with less experience. As hypothesized by Alchian (1950), it is in highly competitive markets where the evidence of rational behavior is found