Using Prospect Theory To Understand Casino (Gambling) Behavior
Abstract (Via SSRN)
Casino gambling is a hugely popular activity around the world, but there are still very few models of why people go to casinos or of how they behave when they get there. In this paper, we show that prospect theory can offer a surprisingly rich theory of gambling, one that captures many features of actual gambling behavior. First, we demonstrate that, for a wide range of parameter values, a prospect theory agent would be willing to gamble in a casino, even if the casino only offers bets with zero or negative expected value. Second, we show that prospect theory predicts a plausible time inconsistency: at the moment he enters a casino, a prospect theory agent plans to follow one particular gambling strategy; but after he enters, he wants to switch to a different strategy. The model therefore predicts heterogeneity in gambling behavior: how a gambler behaves depends on whether he is aware of the time-inconsistency; and, if he is aware of it, on whether he is able to commit, in advance, to his initial plan of action.