A moderately risk averse person may turn down a 50/50 gamble that either results in her winning $200 or losing $100. Such behaviour seems rational if, for instance, the pain of losing $100 is felt more strongly than the joy of winning $200. The aim of this paper is to examine an influential argument that some have interpreted as showing that such moderate riskaversion is irrational. After presenting an axiomatic argument that I take to be the (...) strongest case for the claim that moderate riskaversion is irrational, I show that it essentially depends on an assumption that those who think that riskaversion can be rational should be skeptical of. Hence, I conclude that riskaversion need not be irrational. (shrink)
Risk attitude is known to be a key determinant of various economic and financial choices. Behavioral studies that aim to evaluate the role of risk attitudes in contexts of this type, therefore, require tools for measuring individual risk tolerance. Recent developments in decision theory provide such tools. However, the methods available can be time consuming. As a result, some practitioners might have an incentive to prefer “fast and frugal” methods to clean but more costly methods. In this (...) article, we focus on a tractable procedure initially proposed by Holt and Laury (2002) to elicit risk attitude. We generalize this method to measure utility and riskaversion as follows. First, we allow measurement of probabilistic risk attitude through violations of expected utility due to probability weighting. Second, we use the outcome scale rather than the probability scale in the menu of choices. Third, we compare sure payoffs with lotteries instead of comparing non-degenerate lotteries. A within-subject experimental study illustrates the gains in tractability and bias minimization that can result from such an extension. (shrink)
A central point of debate over environmental policies concerns how future costs and benefits should be assessed. The most commonly used method for assessing the value of future costs and benefits is economic discounting. One often-cited justification for discounting is uncertainty. More specifically, it is riskaversion coupled with the expectation that future prospects are more risky. In this paper I argue that there are at least two reasons for disputing the use of riskaversion as (...) a justification for discounting when dealing with longterm decisions, one technical and one ethical. Firstly, I argue that technically, it implies an inconsistency between theory and practice. And secondly, I argue that discounting for uncertainty relies on a form of individualism which, while reasonable in standard microeconomic theory where an agent chooses how to spread her own consumption over her own lifetime, is inappropriate in the context of intergenerational social decisions. (shrink)
Fishburn and Vickson showed that, when applied to random alternatives with an equal mean, 3rd-degree and decreasing absolute riskaversion stochastic dominances represent equivalent rules. The present paper generalizes this result to higher degrees. Specifically, higher-degree stochastic dominance rules and common preference by all decision makers with decreasing higher-order absolute riskaversion are shown to coincide under appropriate constraints on the respective moments of the random variables to be compared.
Nash equilibria with identical supports are compared for bimatrix games that are different with respect to the riskaversion of player 2. For equilibria in 2× 2-bimatrix games and for equilibria with efficient supports in coordination games it is established for which cases increased riskaversion of player 2 benefits or hurts player 2.
We consider a situation where an individual is facing an uncertain situation, but may costly alter his knowledge of the uncertainties. We study in this context how riskaversion may modify the individual search behavior. We consider a one-armed bandit problem (where one arm is safe and the other is risky) and study how the agent riskaversion can change the sequence of arms selected. The main result is that when the utility function is more concave, (...) the agent has more chances to select the safe arm. We also discuss how search is affected by riskaversion. (shrink)
For linear distribution classes, mean-variance and expected utility specifications have been shown in the literature to be fully compatible when studying the concepts of riskaversion, prudence, risk vulnerability and temperance. This paper shows that such compatibility does hold for the concept of standard riskaversion but not for the concepts of proper riskaversion and proper prudence.
Various experimental procedures aimed at measuring individual riskaversion involve a list of pairs of alternative prospects. We first study the widely used method by Holt and Laury :1644–1655, 2002), for which we find that the removal of some items from the lists yields a systematic decrease in riskaversion and scrambles the ranking of individuals by riskaversion. This bias, that we call embedding bias, is quite distinct from other confounds that have been (...) previously observed in the use of the HL method. It may be related to empirical phenomena and theoretical developments where better prospects increase riskaversion. Nevertheless, we also find that the more recent elicitation method due to Abdellaoui et al., also based on lists but using only one and the same probability in the list, does not display any statistically significant bias when the corresponding items of the list are removed. Our results suggest that methods other than the popular HL one may be preferable for the measurement of riskaversion. (shrink)
A usual argument in finance refers to no arbitrage opportunities for the positivity of the bid-ask spread. Here we follow the decision theory approach and show that if positivity of the bid-ask spread is identified with strong riskaversion for an expected utility market-maker, this is no longer true for a rank-dependent expected utility one. For such a decision-maker only a very weak form of riskaversion is required, a result which seems more in accordance with (...) his actual behavior. We conclude by showing that the no-trade interval result of Dow and Werlang (1992a) remains valid for a rank-dependent expected utility market-maker merely exhibiting this weak form of riskaversion. (shrink)
The existing literature on savings, insurance, and portfolio choices under risk has revealed that quite often comparative statics results depend, among other things, upon the values of the coefficients of relative riskaversion and relative prudence. More specifically the benchmark values for these coefficients are, respectively, one and two. Recently, several papers investigated constraints on the higher degree extensions of the coefficients of relative riskaversion and of relative prudence. The present work provides a unified (...) approach to this question based on the concept of elementary correlation increasing transformations, allowing for a better understanding of changes in risk in the multiplicative case. (shrink)
Health security has become a popular way of justifying efforts to control catastrophic threats to public health. Unfortunately, there has been little analysis of the concept of health security, nor the relationship between health security and other potential aims of public health policy. In this paper I develop an account of health security as an aversion to risky policy options. I explore three reasons for thinking risk avoidance is a distinctly worthwhile aim of public health policy: that security (...) is intrinsically valuable, that it is necessary for social planning and that it is an appropriate response to decision-making in contexts of very limited information. Striking the right balance between securing and maximizing population health thus requires a substantive, and hitherto unrecognized, value judgment. Finally, I critically evaluate the current health security agenda in light of this new account of the concept and its relationship to the other aims of public health policy. (shrink)
This article argues that Lara Buchak’s risk-weighted expected utility theory fails to offer a true alternative to expected utility theory. Under commonly held assumptions about dynamic choice and the framing of decision problems, rational agents are guided by their attitudes to temporally extended courses of action. If so, REU theory makes approximately the same recommendations as expected utility theory. Being more permissive about dynamic choice or framing, however, undermines the theory’s claim to capturing a steady choice disposition in the (...) face of risk. I argue that this poses a challenge to alternatives to expected utility theory more generally. (shrink)
According to the orthodox treatment of risk preferences in decision theory, they are to be explained in terms of the agent's desires about concrete outcomes. The orthodoxy has been criticised both for conflating two types of attitudes and for committing agents to attitudes that do not seem rationally required. To avoid these problems, it has been suggested that an agent's attitudes to risk should be captured by a risk function that is independent of her utility and probability (...) functions. The main problem with that approach is that it suggests that attitudes to risk are wholly distinct from people's (non-instrumental) desires. To overcome this problem, we develop a framework where an agent's utility function is defined over chance propositions (i.e., propositions describing objective probability distributions) as well as ordinary (non-chance) ones, and argue that one should explain different risk attitudes in terms of different forms of the utility function over such propositions. (shrink)
In the television show Deal or No Deal a contestant is endowed with a sealed box, which potentially contains a large monetary prize. In the course of the show the contestant learns more information about the distribution of possible monetary prizes inside her box. Consider two groups of contestants, who learned that the chances of their boxes containing a large prize are 20% and 80% correspondingly. Contestants in both groups receive qualitatively similar price offers for selling the content of their (...) boxes. If contestants are less risk averse when facing unlikely gains, the price offer is likely to be more frequently rejected in the first group than in the second group. However, the fraction of rejections is virtually identical across two groups. Thus, contestants appear to have identical risk attitudes over (large) gains of low and high probability. (shrink)
In a recent article entitled “Putting Risk in its Proper Place,” Eeckhoudt and Schlesinger (2006) established a theorem linking the sign of the n-th derivative of an agent’s utility function to her preferences among pairs of simple lotteries. We characterize these lotteries and show that, in a given pair, they only differ by their moments of order greater than or equal to n. When the n-th derivative of the utility function is positive (negative) and n is odd (even), the (...) agent prefers a lottery with higher (lower) n + 2p-th moments for p belonging to the set of positive integers. This result links the preference for disaggregation of risks across states of nature to the complete structure of moments preferred by mixed risk averse agents. It can be viewed as a generalization of a proposition appearing in Ekern (1980) which focused only on the differences in the n-th moments. (shrink)
Behavioral research has revealed how normal human cognitive processes can tend to lead us astray. But do these affect economic researchers, ourselves? This article explores the consequences of stereotyping and confirmation bias using a sample of published articles from the economics literature on gender and riskaversion. The results demonstrate that the supposedly ‘robust’ claim that ‘women are more risk averse than men’ is far less empirically supported than has been claimed. The questions of how these cognitive (...) biases arise and why they have such power are discussed, and methodological practices that may help to attenuate these biases are outlined. (shrink)
Bernhard and Young (Journal of Academic Ethics, 7, 175-191, 2009) allege that a myth of confidentiality plagues research in North America because of the absence of statute-based legal protections and the requirements of some REBs to limit confidentiality to the extent permitted by law. In this commentary we describe statute-based protections for research confidentiality available in the United States, clarify the legal situation regarding research confidentiality in Canada, and explain that REBs that require confidentiality to be limited by law are (...) imposing a doctrine that is not required by the TCPS and may violate researchers’ academic freedom. The paper laments how excessive REB riskaversion and inaction by the granting agency Presidents has created a situation where some REBs are encouraging researchers to download research risks to research participants and forcing researchers to choose between exposing themselves to the prospect of going to jail to protect confidentiality, watering down their research objectives, or conducting vanilla research rather than engaging in controversial and/or sensitive areas of study. The paper urges the granting agency Presidents to seek legislative change to protect research participants who provide information that could cause them harm if their identity were to be revealed. (shrink)
Prominent theories of decision under risk that challenge expected utility theory model risk attitudes at least partly with transformation of probabilities. This paper shows how attributing local riskaversion to attitudes towards probabilities can produce extreme probability distortions that imply paradoxical riskaversion.
Consumer distrust is only recently beginning to be perceived as an important e-commerce issue and, unlike online trust, the nature and role of distrust is much less established. This study examines the influence of two important consumer characteristics on consumer’s ethically-based distrust of online retailers. Also, the moderating role of consumer’s need for personal contact with sales staff is tested. Results from 409 online consumers confirm that both relativist-based ethical ideology and riskaversion are strongly and positively related (...) to consumers’ distrust. Interestingly, our findings show that positive effects of relativism and riskaversion on consumer’s distrust are moderated by consumers’ need for personal interaction, which is more pronounced for those consumers with a high need for personal interaction with retail salespeople. (shrink)
According to Mark Rubinstein ‘In 1952, anticipating Kenneth Arrow and John Pratt by over a decade, he [de Finetti] formulated the notion of absolute riskaversion, used it in connection with risk premia for small bets, and discussed the special case of constant absolute riskaversion.’ The purpose of this note is to ascertain the extent to which this is true, and at the same time, to correct certain minor errors that appear in de Finetti's (...) work. (shrink)
Evidence of riskaversion in laboratory settings over small stakes leads to a priori implausible levels of riskaversion over large stakes under certain assumptions. One core assumption in statements of this calibration puzzle is that small-stakes riskaversion is observed over all levels of wealth, or over a â sufficiently largeâ range of wealth. Although this assumption is viewed as self-evident from the vast experimental literature showing riskaversion over laboratory stakes, (...) it actually requires that lab wealth be varied for a given subject as one evaluates the risk attitudes of the subject. We consider evidence from a simple design that tests this assumption, and find that the assumption is strikingly rejected for a large sample of subjects from a population of college students. We conclude that the implausible predictions that flow from these assumptions do not apply to one specialized population widely used to study economic behavior in laboratory experiments. (shrink)
By means of minimal assumptions on the individual preferences, I show that the Willingness To Pay (WTP) for both a FSD and SSD reduction of risk is the sum of a mean effect, a pure risk effect and a wealth effect. As a result, the WTP of a risk-averse decision maker may be lower than the WTP of a risk-neutral one, for a large class of individual preferences’ representation and a large class of risks.
The question of whether females tend to act more ethically or risk-averse compared to males is an interesting ethical puzzle. Using a large sample of US firms over the 1992–2014 period, we investigate the effect that the gender of a chief executive officer has on earnings management using classification shifting. We find that the pre-Sarbanes–Oxley Act period was characterized by high levels of classification shifting by both female and male CEOs, but the magnitude of such practices is, surprisingly, significantly (...) higher in firms with female CEOs than in those with male CEOs. By contrast, our results suggest that following the passage of the punitive SOX Act, classification shifting by female CEOs declined significantly, whilst it remained pervasive in firms with male CEOs. This suggests that the observable differences in financial reporting behavior between male and female CEOs seem to be because female CEOs are more risk-averse, but not necessarily more ethically sensitive than their male counterparts are. The central tenets of our findings remain unchanged after several additional checks, including controlling for alternative earnings management techniques, corporate governance mechanisms, CEO and chief financial officer characteristics and propensity score-matching. (shrink)
In this paper, we consider the composition of an optimal portfolio made of two dependent risky assets. The investor is first assumed to be a risk-averse expected utility maximizer, and we recover the existing conditions under which all these investors hold at least some percentage of their portfolio in one of the assets. Then, we assume that the decision maker is not only risk-averse, but also prudent and we obtain new minimum demand conditions as well as intuitively appealing (...) interpretations for them. Finally, we consider the general case of investor’s preferences exhibiting risk apportionment of any order and we derive the corresponding minimum demand conditions. As a byproduct, we obtain conditions such that an investor holds either a positive quantity of one of the assets or a proportion greater than 50 %. (shrink)
Empirical evidence suggests that mindfulness, psychological flexibility, and addiction are interrelated in decision making. In our study, we investigated the relationship of the behavioral profile, composed of mindfulness and psychological flexibility, and smoking status on delay and probability discounting. We demonstrated the interaction of the behavioral profile of mindfulness and psychological flexibility and smoking status on delay discounting. We found that individuals who smoked and displayed higher mindfulness and psychological flexibility devalued rewards at a slower rate, compared to smokers with (...) a lower profile. Importantly, in those with a higher profile, smokers discounted rewards no differently than nonsmokers. Smokers with a lower profile did display, however, increased impulsivity, compared to nonsmokers. These results suggest that behavioral interventions aiming to modify the behavioral profile with regard to mindfulness and psychological flexibility can indeed support the regulation of elevated impulsivity in smokers to equate with that of nonsmokers. In probability discounting, we observed that individuals with a higher profile displayed lower discounting rates, i.e., were less risk-averse, with no other significant main effect or interaction. (shrink)
The present note first discusses the concept of s-convex pain functions in decision theory. Then, the economic behavior of an agent with such a pain function is represented through the comparison of some recursive lotteries.
A decomposition model of Net Final Values, named Systemic Value Added, is proposed for decision-making purposes, based on a systemic approach introduced in Magni [Magni, C. A., Bulletin of Economic Research 55, 149–176; Magni, C. A. Economic Modelling 21, 595–617]. The model translates the notion of excess profit giving formal expression to a counterfactual alternative available to the decision maker. Relations with other decomposition models are studied, among which Stewart’s [Stewart, G.B., The Quest for Value: The EVA™ Management Guide, Harper (...) Collins, Publishers Inc]. The index here introduced differs from Stewart’s Economic Value Added in that it rests on a different interpretation of the notion of excess profit and is formally connected with the EVA model by means of a shadow project. The SVA is formally and conceptually threefold, in that it is economic, financial, accounting-flavoured. Some results are offered, providing sufficient and necessary conditions for decomposing NFV. Relations between a project’s SVA and its shadow project’s EVA are shown, all results of Pressacco and Stucchi [Pressacco, F. and Stucchi, P., Rivista di Matematica per le Scienze Economiche e Sociali 20, 165–185] are proved by making use of the systemic approach and the shadow counterparts of those results are also shown. (shrink)
Using a large sample of retail investors as well as experimental data we find that risk and ambiguity aversion are positively correlated. We provide evidence that a common link is decision mode: intuitive thinkers tolerate more risk and ambiguity than effortful reasoners. One interpretation is that intuitive thinking confers an advantage in risky or ambiguous situations. We present supporting lab and field evidence that intuitive thinkers outperform others in uncertain environments. Finally, we find that risk and (...) ambiguity aversion vary with individual characteristics and wealth. The wealthy are less risk averse but more ambiguity averse, which has implications for financial puzzles. (shrink)
This paper presents a new decision theory for modelling choice under risk. The new theory is a two-parameter generalization of expected utility theory. The proposed theory assumes that a decision maker: behaves as if maximizing expected utility; but may experience disappointment when the utility of a lottery’s outcome falls short of the expected utility of the lottery; and may have a preference for gambling. The proposed theory can rationalize the fourfold pattern of risk attitudes; the common ratio effect (...) and the reverse thereof ; the Allais paradox in classical common consequence problems and the reverse Allais paradox—in common consequence problems with an even split of a probability mass; violations of the betweenness axiom; switching behavior in the Samuelson’s example; violations of ordinal, upper and lower cumulative independence ; and preference reversals between valuations and choice. In application to insurance, the theory can rationalize full insurance with an actuarially unfair premium and aversion to probabilistic insurance. In application to optimal portfolio investment, the theory can rationalize the equity premium puzzle. (shrink)
The article gives a graphical interpretation of the concept of risk vulnerability. It shows that in a specific context of binary lotteries the assumption of risk vulnerability adds to prudence what the assumption of decreasing absolute riskaversion adds to riskaversion. We end the presentation showing that results can be extended to the concept of multiplicative risk vulnerability.
This article analyzes the conditions under which any change in a multiplicative background risk induces a more cautious behavior. We give necessary and sufficient conditions under which any change in the multiplicative background risk with respect to the Nth-degree stochastic dominance raises local riskaversion. Surprisingly, decreasing relative riskaversion of any order up to N in the sense of Pratt coupled with decreasing relative riskaversion in the sense of Ross are (...) sufficient to guarantee an increase in local riskaversion after any deterioration of the multiplicative background risk thanks to the Nth-degree stochastic dominance. We link our results concerning second-order stochastic dominance with the concept of multiplicative risk vulnerability. (shrink)