Individual vs. couple behavior: an experimental investigation of risk preferences

In this article, we elicit both individuals’ and couples’ preferences assuming prospect theory (PT) as a general theoretical framework for decision under risk. Our experimental method, based on certainty equivalents, allows to infer measurements of utility and probability weighting at the individual level and at the couple level. Our main results are twofold. First, risk attitude for couples is compatible with PT and incorporates deviations from expected utility similar to those found in individual decision making. Second, couples’ attitudes towards risk are found to be consistent with a mix of individual attitudes, women being more influent on couples’ preferences at low probability levels.     

Boundedly rational expected utility theory

We build a satisficing model of choice under risk which embeds Expected Utility Theory (EUT) into a boundedly rational deliberation process. The decision maker accumulates evidence for and against alternative options by repeatedly sampling from her underlying set of EU preferences until the evidence favouring one option satisfies her desired level of confidence. Despite its EUT core, the model produces patterns of behaviour that violate standard EUT axioms, while at the same time capturing systematic relationships between choice probabilities, response times and confidence judgments, which are beyond the scope of theories that do not take deliberation into account.

     

Metapreferences and the reasons for stability in social choice: Thoughts on broadening and clarifying the debate

The standard model of collective choice looks at aggregation procedures which take individual preferences as existing for a specified set of alternatives. In this paper we propose that actors also have preferences for rules of choice or characteristics of choice processes (e.g., the perceived fairness of procedures or the popularity of outcomes) rather than simply for alternatives (outcomes) themselves. We argue that the positing of the existence of meta-preferences can illuminate a number of areas of choice theory. Here we focus on one such area: the problem of “too much” stability in majority rule decision making - a stability which belies the standard theoretical results on the generic instability of majority rule processes. We also show that discussion of the prevalence of stability in collective decision making needs to be clarified because there are at least six distinct types of stability which are sometimes confounded in the literature.     

Utility theory with probability dependent outcome valuation: Extensions and applications

This article extends Karni's (1992) Utility Theory with Probability Dependent Outcome Valuation (UTP-DOV) to accommodate a wider set of preferences, and applies the new representation to a variety of decision problems under risk. First, we present a new, more general, axiomatization of UTPDOV that renders the underlying intuition more transparent. Second, we develop sufficient conditions under which UTPDOV satisfies the betweenness and the ordinal independence axioms. Finally, we examine functional forms of the UTPDOV model that are consistent with several well known departures from the independence axiom.     

Dynamic Decision Making when Risk Perception Depends on Past Experience

The aim of the article is to propose a preferences representation under risk where risk perception can be past experience dependent. A first step consists in considering a one-period decision problem where individual preferences are no more defined only on decisions but on pairs (decision, past experience). The obtained criterion is used in the construction of a dynamic choice model under risk. The article ends with an illustrative example concerning insurance demand. It appears that our model allows to explain modifications in the insurance demand behavior over time observed on the insurance markets for catastrophic risk and difficult to justify with standard models.     

Choice under risk and the security factor: An axiomatic model

The particular attention paid by decision makers to the security level ensured by each decision under risk, which is responsible for the certainty effect, can be taken into account by weakening the independence and continuity axioms of expected utility theory. In the resulting model, preferences depend on: (i) the security level, (ii) the expected utility, offered by each decision. Choices are partially determined by security level comparison and completed by the maximization of a function, which express the existing tradeoffs between expected utility and security level, and is, at a given security level, an affine function of the expected utility. In the model, risk neutrality at a given security level implies risk aversion.     

The effect of fast and slow decisions on risk taking

We experimentally compare fast and slow decisions in a series of experiments on financial risk taking in three countries involving over 1700 subjects. To manipulate fast and slow decisions, subjects were randomly allocated to responding within 7 seconds (time pressure) or waiting for at least 7 or 20 seconds (time delay) before responding. To control for different effects of time pressure and time delay on measurement noise, we estimate separate parameters for noise and risk preferences within a random utility framework. We find that time pressure increases risk aversion for gains and risk taking for losses compared to time delay, implying that time pressure increases the reflection effect of Prospect Theory. The results for gains are weaker and less robust than the results for losses. We find no significant difference between time pressure and time delay for loss aversion (tested in only one of the experiments). Time delay also leads to less measurement noise than time pressure and unconstrained decisions, and appears to be an effective way of decreasing noise in experiments.     

Joint measurement of risk aversion,prudence, and temperance

Risk aversion—but also the higher-order risk preferences of prudence and temperance—are fundamental concepts in the study of economic decision making. We propose a method to jointly measure the intensity of risk aversion, prudence, and temperance. Our theoretical approach is to define risk compensations of different orders, and in an experiment we elicit these compensations with a price list technique. We find evidence for risk aversion, prudence, and temperance. These traits correlate within subjects. The compensations elicited for prudence are significantly larger than those for risk aversion and temperance. In contrast to commonly used utility functions, prospect theory can predict this behavioral pattern. In our experiment, risk-averse, risk-loving, and risk-neutral subjects are prudent. This supports a recent theoretical observation that prudence may be a more universal trait than previously realized.     

Giving in the face of risk

Decisions about how to share resources with others often need to be taken under uncertainty regarding its allocational consequences. Although risk preferences are likely important, existing research is silent about how social and risk preferences interact in such situations. In this paper we provide experimental evidence on this question. In a first experiment givers are not exposed to risk while beneficiaries’ final earnings may be larger or smaller than the allocation itself, depending on the realized state of the world. In a second experiment, risk affects the earnings of givers but not of beneficiaries. We find that individuals’ risk preferences are predictive for giving in both experiments. Increased risk exposure of beneficiaries tends to decrease giving whereas increased risk exposure of givers has no effect. We propose a simple non-linear generalization of a model allowing for other-regarding preferences, ex-post and ex-ante fairness, and risk aversion. We find some support for it in our data when risk is on the beneficiaries’ side but less so when risk is on the givers’ side. Our results point to the importance of the further development of models of social preferences that also incorporate risk preferences.     

At the nexus of risk and time preferences: An experimental investigation

Although many economic decisions involve choices between uncertain outcomes occurring at different times, most theoretical and empirical work restricts attention to one dimension or another. In this paper, we investigate whether both risk and time preferences can be represented by a single parameter. We collect experimental data to estimate models which allows for a disentanglement of risk and time preferences. Results reveal that the discounted expected utility model assumption, that risk and time preferences can be explained by a single parameter, is not supported by the data. The model estimates imply people prefer to delay the resolution of risky outcomes.     

Stability of risk preferences and the reflection effect of prospect theory

Are risk preferences stable over time? To address this question we elicit risk preferences from the same pool of subjects at two different moments in time. To interpret the results, we use a Fechner stochastic choice model in which the revealed preference of individuals is governed by some underlying preference, together with a random error. We take cumulative prospect theory as the underlying preference model (Kahneman and Tversky, Econometrica 47:263–292, 1979; Tversky and Kahneman, Journal of Risk and Uncertainty 5:297–323, 1992). We observe that the aggregate pattern of preferences is very similar in both sessions, and it matches the results reported in the literature. Most subjects are risk averse for gains, and risk seeking for losses. However, the subjects that jointly agree with the reflection effect of prospect theory are around 50%. The percentage of individuals that change their responses across sessions is quite high, 63%. Estimating the stochastic choice model we find that 72% of the subjects have an underlying preference which agrees with the reflection effect of prospect theory. The remaining 28% are mainly classified as risk averse for both gains and losses. The results reinforce the empirical validity of the reflection effect. Deviations from the reflection effect can be attributed to noise, as well as to the existence of a fraction of risk averse subjects.     

Estimating cumulative prospect theory parameters from an international survey

We conduct a standardized survey on risk preferences in 53 countries worldwide and estimate cumulative prospect theory parameters from the data. The parameter estimates show that significant differences on the cross-country level are to some extent robust and related to economic and cultural differences. In particular, a closer look on probability weighting underlines gender differences, economic effects, and cultural impact on probability weighting. The data set is a useful starting point for future research that investigates the impact of risk preferences on the market level.     

Learning-by-doing in an ambiguous environment

How well do revealed ambiguity preferences predict how people choose to seek new information about uncertain events? In an economics experiment, we apply a new instrument to measure ambiguity preferences, and in a later session observe to what extent the measure predicts the choice to receive costly information in a learning-by-doing game. Ambiguity averse subjects are more willing to pay to receive information, while risk averse subjects are not. Holding ambiguity preferences constant, risk averse subjects tend to perform worse than risk loving subjects. The returns to experimentation, especially for ambiguity averse subjects, suggest a not-well studied but important role that ambiguity preferences play in decision-making under uncertainty.     

Sequential decision making without independence: a new conceptual approach

This paper presents a critical reflection on dynamic consistency as commonly used in economics and decision theory, and on the difficulty to test it experimentally. It distinguishes between the uses of the term dynamic consistency in order to characterize two different properties: the first accounts for the neutrality of individual preferences towards the timing of resolution of uncertainty whereas the second guarantees that a strategy chosen at the beginning of a sequential decision problem is immune to any reevaluation and will effectively be implemented from then on in the decision problem. Although these two properties are equivalent under expected utility (EU), this is not the case under non-EU. Building on the possible characteristics of individual dynamic preferences under risk, this paper proposes a conceptual categorization, that is experimentally testable, of possible sequential decision making behaviors of non-EU maximizers.     

Two-parameter decision models and rank-dependent expected utility

This paper extends the existing literature concerning the relationship between two parameter decision models and those based on expected utility in two main directions. The first relaxes Meyer's location and scale (or Sinn's linear class) condition and shows that a two-parameter representation of preferences over uncertain prospects and the expected utility representation yield consistent rankings of random variables when the decision maker's choice set is restricted to random variables differing by mean shifts and monotone meanpreserving spreads. The second shows that the rank-dependent expected utility model is also consistent with two-parameter ranking methods if the probability transform satisfies certain dominance conditions. The main implication of these results is that the simple two-parameter model can be used to analyze the comparative statics properties of a wide variety of economic models, including those with multiple sources of uncertainty when the random variables are comonotonic. To illustrate this point, we apply our results to the problem of optimal portfolio investment with random initial wealth. We find that it is relatively easy to obtain strong global comparative statics results even if preferences do not satisfy the independence axiom.     

Why do people prefer randomisation? An experimental investigation

Theory and Decision - Increasingly, experimental economists, when eliciting risk preferences using a set of pairwise-choice problems (between two risky lotteries A and B), have given subjects a...     

The Independence Postulate,Hypothetical and Called-off Acts: a further reply to Rabinowicz

The Independence postulate links current preferences between called-off acts with current preferences between constant acts. Under the assumption that the chance-events used in compound von Neumann-Morgenstern lotteries are value-neutral, current preferences between these constant acts are linked to current preferences between hypothetical acts, conditioned by those chance events. Under an assumption of stability of preferences over time, current preferences between these hypothetical acts are linked to future preferences between what are then and there constant acts. Here, I show that a failure of Independence with respect to current preferences leads to an inconsistency in sequential decisions. Two called-off acts are constructed such that each is admissible in the same sequential decision and yet one is strictly preferred to the other. This responds to a question regarding admissibility posed by Rabinowicz ([2000] Preference stability and substitution of indifferents: A rejoinder to Seidenfeld, Theory and Decision 48: 311–318 [this issue]).     

Conditional expected utility

Let \({\mathcal {E}}\) be a class of events. Conditionally Expected Utility decision makers are decision makers whose conditional preferences \(\succsim _{E}\), \(E\in {\mathcal {E}}\), satisfy the axioms of Subjective Expected Utility (SEU) theory. We extend the notion of unconditional preference that is conditionally EU to unconditional preferences that are not necessarily SEU. We study a subclass of these preferences, namely those that satisfy dynamic consistency. We give a representation theorem, and show that these preferences are Invariant Bi-separable in the sense of Ghirardato et al. (Journal of Economic Theory 118:133–173, 2004). We also show that these preferences have only a trivial overlap with the class of Choquet Expected Utility preferences, but there are plenty of preferences of the \(\alpha \)-Maxmin Expected Utility type that satisfy our assumptions. We identify several concrete settings where our results could be applied. Finally, we consider the special case where the unconditional preference is itself SEU, and compare our results with those of Fishburn (Econometrica 41:1–25, 1973).