The effect of the background risk in a simple chance improving decision model |
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Authors: | Jinkwon Lee |
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Institution: | (1) Department of Economics, Kyonggi University, San 94-6 Yiui-Dong, Yeongtong-Gu, Suwon-Si, Kyonggi-Do, 443-760, South Korea |
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Abstract: | We experimentally investigate the effect of an independent and exogenous background risk to initial wealth on subjects’ risk
attitudes and explore an appropriate incentive mechanism when identical or similar tasks are repeated in an experiment. Taking
a simple chance improving decision model under risk where the winning probabilities are negatively related to the potential
gain, we find that such a background risk tends to make risk-averse subjects behave more risk aversely. Furthermore, we find
that risk-averse subjects tend to show decreasing absolute risk aversion (DARA), and that a random round payoff mechanism
(RRPM) would control the possible wealth effect. This suggests that RRPM would be a better incentive mechanism for an experiment
where repetition of a task is used.
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Keywords: | Background risk Risk aversion Opportunity effect Wealth effect Random round payoff mechanism |
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