Showing papers in "Journal of Risk and Uncertainty in 2012"
TL;DR: The authors investigate the simplest possible situation with both social comparison and risk: participants choose between two lotteries while a referent faces a fixed payoff, and show that straightforward extensions of existing theories to allow for social comparison do not provide accurate predictions.
Abstract: Theories (and experiments) on decision making under risk typically ignore (and exclude) a social context. We explore whether this omission is detrimental. To do so we experimentally investigate the simplest possible situation with both social comparison and risk: participants choose between two lotteries while a referent faces a fixed payoff. Participants are more risk averse when they can earn at most as much as their referent (loss situation) than when they are ensured they will earn at least as much as their referent (gain situation). Prospect theory with a social reference point would predict the exact opposite behavior. These results show that straightforward extensions of existing theories to allow for social comparison do not provide accurate predictions.
115 citations
TL;DR: The authors examined the predictive power of alternative principles of choice under uncertainty, including the objective maximin and Hurwicz criteria, the sure-thing principle, and the principle of insufficient reason.
Abstract: Experimental results on the Ellsberg paradox typically reveal behavior that is commonly interpreted as ambiguity aversion. The experiments reported in the current paper find the objective probabilities for drawing a red ball that make subjects indifferent between various risky and uncertain Ellsberg bets. They allow us to examine the predictive power of alternative principles of choice under uncertainty, including the objective maximin and Hurwicz criteria, the sure-thing principle, and the principle of insufficient reason. Contrary to our expectations, the principle of insufficient reason performed substantially better than rival theories in our experiment, with ambiguity aversion appearing only as a secondary phenomenon.
81 citations
TL;DR: In this article, a method for eliciting curvature-controlled discount rates that are invariant to the form of the utility function is proposed and compared to a double elicitation technique in which the utility and discount rate are jointly estimated.
Abstract: We propose and test a new method for eliciting curvature-controlled discount rates that are invariant to the form of the utility function. Our method uses a single elicitation task and obtains individual discount rates without knowledge of risk attitude or parametric assumptions about the form of the utility function. We compare our method to a double elicitation technique in which the utility function and discount rate are jointly estimated. Our experiment shows that these methods yield consistent estimates of the discount rate, which is reassuring given the wide range of estimates in the literature. We find little evidence of probability weighting, but in a second experiment, we observe that discount rates are sensitive to the length of the front-end delay, suggesting present bias. When the front-end delay is at least two weeks, we estimate average discount rates to be 11.3 and 12.2% in the two experiments.
77 citations
TL;DR: In this article, the Allais paradox questions are administered to both a representative sample of the Dutch population and to student subjects and three treatments are implemented: one with the original high hypothetical payoffs, one with low hypothetical payoff and a third with low real payoffs.
Abstract: We administer the Allais paradox questions to both a representative sample of the Dutch population and to student subjects. Three treatments are implemented: one with the original high hypothetical payoffs, one with low hypothetical payoffs and a third with low real payoffs. Our key findings are: (i) violations in the non-lab sample are systematic and a large bulk of violations is likely to stem from non-familiarity with large payoffs, (ii) we can identify groups of the general population that have much higher than average violation rates; this concerns mainly the lowly educated and unemployed, and (iii) the relative treatment differences in the population at large are accurately predicted by the lab sample, but violation rates in all lab treatments are about 15 percentage points lower than in the corresponding non-lab treatments.
76 citations
TL;DR: In this paper, the effects of uncertainty on an individual's decision to commit a traffic violation were investigated in controlled conditions, and they found that individuals respond considerably to increases in the expected cost of speeding, uncertainty about the enforcement regime yields a significant reduction in violations committed, and people are much more likely to speed when the punishment regime for which they voted is implemented.
Abstract: We conduct laboratory experiments to investigate the effects of deterrence mechanisms under controlled conditions. The effect of the expected cost of punishment of an individual’s decision to engage in a proscribed activity and the effect of uncertainty on an individual’s decision to commit a violation are very difficult to isolate in field data. We use a roadway speeding framing and find that (a) individuals respond considerably to increases in the expected cost of speeding, (b) uncertainty about the enforcement regime yields a significant reduction in violations committed, and (c) people are much more likely to speed when the punishment regime for which they voted is implemented. Our results have important implications for a behavioral theory of deterrence under uncertainty.
61 citations
TL;DR: Zhang et al. as discussed by the authors conducted a neurogenetic study of ambiguity aversion and familiarity bias in an incentivized laboratory setting and found that 49.4% of the subjects choose to bet on the 50-50 deck despite the unknown deck paying 20% more.
Abstract: It is increasingly recognized that decision making under uncertainty depends not only on probabilities, but also on psychological factors such as ambiguity and familiarity. Using 325 Beijing subjects, we conduct a neurogenetic study of ambiguity aversion and familiarity bias in an incentivized laboratory setting. For ambiguity aversion, 49.4% of the subjects choose to bet on the 50–50 deck despite the unknown deck paying 20% more. For familiarity bias, 39.6% choose the bet on Beijing’s temperature rather than the corresponding bet with Tokyo even though the latter pays 20% more. We genotype subjects for anxiety-related candidate genes and find a serotonin transporter polymorphism being associated with familiarity bias, but not ambiguity aversion, while the dopamine D5 receptor gene and estrogen receptor beta gene are associated with ambiguity aversion only among female subjects. Our findings contribute to understanding of decision making under uncertainty beyond revealed preference.
56 citations
TL;DR: In this article, the authors use modern ambiguity theories to analyze belief aggregation, thus obtaining more refined and empirically more valid results than traditional theories can provide, and confirm more reliably that conflicting (heterogeneous) beliefs where some agents express certainty are processed differently than informationally equivalent homogeneous beliefs.
Abstract: Two experiments show that violations of expected utility due to ambiguity, found in general decision experiments, also affect belief aggregation. Hence we use modern ambiguity theories to analyze belief aggregation, thus obtaining more refined and empirically more valid results than traditional theories can provide. We can now confirm more reliably that conflicting (heterogeneous) beliefs where some agents express certainty are processed differently than informationally equivalent imprecise homogeneous beliefs. We can also investigate new phenomena related to ambiguity. For instance, agents who express certainty receive extra weight (a cognitive effect related to ambiguity-generated insensitivity) and generate extra preference value (source preference; a motivational effect related to ambiguity aversion). Hence, incentive compatible belief elicitations that prevent manipulation are especially warranted when agents express certainty. For multiple prior theories of ambiguity, our findings imply that the same prior probabilities can be treated differently in different contexts, suggesting an interest of corresponding generalizations.
49 citations
TL;DR: In this article, the authors proposed using "more decreasingly absolute risk averse" or "more prudent" as alternative definitions of increased downside risk aversion, which generate a transitive ordering, while the existing definition based on a transformation function with positive third derivative does not.
Abstract: Downside risk increases have previously been characterized as changes preferred by all decision makers u(x) with u′′′(x) > 0. For risk averse decision makers, u′′′(x) > 0 also defines prudence. This paper finds that downside risk increases can also be characterized as changes preferred by all decision makers displaying decreasing absolute risk aversion (DARA) since those changes involve random variables that have equal means. Building on these findings, the paper proposes using “more decreasingly absolute risk averse” or “more prudent” as alternative definitions of increased downside risk aversion. These alternative definitions generate a transitive ordering, while the existing definition based on a transformation function with a positive third derivative does not. Other properties of the new definitions of increased downside risk aversion are also presented.
47 citations
TL;DR: This paper explored the question of whether there are inherent limits to our ability to learn from experience about the value of protection against low-probability, high-consequence, events.
Abstract: This paper explores the question of whether there are inherent limits to our ability to learn from experience about the value of protection against low-probability, high-consequence, events. Findings are reported from two controlled experiments in which participants have a monetary incentive to learn from experience making investments to protect against hurricane risks. A central finding is that investments display a short-term forgetting effect consistent with the use of reinforcement learning rules, where a significant driver of investments in a given period is whether storm losses were incurred in the precious period. Given the relative rarity of such losses, this reinforcement process produces a mean investment level below that which would be optimal for most storm threats. Investments are also found to be insensitive to the censoring effect of protection itself, implying that the size of experienced losses—rather than losses that are avoided—is the primary driver of investment decisions.
46 citations
TL;DR: The authors found that sampling from a student population leads to lower estimates of average risk aversion and loss aversion parameters and dramatically reduces the amount of heterogeneity in all parameters, while self-selection within a broad population does not seem to matter for average preferences.
Abstract: An ever increasing number of experiments attempts to elicit risk preferences of a population of interest with the aim of calibrating parameters used in economic models. We are concerned with two types of selection effects, which may affect the external validity of standard experiments: Sampling from a narrowly defined population of students (“experimenter-induced selection”) and self-selection due to non-response or incomplete response of participants in a random sample from a broad population. We find that both types of selection lead to a sample of experts: Participants perform significantly better than the general population, in the sense of fewer violations of revealed preference conditions. Self-selection within a broad population does not seem to matter for average preferences. In contrast, sampling from a student population leads to lower estimates of average risk aversion and loss aversion parameters. Furthermore, it dramatically reduces the amount of heterogeneity in all parameters.
45 citations
TL;DR: In this article, the authors evaluate the development of risk preferences using a field experiment with high school students and find that individuals in schools with a higher percentage of low-income peers with whom to interact are significantly more risk averse.
Abstract: Using a field experiment with high school students, we evaluate the development of risk preferences. Examining the impact of school characteristics on preference development reveals both peer and quality effects. For the peer effect, individuals in schools with a higher percentage of students on free or reduced lunches (hence a higher proportion of low-income peers with whom to interact) are significantly more risk averse. For the quality effect, individuals in schools with smaller class sizes and a higher percentage of educators with advanced degrees have higher, more moderate levels of risk aversion. We further discuss economic, cognitive and emotional development theories of risk preferences. Data show demographic-related patterns: girls are more risk averse on average, while taller and nonwhite individuals are more risk tolerant.
TL;DR: In this article, the authors compare the performance of two elicitation mechanisms, denoted as declarative and clock, and show that, theoretically and empirically, with a sufficient fraction of naive participants, the clock mechanism elicits beliefs more accurately than the declARative mechanism.
Abstract: It is often of interest to elicit beliefs from populations that may include naive participants. Unfortunately, elicitation mechanisms are typically assessed by assuming optimal responses to incentives. Using laboratory experiments with a population that potentially includes naive participants, we compare the performance of two elicitation mechanisms proposed by Karni (Econometrica 77(2):603-606, 2009). These mechanisms, denoted as “declarative” and “clock,” are valuable because their incentive compatibility does not require strong assumptions such as risk neutrality or expected utility maximization. We show that, theoretically and empirically, with a sufficient fraction of naive participants, the clock mechanism elicits beliefs more accurately than the declarative. The source of this accuracy advantage is twofold: the clock censors naive responses, and participants are more likely to employ dominant strategies under the clock. Our findings hold practical value to anyone interested in eliciting beliefs from representative populations, a goal of increasing importance when conducting large-scale surveys or field experiments.
TL;DR: In this paper, the reference dependence of preferences is derived from behavior and the reference point arises endogenously, without assuming reference-dependent preferences a priori, and a set of principles that provide critical tests and foundations for prospect theory preferences are presented.
Abstract: In most models of (cumulative) prospect theory, reference dependence of preferences is imposed beforehand and the location of the reference point is determined exogenously. This paper presents principles that provide critical tests and foundations for prospect theory preferences without assuming reference-dependent preferences a priori. Instead, reference dependence is derived from behavior and the reference point arises endogenously.
TL;DR: In this paper, the authors generalize models of reference dependence to identify separate reference dependence effects for increases and decreases in environmental health risk probabilities, for increases in costs, and reference dependence effect embodying the interaction of two changes.
Abstract: The gap between willingness-to-pay (WTP) and willingness-to-accept (WTA) benefit values typifies situations in which reference points—and direction of movement from reference points—are consequential. Why WTA-WTP discrepancies arise is not well understood. We generalize models of reference dependence to identify separate reference dependence effects for increases and decreases in environmental health risk probabilities, for increases and decreases in costs, and reference dependence effects embodying the interaction of two changes. We estimate separate reference dependence effects for the four possible cost and health risk change combinations using data from our choice-based experiment for a nationally representative sample of 4,745 households. The WTA-WTP gap is due largely to the reference dependence effects related to costs. Standard models of reference dependence are not consistent with the results, as there is an interactive effect. Estimated income effects are under a penny and thus cannot account for higher values of WTA relative to WTP.
TL;DR: The authors found that disgust promotes disposal of objects that disgust them, such as foul-smelling food, and that warning about this tendency would not diminish it, even when presented with tangible rewards.
Abstract: Individuals tend toward status quo bias: preferring existing options over new ones. There is a countervailing phenomenon: Humans naturally dispose of objects that disgust them, such as foul-smelling food. But what if the source of disgust is independent of the object? We induced disgust via a film clip to see if participants would trade away an item (a box of unidentified office supplies) for a new item (alternative unidentified box). Such "incidental disgust" strongly countered status quo bias. Disgusted people exchanged their present possession 51% of the time compared to 32% for people in a neutral state. Thus, disgust promotes disposal. A second experiment tested whether a warning about this tendency would diminish it. It did not. These results indicate a robust disgust-promotes-disposal effect. Because these studies presented real choices with tangible rewards, their findings have implications for everyday choices and raise caution about the effectiveness of warnings about biases.
TL;DR: The authors investigated whether preferences over environmental risks are best modeled using probability-weighted utility functions or can be reasonably approximated by expected utility (EU) or subjective EU models as is typically assumed.
Abstract: This paper investigates whether preferences over environmental risks are best modeled using probability-weighted utility functions or can be reasonably approximated by expected utility (EU) or subjective EU models as is typically assumed. I elicit risk attitudes in the financial and environmental domains using multiple-price list experiment. I examine how subjects’ behavioral, attitudinal, and demographic characteristics affect their probability weighting functions first for financial risks, then for oil-spill risks. I find that most subjects tend to overweight extreme positive outcomes relative to expected utility in both the environmental and financial domains. Subjects are more likely to overemphasize low probability, extreme environmental outcomes than low probability, extreme financial outcomes, leading subjects to offer more support for mitigating environmental gambles than financial gambles with the same odds and equivalent outcomes. I conclude that EU models are likely to underestimate subjects’ willingness to pay for environmental cleanup programs or policies with uncertain outcomes.
TL;DR: In this paper, a stated preference survey was used to investigate the potential discrepancy between the priorities of public administrators and the general public regarding risk reductions regarding fatalities and serious injuries for different age groups and accidents.
Abstract: A stated preference survey was used to investigate the potential discrepancy between the priorities of public administrators and the general public regarding risk reductions. Both groups of respondents were asked to assume the role of a public policy-maker and choose between different public safety projects. We investigate differences in three areas: (i) large vs. small accidents, (ii) actual vs. subjective risk, and (iii) the trade-off between avoiding fatalities and serious injuries for different age groups and accidents. We find only minor differences between the responses of administrators and the general public, the most important of which is the difference in priorities between reducing the risk of many small or one large accident. In this area the most common response from the general public is that they prefer avoiding many small accidents rather than one large accident while among the administrators there is almost an equal split between the two options.
TL;DR: In this article, the authors examined the demand and supply of annual and multi-year insurance contracts with respect to protection against a catastrophic risk in a competitive market and proposed a competitive equilibrium consisting of a set of prices where homeowners who are not very risk averse decide to be uninsured.
Abstract: This paper examines the demand and supply of annual and multi-year insurance contracts with respect to protection against a catastrophic risk in a competitive market. Insurers who offer annual policies can cancel policies at the end of each year and change the premium in the following year. Multi-year insurance has a fixed annual price for each year and no cancellations are permitted at the end of any given year. Homeowners are identical with respect to their exposure to the hazard. Each homeowner determines whether or not to purchase an annual or multi-year contract so as to maximize her expected utility. The competitive equilibrium consists of a set of prices where homeowners who are not very risk averse decide to be uninsured. Other individuals demand either single-year or multi-year policies depending on their degree of risk aversion and the premiums charged by insurers for each type of policy.
TL;DR: In this article, it was observed that the measure Su = u′′′/u′ − (3/2) 2, previously shown to be a relevant measure of the degree of downside risk aversion, is known in the mathematics literature as the Schwarzian derivative, which has invariance properties under composition of functions that make it particularly well-behaved as a ranking of risk aversion.
Abstract: It is observed that the measure Su = u′′′/u′ − (3/2)(u′′/u′)2, previously shown to be a relevant measure of the degree of downside risk aversion, is known in the mathematics literature as the Schwarzian derivative. The Schwarzian derivative has invariance properties under composition of functions that make it particularly well-behaved as a ranking of downside risk aversion. Indeed, it has the same invariance properties as the measure Ru = −u′′/u′, familiar to economists as a ranking of utility functions by degree of Arrow-Pratt risk aversion.
TL;DR: An experimental test of the Basic Fechner model is presented, finding that one of the model’s key assumptions—that the noise around the subjective value of a risky option is independent of other features of the decision problem is systematically violated.
Abstract: Models of stochastic choice are intended to capture the substantial amount of noise observed in decisions under risk. We present an experimental test of one model, which many regard as the default—the Basic Fechner model. We consider one of the model’s key assumptions—that the noise around the subjective value of a risky option is independent of other features of the decision problem. We find that this assumption is systematically violated. However the main patterns in our data can be accommodated by a more recent variant of the Fechner model, or within the random preference framework.
TL;DR: In this article, the authors examine the way in which the WTA/WTP ratio varies as the severity of a health complaint is reduced, and they find that as severity of the health effect is reduced the ratio converges across the sample and tends to a level that does not significantly exceed unity.
Abstract: The aim of the study reported in this paper is to test the hypothesis that individual utility of wealth functions may violate the assumption of smoothness that underpins the standard analysis of the Value of Statistical Life (VSL) and safety. In order to do so we examine the way in which the Willingness to Accept/Willingness to Pay (WTA/WTP) ratio varies as the severity of a health complaint is reduced. We find that as the severity of the health effect is reduced, the WTA/WTP ratio converges across the sample and tends to a level that does not significantly exceed unity. While we acknowledge that this does not constitute conclusive evidence of smoothness, it does suggest that the case in favour of the assumption that individual utility of wealth functions tend to display a kink at the current level of wealth is less than wholly persuasive.
TL;DR: In this article, the authors studied updating of the Jaffray-Philippe sub-class of Choquet Expected Utility preferences and found necessary and sufficient conditions for ambiguity attitude to be unchanged when updated on an arbitrary event.
Abstract: This paper studies how updating affects ambiguity attitude. In particular we focus on generalized Bayesian updating of the Jaffray–Philippe sub-class of Choquet Expected Utility preferences. We find conditions for ambiguity attitude to be the same before and after updating. A necessary and sufficient condition for ambiguity attitude to be unchanged when updated on an arbitrary event is for the capacity to be neo-additive. We find a condition for updating on a given partition to preserve ambiguity attitude. We relate this to necessary and sufficient conditions for dynamic consistency. Finally, we study whether ambiguity increases or decreases after updating.
TL;DR: In this paper, the authors examine how recent reforms have affected a key aspect of patients' implicit insurance present in medical malpractice torts and estimate how noneconomic damages caps affected pre-trial settlement speed and settlement amounts.
Abstract: Our research examines how recent reforms have affected a key aspect of patients’ implicit insurance present in medical malpractice torts. Specifically, we estimate how non-economic damages caps affected pre-trial settlement speed and settlement amounts. Maximum entropy (most likely) quantile regressions emphasize that the post-reform settlement effects most informative for policy evaluation differ greatly from OLS (mean) estimates and clarify the conclusion emerging. In particular, the effect of the tort reform here can best be thought of as a 25% tax on the asset value of settlements that exempts settlements involving infants. The social welfare effects of tort reform are less clear than the asset reduction effects due to likely health state dependent utility.
TL;DR: The authors study individual choice under risk in which an agent receives a signal that restricts the number of possible states of the world and find that this type of signal increases the frequency of correct assessments and that prediction accuracy is higher for lower levels of risk.
Abstract: We conduct an experiment on individual choice under risk in which we study belief updating when an agent receives a signal that restricts the number of possible states of the world. Subjects observe a sample drawn from an urn and form initial beliefs about the urn’s composition. We then elicit how beliefs are modified after subjects receive a signal that restricts the set of the possible urns from which the observed sample could have been drawn. We find that this type of signal increases the frequency of correct assessments and that prediction accuracy is higher for lower levels of risk. We also show that prediction accuracy is higher after invalidating signals (i.e. signals that contradict the initial belief). This pattern is explained by the lower level of risk associated with invalidating signals. Finally, we find evidence for a lack of persistence of choices under high risk.