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on Utility Models and Prospect Theory |
| By: | John List; Charles Mason |
| Abstract: | Are individuals expected utility maximizers? This question represents much more than academic curiosity. In a normative sense, at stake are the fundamental underpinnings of the bulk of the last half-century’s models of choice under uncertainty. From a positive perspective, the ubiquitous use of benefit-cost analysis across government agencies renders the expected utility maximization paradigm literally the only game in town. In this study, we advance the literature by exploring CEO’s preferences over small probability, high loss lotteries. Using undergraduate students as our experimental control group, we find that both our CEO and student subject pools exhibit frequent and large departures from expected utility theory. In addition, as the extreme payoffs become more likely CEOs exhibit greater aversion to risk. Our results suggest that use of the expected utility paradigm in decision making substantially underestimates society’s willingness to pay to reduce risk in small probability, high loss events. |
| JEL: | C9 C91 C93 Q5 Q58 |
| Date: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15453&r=upt |
| By: | Dohmen Thomas; Falk Armin; Huffman David; Sunde Uwe (METEOR) |
| Abstract: | This paper investigates whether risk aversion and impatience are correlated with cognitive ability. We conduct incentive compatible choice experiments measuring risk aversion, and impatience over an annual time horizon, for a representative sample of roughly 1,000 German adults. A measure of cognitive ability is provided by two submodules of one of the most widely used IQ tests. Interviews are conducted in subjects'' own homes. We find that lower cognitive ability is associated with greater risk aversion, and more pronounced impatience. These relationships are statistically and economically significant, and robust to controlling for personal characteristics, educational attainment, income, and measures of liquidity constraints. We perform a series of additional robustness checks, which help rule out other possible confounds. |
| Keywords: | Economics ; |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:umamet:2009042&r=upt |
| By: | Dohmen Thomas; Falk Armin; Huffman David; Sunde Uwe; Schupp Jürgen; Wagner Gert G. (METEOR) |
| Abstract: | This paper studies risk attitudes using a large representative survey and a complementary experiment conducted with a representative subject pool in subjects'' homes. Using a question asking people about their willingness to take risks "in general", we find that gender, age, height, and parental background have an economically significant impact on willingness to take risks. The experiment confirms the behavioral validity of this measure, using paid lottery choices. Turning to other questions about risk attitudes in specific contexts, we find similar results on the determinants of risk attitudes, and also shed light on the deeper question of stability of risk attitudes across contexts. We conduct a horse race of the ability of different measures to explain risky behaviors such as holdings stocks, occupational choice, and smoking. The question about risk-taking in general generates the best all-around predictor of risky behavior. |
| Keywords: | Economics ; |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:umamet:2009041&r=upt |
| By: | Schipper, Burkhard C |
| Abstract: | Contrary to claims by Gul and Pesendorfer (2008), I show that standard economics makes use of non-choice evidence in a meaningful way. This is because standard economics solely grounded in the theory of choice is "incomplete". That is, it has content that can not be revealed with any general choice procedure. |
| Keywords: | Revealed preference; theory of choice; neuroeconomics; non-choice evidence; machines |
| JEL: | A12 C90 D60 D80 B41 C80 D87 |
| Date: | 2009–10–22 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:18080&r=upt |
| By: | Breuer, Janice; McDermott, John |
| Abstract: | Trust is often considered a determinant of economic performance. The exogeneity of trust, however, is questionable. We develop a model with heterogeneous agents to determine aggregate trustworthiness, trust, and output. People differ according to their risk aversion (caution). The distribution of risk aversion across individuals -- along with the threat of punishment -- is critical in the process by which trust is formed. The mean and variance of the distribution of caution have direct and indirect effects on trust. For the mean, the direct effect of caution is intuitive: societies with more cautious populations would have less trust. The indirect effect, however works through the perception of trustworthiness and leads to more trust. The net effect is, paradoxically, positive in homogenous societies. In heterogeneous societies, the reverse is true. Trust and output are endogenous, and not monotonically related across countries with different moments of the distribution of caution. |
| Keywords: | trust; trustworthiness; risk aversion; caution; output |
| JEL: | Z1 C7 Z13 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:18112&r=upt |
| By: | Piero Gottardi; Jean Marc Tallon; Paolo Ghirardato |
| Abstract: | This paper studies the costs and benefits of delegating decisions to superiorly informed agents relative to the use of rigid, non discretionary contracts. Delegation grants some flexibility in the choice of the action by the agent, but also requires the use of an appropriate incentive contract so as to realign his interests with those of the principal. The parties’ understanding of the possible circumstances in which actions will have to be chosen and their attitude towards risk and uncertainty play then an important role in determining the costs of delegation. The main focus of the paper lies indeed in the analysis of these costs and the consequences for whether or not delegation is optimal. We determine and characterize the properties of the optimal flexible contract both when the parties have sharp probabilistic beliefs over the possible events in which the agent will have to act and when they only have a set of such beliefs. We show that the higher the agent’s degree of risk aversion, the higher the agency costs for delegation and hence the less profitable is a flexible contract versus a rigid one. The agent’s imprecision aversion in the case of multiple priors introduces another, additional agency costs; it again implies that the higher the degree of imprecision aversion the less profitable flexible contracts versus rigid ones. Even though, with multiple priors, the contract may be designed in such a way that principal and agent end up using ’different beliefs’ and hence engage in speculative trade, this is never optimal, in contrast with the case where the parties have sharp heterogeneous beliefs. |
| Keywords: | Delegation, Flexibility, Agency Costs, Multiple Priors, Imprecision Aversion |
| JEL: | D86 D82 D81 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2009/34&r=upt |