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Experiments on Compound Risk in Relation to Simple Risk and to Ambiguity

Author

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  • Mohammed Abdellaoui

    (GREGHEC-CNRS, HEC Paris, 78351 Jouy-en-Josas, France)

  • Peter Klibanoff

    (Managerial Economics and Decision Sciences Department, Kellogg School of Management, Northwestern University, Evanston, Illinois 60208)

  • Lætitia Placido

    (Paris School of Economics, 75014 Paris, France; Université Paris 1 Panthéon-Sorbonne, Centre d’Economie de la Sorbonne UMR CNRS 8174, 75647 Paris Cedex 13, France; and Department of Economics and Finance, Zicklin School of Business, Baruch College, City University of New York, New York, New York 10010)

Abstract

We conduct experiments measuring individual behavior under compound risk, simple risk, and ambiguity. We focus on (1) treatment of compound risks relative to simple risks and (2) the relationship between compound risk attitudes and ambiguity attitudes. We find that compound risks are valued differently than corresponding reduced simple risks. These differences measure compound risk attitudes. These attitudes display more aversion as the reduced probability of the winning event increases. Like Halevy [Halevy Y (2007) Ellsberg revisited: An experimental study. Econometrica 75:503–536], we find an association between compound risk reduction and ambiguity neutrality. However, in contrast to the almost perfect identification in Halevy’s data, we find a substantially weaker relation in both directions. First, a majority of our ambiguity-neutral subjects fail to reduce compound risk. Second, almost a quarter of our subjects who reduce compound risk are nonneutral to ambiguity. All of the latter come from the more quantitatively sophisticated part of our subject pool.Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2014.1953 . This paper was accepted by Peter Wakker, decision analysis .

Suggested Citation

  • Mohammed Abdellaoui & Peter Klibanoff & Lætitia Placido, 2015. "Experiments on Compound Risk in Relation to Simple Risk and to Ambiguity," Management Science, INFORMS, vol. 61(6), pages 1306-1322, June.
    • Handle: RePEc:inm:ormnsc:v:61:y:2015:i:6:p:1306-1322
    DOI: 10.1287/mnsc.2014.1953
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    References listed on IDEAS

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