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An Evolutionary Risk Basis for the Differential Treatment of Gains and Losses

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  • Nagar, Venky

    (University of MI)

  • Rajan, Madhav V.

    (Stanford University)

  • Ray, Korok

    (George Washington University)

Abstract

This study endogenously generates the asymmetric verification concept of conservatism, using evolutionary biology as a foundation. A producer produces (or hunts) a consumable with a stochastic production technology, and possibly faces a stealer thereafter, who seeks to expropriate the consumable. The producer, for fear of being perceived as weak, will never share her output with the stealer, but will launch an all-out fight. This all-or nothing gamble demonstrates the producer's convex utility in losses. On the other hand, the optimal choice in production (or hunting) indicates a concave preference in gains. These endogenously derived asymmetric risk-profiles towards gains and losses, when applied to choice theory, generate a demand for higher verifiability standards for probable gains than losses. The model then shows how this preference is modulated by various social and informational configurations of individuals. Our findings explain observed conservatism patterns in a variety of institutional settings.

Suggested Citation

  • Nagar, Venky & Rajan, Madhav V. & Ray, Korok, 2014. "An Evolutionary Risk Basis for the Differential Treatment of Gains and Losses," Research Papers 3053, Stanford University, Graduate School of Business.
    • Handle: RePEc:ecl:stabus:3053
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    File URL: http://www.gsb.stanford.edu/faculty-research/working-papers/evolutionary-risk-basis-differential-treatment-gains-losses
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