Source-Dependence of Utility and Loss Aversion: A Critical Test of Ambiguity Models
AbstractThis paper tests whether utility is the same for risk and for uncertainty. This test is critical for models that capture ambiguity aversion through a difference in event weighting between risk and uncertainty, like the multiple priors models and prospect theory. We present a new method to measure utility and loss aversion under uncertainty without the need to introduce simplifying parametric assumptions. Our method extends Wakker and Deneffe’s (1996) trade‐off method by allowing for standard sequences that include gains, losses, and the reference point. It provides an efficient way to measure loss aversion and a useful tool for practical applications of ambiguity models. We could not reject the hypothesis that utility and loss aversion were the same for risk and uncertainty, suggesting that utility primarily reflects attitudes towards outcomes. Utility was S‐shaped, concave for gains and convex for losses and there was substantial loss aversion. Our findings support models that explain ambiguity aversion through a difference in event weighting and suggest that descriptive ambiguity models should allow for reference‐dependence of utility.
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Bibliographic InfoPaper provided by Center for Research in Economics and Management (CREM), University of Rennes 1, University of Caen and CNRS in its series Economics Working Paper Archive (University of Rennes 1 & University of Caen) with number 201330.
Date of creation: Jul 2013
Date of revision:
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Postal: CREM (UMR CNRS 6211) - Faculty of Economics, 7 place Hoche, 35065 Rennes Cedex - France
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-10-18 (All new papers)
- NEP-CBE-2013-10-18 (Cognitive & Behavioural Economics)
- NEP-UPT-2013-10-18 (Utility Models & Prospect Theory)
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