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Averting risk in the face of large losses: Bernoulli vs. Tversky and Kahneman

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Abstract

We experimentally question the assertion of Prospect Theory that people display risk attraction in choices involving high-probability losses. Indeed, our experimental participants tend to avoid fair risks for large (up to € 90), high-probability (80%) losses. Our research hinges on a novel experimental method designed to alleviate the house-money bias that pervades experiments with real (not hypothetical) loses. Our results vindicate Daniel Bernoulli’s view that risk aversion is the dominant attitude, But, contrary to the Bernoulli-inspired canonical expected utility theory, we do find frequent risk attraction for small amounts of money at stake. In any event, we attempt neither to test expected utility versus nonexpected utility theories, nor to contribute to the important literature that estimates value and weighting functions. The question that we ask is more basic, namely: do people display risk aversion when facing large losses, or large gains? And, at the risk of oversimplifying, our answer is yes.

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Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 932.

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Date of creation: Jan 2006
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Handle: RePEc:upf:upfgen:932

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Web page: http://www.econ.upf.edu/

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Keywords: Losses; Risk Attraction; Risk Aversion; Experiments; Prospect Theory; Bernoulli; Kahneman; Tversky; Leex;

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Citations

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Cited by:
  1. Morrison, William G. and Robert Oxoby, 2014. "Loss Aversion in the Laboratory," LCERPA Working Papers 0073, Laurier Centre for Economic Research and Policy Analysis, revised 30 Jun 2014.
  2. Juan Cárdenas & Nicolas Roux & Christian Jaramillo & Luis Martinez, 2014. "Is it my money or not? An experiment on risk aversion and the house-money effect," Experimental Economics, Springer, Springer, vol. 17(1), pages 47-60, March.
  3. Nathalie Etchart-Vincent & Olivier l’Haridon, 2011. "Monetary incentives in the loss domain and behavior toward risk: An experimental comparison of three reward schemes including real losses," Journal of Risk and Uncertainty, Springer, Springer, vol. 42(1), pages 61-83, February.
  4. Antoni Bosch-Domènech & Joaquim Silvestre, 2013. "Measuring risk aversion with lists: a new bias," Theory and Decision, Springer, Springer, vol. 75(4), pages 465-496, October.
  5. Antoni Bosch-Domènech & Joaquim Silvestre, 2006. "Risk aversion and embedding bias," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 934, Department of Economics and Business, Universitat Pompeu Fabra.
  6. Antoni Bosch-Domènech & Joaquim Silvestre, 2006. "Reflections on gains and losses: A 2 × 2 × 7 experiment," Journal of Risk and Uncertainty, Springer, Springer, vol. 33(3), pages 217-235, December.
  7. Antoni Bosch-Domènech & Joaquim Silvestre, 2012. "Measuring risk aversion with lists: A new bias," Working Papers, University of California, Davis, Department of Economics 1210, University of California, Davis, Department of Economics.
  8. Antoni Bosch-Dom�nech & Joaquim Silvestre, 2012. "Measuring Risk Aversion with Lists: A New Bias," Working Papers 634, Barcelona Graduate School of Economics.
  9. Peel, D.A., 2013. "Heterogeneous agents and the implications of the Markowitz model of utility for multi-prize lottery tickets," Economics Letters, Elsevier, Elsevier, vol. 119(3), pages 264-267.
  10. Peel, D.A. & Zhang, Jie, 2012. "On the potential for observational equivalence in experiments on risky choice when a power value function is assumed," Economics Letters, Elsevier, Elsevier, vol. 116(1), pages 8-10.
  11. Luis Roberto Martínez & Christian Jaramillo & Nicolas De Roux & Juan-Camilo Cárdenas, 2010. "It´s Not My Money: An Experiment on Risk Aversion and the House-money Effect," DOCUMENTOS CEDE, UNIVERSIDAD DE LOS ANDES-CEDE 006712, UNIVERSIDAD DE LOS ANDES-CEDE.

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