Strategic Risk Management Behavior: What Can Utility Functions Tell Us?
The validity of the utility concept, particularly in an expected utility framework, has been questioned because of its inability to predict revealed behavior. In this paper we focus on the global shape of the utility function instead of the local shape of the utility function. We examine the extent of heterogeneity in the global shape of the utility function of decision makers and test whether its shape predicts strategic risk management behavior. We assess the utility functions and relate them to strategic decisions for portfolio managers (N = 104) and hog farmers (N = 239). The research design allows us to examine the robustness of our results and the extent to which the results can be generalized. Furthermore, we assess the shape of the utility functions for these decision makers applying two different methods. This allows us to further test the robustness of our empirical results. If there exists a relationship between the shape of the utility function and strategic decisions, both methods should yield the same result. The empirical results indicate that the global shape of the utility function differs across decision makers (fully concave or convex versus S-shaped), and that the global shape predicts strategic decisions (e.g., asset allocation strategy in the case of portfolio managers; type of production process employed in the case of hog farmers). These findings support the notion that the often criticized concept of utility is a useful concept when studying actual behavior, and highlight the importance of considering decision-maker behavior over a wide outcome range when examining strategic behavior.
|Date of creation:||2004|
|Date of revision:|
|Contact details of provider:|| Postal: 555 East Wells Street, Suite 1100, Milwaukee, Wisconsin 53202|
Phone: (414) 918-3190
Fax: (414) 276-3349
Web page: http://www.aaea.org
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Schoemaker, Paul J H, 1982. "The Expected Utility Model: Its Variants, Purposes, Evidence and Limitations," Journal of Economic Literature, American Economic Association, vol. 20(2), pages 529-63, June.
- Butler, D. J., 2000. "Do non-expected utility choice patterns spring from hazy preferences? An experimental study of choice 'errors'," Journal of Economic Behavior & Organization, Elsevier, vol. 41(3), pages 277-297, March.
- Schwartz, Eduardo S, 1997. " The Stochastic Behavior of Commodity Prices: Implications for Valuation and Hedging," Journal of Finance, American Finance Association, vol. 52(3), pages 923-73, July.
- Robison, Lindon J. & Shupp, Robert S. & Myers, Robert J., 2010. "Expected utility paradoxes," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 39(2), pages 187-193, April.
- John C. Hershey & Howard C. Kunreuther & Paul J. H. Schoemaker, 1982. "Sources of Bias in Assessment Procedures for Utility Functions," Management Science, INFORMS, vol. 28(8), pages 936-954, August.
- Joost M.E. Pennings & Ale Smidts, 2000. "Assessing the Construct Validity of Risk Attitude," Management Science, INFORMS, vol. 46(10), pages 1337-1348, October.
- Charles A. Holt & Susan K. Laury, 2002. "Risk Aversion and Incentive Effects," American Economic Review, American Economic Association, vol. 92(5), pages 1644-1655, December.
- Jimmy E. Hilliard & Jorge A. Reis, 1999. "Jump Processes in Commodity Futures Prices and Options Pricing," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 81(2), pages 273-286.
- Joost M.E. Pennings & Philip Garcia, 2001. "Measuring Producers' Risk Preferences: A Global Risk-Attitude Construct," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 83(4), pages 993-1009.
- Fuhrken, Gebhard & Richter, Marcel K, 1991. "Additive Utility," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 1(1), pages 83-105, January.
- Hans Binswanger, 1981.
"Attitudes toward risk: Theoretical implications of an experiment in rural india,"
Artefactual Field Experiments
00010, The Field Experiments Website.
- Binswanger, Hans P, 1981. "Attitudes toward Risk: Theoretical Implications of an Experiment in Rural India," Economic Journal, Royal Economic Society, vol. 91(364), pages 867-90, December.
- Smith, Vernon L, 1991. "Rational Choice: The Contrast between Economics and Psychology," Journal of Political Economy, University of Chicago Press, vol. 99(4), pages 877-97, August.
- Harrison, Glenn W., 1986. "Risk aversion and preference distortion in deterministic bargaining experiments," Economics Letters, Elsevier, vol. 22(2-3), pages 191-196.
- Ale Smidts, 1997. "The Relationship Between Risk Attitude and Strength of Preference: A Test of Intrinsic Risk Attitude," Management Science, INFORMS, vol. 43(3), pages 357-370, March.
- Frederick Mosteller & Philip Nogee, 1951. "An Experimental Measurement of Utility," Journal of Political Economy, University of Chicago Press, vol. 59, pages 371.
When requesting a correction, please mention this item's handle: RePEc:ags:aaea04:20388. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (AgEcon Search)
If references are entirely missing, you can add them using this form.