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Consistency of Higher Order Risk Preferences

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  • Cary Deck
  • Harris Schlesinger

Abstract

Risk aversion (a 2nd order risk preference) is a time-proven concept in economic models of choice under risk. More recently, the higher order risk preferences of prudence (3rd order) and temperance (4th order) also have been shown to be quite important. While a majority of the population seems to exhibit both risk aversion and such higher-order risk preferences, a significant minority does not. Rather than simply dismissing this behavior, we show how both risk-loving as well as risk-averse behaviors might be generated by a simple type of basic lottery preference for either (1) combining "good" outcomes with "bad" ones, or (2) combining "good with good" and "bad with bad." We further show that this dichotomy is fairly robust at explaining higher order risk attitudes in the laboratory. In addition to our own experimental evidence, we take a second look at the extant laboratory experiments that measure higher order risk preferences and we find a fair amount of support for this dichotomy. Our own experiment is the first to look beyond 4th order risk preferences and we examine risk attitudes at even higher levels. The consistency of these results with expected utility theory and with a few non-expected utility theories is also examined.

Suggested Citation

  • Cary Deck & Harris Schlesinger, 2012. "Consistency of Higher Order Risk Preferences," CESifo Working Paper Series 4047, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_4047
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    References listed on IDEAS

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    1. Miles Kimball & Philippe Weil, 2009. "Precautionary Saving and Consumption Smoothing across Time and Possibilities," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(2-3), pages 245-284, March.
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    Citations

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    Cited by:

    1. Jahedi, Salar & Deck, Cary & Ariely, Dan, 2017. "Arousal and economic decision making," Journal of Economic Behavior & Organization, Elsevier, pages 165-189.
    2. repec:kap:expeco:v:20:y:2017:i:2:d:10.1007_s10683-016-9486-z is not listed on IDEAS
    3. Breaban, Adriana & van de Kuilen, Gijs & Noussair, Charles, 2016. "Prudence, Personality, Cognitive Ability and Emotional State," Discussion Paper 2016-030, Tilburg University, Center for Economic Research.
    4. Crainich, David & Eeckhoudt, Louis & Menegatti, Mario, 2016. "Changing risks and optimal effort," Journal of Economic Behavior & Organization, Elsevier, pages 97-106.
    5. Durmaz, Tunç, 2016. "Precautionary Storage in Electricity Markets," Discussion Papers 2016/5, Norwegian School of Economics, Department of Business and Management Science.
    6. Timo Heinrich & Thomas Mayrhofer, 2014. "Higher-order Risk Preferences in Social Settings - An Experimental Analysis," Ruhr Economic Papers 0508, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen.
    7. repec:zbw:rwirep:0508 is not listed on IDEAS
    8. Klajdi Bregu & Cary Deck & Lindsay Ham & Salar Jahedi, 2016. "The Effects of Alcohol Use on Economic Decision Making," Working Papers 16-03, Chapman University, Economic Science Institute.
    9. Li, Jingyuan & Liu, Dongri & Wang, Jianli, 2016. "Risk aversion with two risks: A theoretical extension," Journal of Mathematical Economics, Elsevier, vol. 63(C), pages 100-105.
    10. Wang, Hongxia & Wang, Jianli & Li, Jingyuan & Xia, Xinping, 2015. "Precautionary paying for stochastic improvements under background risks," Insurance: Mathematics and Economics, Elsevier, vol. 64(C), pages 180-185.
    11. repec:eee:ecolet:v:159:y:2017:i:c:p:116-118 is not listed on IDEAS
    12. Heinrich, Timo & Mayrhofer, Thomas, 2014. "Higher-order Risk Preferences in Social Settings - An Experimental Analysis," Ruhr Economic Papers 508, RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
    13. Louis R. Eeckhoudt & Roger J. A. Laeven & Harris Schlesinger, 2017. "Risk Apportionment: The Dual Story," Papers 1712.02182, arXiv.org.
    14. Jim Engle-Warnick & Diego Pulido & Marine de Montaignac, 2016. "A Comparison of Survey and Incentivized-Based Risk Attitude Elicitation," CIRANO Working Papers 2016s-40, CIRANO.
    15. Broll, Udo & Welzel, Peter & Wong, Kit Pong, 2016. "The banking firm under ambiguity aversion," CEPIE Working Papers 01/16, Technische Universität Dresden, Center of Public and International Economics (CEPIE).

    More about this item

    Keywords

    risk apportionment; mixed risk aversion; mixed risk loving; prudence; temperance; edginess; laboratory experiments; moment preference; prospect theory;

    JEL classification:

    • C90 - Mathematical and Quantitative Methods - - Design of Experiments - - - General
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General

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