The shape of the utility function under risk in the loss domain and the 'ruinous losses' hypothesis: some experimental results
This paper reports some preliminary experimental results as regards the shape of the utility function for losses when elicited over a wide interval of consequences. Individual utility functions are elicited using the trade-off method, which, unlike standard elicitation procedures, is robust to probability weighting (and avoids most cognitive biases). Even though most utility functions exhibit the usual convex shape, nearly 25% of them appear to be inverse-S shaped, with convexity over moderate losses changing to concavity as losses grow. Though not conclusive (due mainly to the small size of our subject pool), this result brings some new support to the old idea that ruinous or unacceptable losses may induce some abrupt change in the shape of the utility function. Most importantly, it paves the way for more systematic investigation of the "ruinous losses" hypothesis.
|Date of creation:||10 Jun 2009|
|Date of revision:|
|Publication status:||Published in Economics Bulletin, Economics Bulletin, 2009, 29 (2), pp.1404-1413|
|Note:||View the original document on HAL open archive server: https://hal.archives-ouvertes.fr/hal-00395871|
|Contact details of provider:|| Web page: https://hal.archives-ouvertes.fr/|
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.:
- Mohammed Abdellaoui, 2000. "Parameter-Free Elicitation of Utility and Probability Weighting Functions," Management Science, INFORMS, vol. 46(11), pages 1497-1512, November.
- Wakker, Peter & Tversky, Amos, 1993. " An Axiomatization of Cumulative Prospect Theory," Journal of Risk and Uncertainty, Springer, vol. 7(2), pages 147-75, October.
- Mao, James C T, 1970. "Survey of Capital Budgeting: Theory and Practice," Journal of Finance, American Finance Association, vol. 25(2), pages 349-60, May.
- Daniel Schunk, 2005.
"Explaining heterogeneity in utility functions by individual differences in decision modes,"
MEA discussion paper series
05078, Munich Center for the Economics of Aging (MEA) at the Max Planck Institute for Social Law and Social Policy.
- Schunk, Daniel & Betsch, Cornelia, 2006. "Explaining heterogeneity in utility functions by individual differences in decision modes," Journal of Economic Psychology, Elsevier, vol. 27(3), pages 386-401, June.
- Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
- Levy, Haim & Levy, Moshe, 2002. " Arrow-Pratt Risk Aversion, Risk Premium and Decision Weights," Journal of Risk and Uncertainty, Springer, vol. 25(3), pages 265-90, November.
- Harry Markowitz, 1952. "The Utility of Wealth," Journal of Political Economy, University of Chicago Press, vol. 60, pages 151.
- Schmidt, Ulrich & Traub, Stefan, 2002. " An Experimental Test of Loss Aversion," Journal of Risk and Uncertainty, Springer, vol. 25(3), pages 233-49, November.
- Han Bleichrodt & Jose Luis Pinto, 2000. "A Parameter-Free Elicitation of the Probability Weighting Function in Medical Decision Analysis," Management Science, INFORMS, vol. 46(11), pages 1485-1496, November.
- Knutson, Brian & Peterson, Richard, 2005. "Neurally reconstructing expected utility," Games and Economic Behavior, Elsevier, vol. 52(2), pages 305-315, August.
- Peter Wakker & Daniel Deneffe, 1996. "Eliciting von Neumann-Morgenstern Utilities When Probabilities Are Distorted or Unknown," Management Science, INFORMS, vol. 42(8), pages 1131-1150, August.
- Nathalie Etchart-Vincent, 2009.
"Probability weighting and the 'level' and 'spacing' of outcomes: An experimental study over losses,"
- Nathalie Etchart-Vincent, 2009. "Probability weighting and the ‘level’ and ‘spacing’ of outcomes: An experimental study over losses," Journal of Risk and Uncertainty, Springer, vol. 39(1), pages 45-63, August.
- Pamela K. Lattimore & Joanna R. Baker & A. Dryden Witte, 1992. "The Influence Of Probability on Risky Choice: A parametric Examination," NBER Technical Working Papers 0081, National Bureau of Economic Research, Inc.
- Kahneman, Daniel & Tversky, Amos, 1979.
"Prospect Theory: An Analysis of Decision under Risk,"
Econometric Society, vol. 47(2), pages 263-91, March.
- Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
- Abdellaoui, Mohammed & Vossman, Frank & Weber, Martin, 2003.
"Choice-Based Elicitation and Decomposition of Decision Weights for Gains and Losses Under Uncertainty,"
CEPR Discussion Papers
3756, C.E.P.R. Discussion Papers.
- Mohammed Abdellaoui & Frank Vossmann & Martin Weber, 2005. "Choice-Based Elicitation and Decomposition of Decision Weights for Gains and Losses Under Uncertainty," Management Science, INFORMS, vol. 51(9), pages 1384-1399, September.
- Peter Wakker & Veronika KÃ¶bberling & Christiane Schwieren, 2007. "Prospect-theoryâ€™s Diminishing Sensitivity Versus Economicsâ€™ Intrinsic Utility of Money: How the Introduction of the Euro can be Used to Disentangle the Two Empirically," Theory and Decision, Springer, vol. 63(3), pages 205-231, November.
- Abdellaoui, Mohammed & Barrios, Carolina & Wakker, Peter P., 2007. "Reconciling introspective utility with revealed preference: Experimental arguments based on prospect theory," Journal of Econometrics, Elsevier, vol. 138(1), pages 356-378, May.
- Pennings, J.M.E. & Smidts, A., 2002.
"The Shape of Utility Functions and Organizational Behavior,"
ERIM Report Series Research in Management
ERS-2002-18-MKT, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
- Joost M. E. Pennings & Ale Smidts, 2003. "The Shape of Utility Functions and Organizational Behavior," Management Science, INFORMS, vol. 49(9), pages 1251-1263, September.
- Lattimore, Pamela K. & Baker, Joanna R. & Witte, Ann D., 1992. "The influence of probability on risky choice: A parametric examination," Journal of Economic Behavior & Organization, Elsevier, vol. 17(3), pages 377-400, May.
- Nathalie Etchart-Vincent, 2004. "Is Probability Weighting Sensitive to the Magnitude of Consequences? An Experimental Investigation on Losses," Journal of Risk and Uncertainty, Springer, vol. 28(3), pages 217-235, 05.
When requesting a correction, please mention this item's handle: RePEc:hal:journl:hal-00395871. 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: (CCSD)
If references are entirely missing, you can add them using this form.