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Risk preference elicitation without the confounding effect of probability weighting

  • Drichoutis, Andreas
  • Lusk, Jayson

In this paper we show that the wildly popular Holt and Laury (2002) risk preference elicitation method confounds estimates of the curvature of the utility function, the traditional notion of risk preference, with an estimate of the extent to which an individual weights probabilities non-linearly. We show that a slight modification to their approach can remove the confound while preserving the simplicity of the method which has made it so popular. Data from a laboratory experiment shows that our new method yields significantly different levels of implied risk aversion than the Holt and Laury task even after econometrically controlling for probability weighting in the latter. Implied risk aversion from the traditional Holt and Laury task is relatively insensitive to payout amount, but our new method reveals increasing relative risk aversion and risk neutrality at low payout amounts.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 37762.

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Date of creation: 27 Mar 2012
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Handle: RePEc:pra:mprapa:37762
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  1. Steffen Andersen & Glenn W. Harrison & Morten I. Lau & E. Elisabet Rutström, 2008. "Eliciting Risk and Time Preferences," Econometrica, Econometric Society, vol. 76(3), pages 583-618, 05.
  2. 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.
  3. Eckel, Catherine C. & Wilson, Rick K., 2004. "Is trust a risky decision?," Journal of Economic Behavior & Organization, Elsevier, vol. 55(4), pages 447-465, December.
  4. Glenn W. Harrison & Eric Johnson & Melayne M. McInnes & E. Elisabet Rutstr�m, 2005. "Risk Aversion and Incentive Effects: Comment," American Economic Review, American Economic Association, vol. 95(3), pages 897-901, June.
  5. Andersen, Steffen & Harrison, Glenn W. & Lau, Morten I. & Rutström, E. Elisabet, 2014. "Discounting behavior: A reconsideration," European Economic Review, Elsevier, vol. 71(C), pages 15-33.
  6. Charles A. Holt & Susan K. Laury, 2005. "Risk Aversion and Incentive Effects: New Data without Order Effects," American Economic Review, American Economic Association, vol. 95(3), pages 902-912, June.
  7. Jayson L. Lusk & Keith H. Coble, 2005. "Risk Perceptions, Risk Preference, and Acceptance of Risky Food," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 87(2), pages 393-405.
  8. Charles Bellemare & Bruce S. Shearer, 2006. "Sorting, Incentives and Risk Preferences: Evidence from a Field Experiment," Cahiers de recherche 0631, CIRPEE.
  9. Quiggin, John, 1982. "A theory of anticipated utility," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 323-343, December.
  10. George Wu & Richard Gonzalez, 1996. "Curvature of the Probability Weighting Function," Management Science, INFORMS, vol. 42(12), pages 1676-1690, December.
  11. 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.
  12. Elisabet Rutstrom & Glenn Harrison & Morten Lau, 2005. "Risk attitudes, randomization to treatment, and self-selection into experiments," Artefactual Field Experiments 00061, The Field Experiments Website.
  13. Wilcox, Nathaniel, 2007. "Stochastically more risk averse: A contextual theory of stochastic discrete choice under risk," MPRA Paper 11851, University Library of Munich, Germany.
  14. David Bruner & Michael McKee & Rudy Santore, 2008. "Hand in the Cookie Jar: An Experimental Investigation of Equity-Based Compensation and Managerial Fraud," Southern Economic Journal, Southern Economic Association, vol. 75(1), pages 261-278, July.
  15. Greiner, Ben, 2004. "An Online Recruitment System for Economic Experiments," MPRA Paper 13513, University Library of Munich, Germany.
  16. Camerer, Colin F & Ho, Teck-Hua, 1994. "Violations of the Betweenness Axiom and Nonlinearity in Probability," Journal of Risk and Uncertainty, Springer, vol. 8(2), pages 167-96, March.
  17. 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.
  18. Urs Fischbacher, 2007. "z-Tree: Zurich toolbox for ready-made economic experiments," Experimental Economics, Springer, vol. 10(2), pages 171-178, June.
  19. Hey, John D & Orme, Chris, 1994. "Investigating Generalizations of Expected Utility Theory Using Experimental Data," Econometrica, Econometric Society, vol. 62(6), pages 1291-1326, November.
  20. 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.
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