Consistency of Higher Order Risk Preferences

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in Consistency of Higher Order Risk Preferences AbstractRisk 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.JEL-Code: C900, D800.

Prudence, Emotional State, Personality, and Cognitive Ability

“…10.84% (9 of 83) of participants made fewer than 6 prudent choices are thus classified as imprudent. The fact that a majority of participants is prudent is consistent with the previous literature (Deck and Schlesinger, 2010, 2014; Ebert and Wiesen, 2011, 2014; Noussair et al, 2014). …”

“…The precise lotteries that were used are given in Table 1. In line with the existing literature (Deck and Schlesinger, 2010, 2014; Noussair et al, 2014), we use the number of prudent choices that a subject makes as a measure of the individual strength of prudence. If an individual chooses the prudent option in 6 or more of the 10 decisions she takes, we classify the individual as prudent.…”

“…The results from these studies show that the degree of prudence varies considerably among individuals within the population (Deck and Schlesinger, 2010, 2014; Ebert and Wiesen, 2011, 2014; Noussair et al, 2014), though all of these studies agree that a majority of individuals are prudent. Furthermore, Noussair et al (2014), who study a large sample of demographically representative individuals, find that those who exhibit more prudent decision making also have greater savings, lower debt, more wealth and higher educational attainment.…”

“…Furthermore, Noussair et al (2014), who study a large sample of demographically representative individuals, find that those who exhibit more prudent decision making also have greater savings, lower debt, more wealth and higher educational attainment. The results for the prevalence of temperance within the population are more mixed (e.g., Deck and Schlesinger, 2010, 2014; Noussair et al, 2014). …”

“…In this paper, we consider the relationship between prudent decision making and emotional state. Our design is guided by the theoretical work of Eeckhoudt and Schlesinger (2006) and the experimental implementation of Deck and Schlesinger (2010, 2014). Eeckhoudt and Schlesinger (2006) show how prudent and imprudent decisions can be distinguished using risk apportionment tasks that are simple to understand and straightforward to implement in the laboratory.…”