Explaining rank-dependent utility with regret and rejoicing

Christian Gollier ()

No 863, IDEI Working Papers from Institut d'Économie Industrielle (IDEI), Toulouse

Abstract: We fill a gap in the literature by formally defining the notion of aversion to risk of regret. An agent is sensitive to regret when her ex-post utility depends upon the forgone best payoff. An increase in the risk of regret occurs when the actual payoff and this best alternative become statistically less concordant. Accordingly, regret-risk aversion is characterized by the supermodularity of the bivariate utility function. We define a measure of regret-risk aversion in the small and in the large. We show that more regretrisk- averse agents are more willing to choose the risky act in a one-risky-one-safe menu, and that this bias is increasing in the skewness of the risky choice. This can explain the "possibility effect" that is well documented in decision theory. Symmetrically, we define the aversion to elation-risk that can prevail when the ex-post utility is alternatively sensitive to the forgone worst payoff. We show that elation-risk-seeking can explain the "certainty effect". We also show that a regret-risk-averse and elation-risk-seeking people behave as if they would have rank-dependent utility preferences with an inverse-S shaped probability weighting function that reproduces estimations existing in the literature.

Keywords: Longshot bias; certainty effect; possibility effect; probability weighting; riskseeking; prospect theory; behavioral finance (search for similar items in EconPapers)
JEL-codes: D81 (search for similar items in EconPapers)
Date: 2016-05
New Economics Papers: this item is included in nep-mic and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
https://idei.fr/sites/default/files/IDEI/documents/wp/2016/wp_idei_863.pdf Full text (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ide:wpaper:30472

Access Statistics for this paper

More papers in IDEI Working Papers from Institut d'Économie Industrielle (IDEI), Toulouse Contact information at EDIRC.
Bibliographic data for series maintained by ().