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Aversion to risk of regret and preference for positively skewed risks

Christian Gollier ()

Economic Theory, 2020, vol. 70, issue 4, No 2, 913-941

Abstract: Abstract We assume that the ex post utility of a regret-sensitive agent facing a menu of lotteries depends upon the payoff of the chosen lottery in the realized state together with the forgone best payoff available in the menu in that state. If two lotteries in the menu have the same distribution of payoffs, the one whose payoff is less statistically concordant with the best alternative yields a larger risk of regret, which should be rejected by regret-risk-averse individuals. This means that regret-risk aversion is equivalent to the supermodularity of the bivariate utility function. We define regret-risk aversion in the small and in the large. We also show that regret-risk aversion tends to induce a bias in favor of the risky act in any one-risky-one-safe menu, in particular when the payoff of the risky choice is highly positively skewed. This is compatible with the “possibility effect” that is well documented in prospect theory. Symmetrically, we define the aversion to rejoicing-risk that can prevail when the ex post utility is alternatively sensitive to the forgone worst payoff. We show that rejoicing-risk-seeking is compatible with the “certainty effect”. We finally show that regret-risk-averse and rejoicing-risk-seeking people behave as if they had rank-dependent utility preferences with an inverse-S shaped probability weighting function that reproduces estimates existing in the literature.

Keywords: Longshot bias; Certainty effect; Possibility effect; Probability weighting; Risk-seeking; Prospect theory; Rejoicing-risk-seeking (search for similar items in EconPapers)
JEL-codes: D81 (search for similar items in EconPapers)
Date: 2020
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Working Paper: Aversion to risk of regret and preference for positively skewed risks (2020) Downloads
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DOI: 10.1007/s00199-018-1154-4

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