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Aversion to risk of regret and preference for positively skewed risks

Christian Gollier ()

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Abstract: We assume that the ex-post utility of an agent facing a menu of lotteries depends upon the actual payoff together with its forgone best alternative, thereby allowing for the expost emotion of regret. An increase in the risk of regret is obtained when the actual payoff and its forgone best alternative are statistically less concordant in the sense of Tchen (1980). The aversion to any such risk of regret is thus equivalent to the supermodularity of the bivariate utility function. We show that more regret-risk-averse agents are more willing to choose the risky act in a one-risky-one-safe menu, in particular when the payoff of the risky choice is highly skewed. This is compatible with the "possibility effect" that is well documented in prospect theory. Symmetrically, we define the aversion to elationrisk that can prevail when the ex-post utility is alternatively sensitive to the forgone worst payoff. We show that elation-risk-seeking is compatible with the "certainty effect". We finally show that regret-risk-averse and elation-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: Riskseeking; Probability weighting; Possibility effect; Certainty effect; Longshot bias; Prospect theory; Behavioral finance (search for similar items in EconPapers)
Date: 2020
New Economics Papers: this item is included in nep-cbe, nep-cwa and nep-upt
Note: View the original document on HAL open archive server: https://hal.archives-ouvertes.fr/hal-03142627
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Published in Economic Theory, Springer Verlag, 2020, 70 (4), pp.913-941. ⟨10.1007/s00199-018-1154-4⟩

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Journal Article: Aversion to risk of regret and preference for positively skewed risks (2020) Downloads
Working Paper: Aversion to risk of regret and preference for positively skewed risks (2016) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-03142627

DOI: 10.1007/s00199-018-1154-4

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