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Risk and Rationality:The Relative Importance of Probability Weighting and Choice Set Dependence

Adrian Bruhin, Maha Manai and Luis Santos-Pinto ()

Cahiers de Recherches Economiques du Département d'économie from Université de Lausanne, Faculté des HEC, Département d’économie

Abstract: We analyze the relative importance of probability weighting and choice set dependence in describing risky choices both non-parametrically and with a structural model. Our experimental design uses binary choices between lotteries that may trigger Allais Paradoxes. We change the choice set by manipulating the correlation structure of the lotteries' payoffs while keeping their marginal distributions constant. This allows us to discriminate between probability weighting and choice set dependence. There are three main results. First, probability weighting and choice set dependence both play a role in describing aggregate choices. Second, the structural model uncovers substantial individual heterogeneity which can be parsimoniously characterized by three types: 38% of subjects engage primarily in probability weighting, 34% are in uenced predominantly by choice set dependence, and 28% are mostly rational. Third, the classification of subjects into types predicts preference reversals out-of-sample. These results may not only further our understanding of choice under risk but may also prove valuable for describing the behavior of consumers, investors, and judges.

Keywords: Individual Choice under Risk; Choice Set Dependence; Probability Weighting; Latent Heterogeneity; Preference Reversals (search for similar items in EconPapers)
JEL-codes: D81 C91 C49 (search for similar items in EconPapers)
Pages: 47 pp.
Date: 2018-07
New Economics Papers: this item is included in nep-upt
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Working Paper: Risk and Rationality:The Relative Importance of Probability Weighting and Choice Set Dependence (2019) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:lau:crdeep:18.04

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