Risk and Rationality:The Relative Importance of Probability Weighting and Choice Set Dependence
Maha Manai and
Luis Santos-Pinto ()
Cahiers de Recherches Economiques du Département d'économie from Université de Lausanne, Faculté des HEC, Département d’économie
The literature suggests that probability weighting and choice set dependence influence risky choices. However, their relative importance has not been tested jointly.We present a joint test that uses binary choices between lotteries provoking Common Consequence and Common Ratio Allais Paradoxes and manipulates their correlation structure. We show non-parametrically that probability weighting and choice set dependence both play a role at describing aggregate choices. To parsimoniously account for heterogeneity, we also estimate a structural model using a finite mixture approach.The model uncovers substantial heterogeneity and classifies subjects into three types: 38% Prospect Theory types whose choices are predominantly driven by probability weighting, 34% Salience Theory types whose choices are predominantly driven by choice set dependence, and 28% Expected Utility Theory types. The model predicts typespecific dierences in the frequency of preference reversals out-of-sample. Moreover, the out-of-sample predictions indicate that the choice context shapes the influence of choice set dependence.
Keywords: Choice under Risk; Choice Set Dependence; Probability Weighting; Salience Theory; Prospect Theory; Preference Reversals (search for similar items in EconPapers)
JEL-codes: C49 C91 D81 (search for similar items in EconPapers)
Pages: 115 pp.
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 (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:lau:crdeep:19.05
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