Choice lists and ‘standard patterns’ of risk-taking

Ranoua Bouchouicha (), Jilong Wu and Ferdinand M. Vieider ()
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Ferdinand M. Vieider: -

Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium from Ghent University, Faculty of Economics and Business Administration

Abstract: The fourfold pattern of risk attitudes has been called ‘the most distinctive implication of prospect theory’. It constitutes the central mechanism by which prospect theory (PT) explains the coexistence of gambling and insurance. Here, we compare risk-taking patterns obtained from certainty equivalents (CEs) to risk-taking patterns observed when presenting all single choices contained in the CE lists one-by-one in a binary choice setup. Choices obtained from CEs indicate a clear fourfold pattern. Binary choices, on the other hand, indicate risk aversion for small probability gains, and risk seeking for small probabilities losses—the opposite of what is predicted by the fourfold pattern. The use of CEs to measure PT parameters is often justified based on the fact that they avoid endogenous reference points, which have been documented by comparing CEs to probability equivalents (PEs). We show that loss aversion in a PT model can actually not account for this discrepancy, since the gap between CEs and PEs requires different loss aversion coefficients for each PE task. Our results thus question the applicability of PT beyond the restrictive realm of CEs, which are arguably a poor proxy for most real-world decisions.

Pages: 23 pages
Date: 2023-05
New Economics Papers: this item is included in nep-dcm, nep-des, nep-rmg and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:rug:rugwps:23/1068

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