Source-Dependence of Utility and Loss Aversion: A Critical Test of Ambiguity Models

Mohammed Abdellaoui, Han Bleichrodt, Olivier L'Haridon and Dennie van Dolder

Economics Working Paper Archive (University of Rennes & University of Caen) from Center for Research in Economics and Management (CREM), University of Rennes, University of Caen and CNRS

Abstract: This paper tests whether utility is the same for risk and for uncertainty. This test is critical for models that capture ambiguity aversion through a difference in event weighting between risk and uncertainty, like the multiple priors models and prospect theory. We present a new method to measure utility and loss aversion under uncertainty without the need to introduce simplifying parametric assumptions. Our method extends Wakker and Deneffe’s (1996) trade-off method by allowing for standard sequences that include gains, losses, and the reference point. It provides an efficient way to measure loss aversion and a useful tool for practical applications of ambiguity models. We could not reject the hypothesis that utility and loss aversion were the same for risk and uncertainty, suggesting that utility primarily reflects attitudes towards outcomes. Utility was S-shaped, concave for gains and convex for losses and there was substantial loss aversion. Our findings support models that explain ambiguity aversion through a difference in event weighting and suggest that descriptive ambiguity models should allow for reference-dependence of utility.

Keywords: prospect theory; loss aversion; utility for gains and losses; probability distortion; decision analysis; risk aversion (search for similar items in EconPapers)
Date: 2013-07
New Economics Papers: this item is included in nep-cbe and nep-upt
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Citations: View citations in EconPapers (4)

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