Domain-specific risk preference and cognitive ability

Abstract

Kahneman and Tversky’s works on Prospect Theory compellingly demonstrate that people tend to show varying risk-attitudes for gains versus losses as well as high versus low probabilities associated with the outcomes. Although some studies have found that individuals with lower cognitive skills tend to be risk averse, the literature has not addressed yet a comprehensive understanding of domain-specific risk preference variation by cognitive ability and by gains versus losses as well as high versus low probabilities associated with the outcomes. Thus, this paper attempts to provide a comprehensive picture of domain-specific risk preference variations. The results of this paper show the following: individuals with low cognitive skills tend to be risk-averse (and more risk-averse compared to people with high cognitive ability) when facing high probability of gain or low probability of loss, however risk-seeking (although less risk-seeking compared to people with high cognitive ability) when facing low probability of gain or high probability of loss. My results are consistent with the implications of Kahneman and Tversky’s prospect theory.