Risk Taking and Problem Context in the Domain of Losses: An Expected Utility Analysis

Abstract

This paper presents an experimental investigation of risk taking in the domain of losses. The results are partly compatible with expected utility theory, assuming an inflection point in the utility function over losses. However, overweighting of low probabilities and underweighting of high ones was observed, which runs counter to the expected utility model. Additionally, a strong context effect was observed in which choices presented in an insurance context were judged with greater risk aversion than mathematically identical choices presented as standard gambles. Both the normative and descriptive implications for expected utility theory are discussed. This article examines two related issues regarding decision-making under conditions of objective or known risk. The first one concerns the nature of people's risk preferences for losses, and its compatibility with expected utility theory; the second concerns the extent to which such risk preferences are influenced by problem context.