Abstract
Abstract Higher-order risk preferences are important determinants of economic behavior. We apply insights from behavioral economics: we measure higher-order risk preferences for pure gains and losses. We find a reflection effect not only for second-order risk preferences, as did Kahneman and Tversky (1979), but also for higher-order risk preferences: we find risk aversion, prudence and intemperance for gains and much more risk-loving preferences, imprudence and temperance for losses. These findings are at odds with a universal preference for combining good with bad or good with good, which previous results suggest may underlie higher-order risk preferences.
Highlights
While risk aversion has been the cornerstone of the economic analysis of decision making under risk since the 1950s, only relatively recently have higher order risk preferences been receiving the attention they arguably deserve
Model-free definitions of prudence and temperance proposed by Eeckhoudt and Schlesinger (2006) are illustrated in Figure 1.1 Prudence is equivalent to aversion to downside risks (Menezes et al, 1980) and temperance relates to whether the presence of background risk makes a person more risk averse (Gollier and Pratt, 1996)
For the two gain treatments, the patterns are very similar: we find risk aversion and prudence in both gain treatments, which is consistent with the usual findings in the literature, and weak intemperance, which is consistent with the findings of Deck and Schlesinger (2010) and Baillon et al (2017), but not with the results of Ebert and Wiesen (2014), Deck and Schlesinger (2014) and Noussair et al (2014), who find modest temperance in the aggregate
Summary
While risk aversion has been the cornerstone of the economic analysis of decision making under risk since the 1950s, only relatively recently have higher order risk preferences been receiving the attention they arguably deserve. Model-free definitions of prudence and temperance proposed by Eeckhoudt and Schlesinger (2006) are illustrated in Figure 1.1 Prudence is equivalent to aversion to downside risks (Menezes et al, 1980) and temperance relates to whether the presence of background risk makes a person more risk averse (Gollier and Pratt, 1996). Gender in particular has been found to influence risk preferences in various studies (see Croson and Gneezy, 2009, for a review). Other characteristics such as age, 13We thank an anonymous referee for this suggestion.
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