Stable Risk Preferences Research Articles

Beyond risk preferences in sequential decision-making: How probability representation, sequential structure and choice perseverance bias optimal search

Sequential decision-making, where choices are made one after the other, is an important aspect of our daily lives. For example, when searching for a job, an apartment, or deciding when to buy or sell a stock, people often have to make decisions without knowing what future opportunities might arise. These situations, which are known as optimal stopping problems, involve a risk associated with the decision to either stop or continue searching. However, previous research has not consistently found a clear connection between individuals’ search behavior in these tasks and their risk preferences as measured in controlled experimental settings. In this paper, we explore how particular characteristics of optimal stopping tasks affect people’s choices, extending beyond their stable risk preferences. We find that (1) the way the underlying sampling distribution is presented (whether it is based on experience or description), (2) the sequential presentation of options, and (3) the unequal frequencies of choices to reject versus to accept significantly bias people choices. These results shed light on the complex nature of decisions that unfold sequentially and emphasize the importance of incorporating context factors when studying human decision behavior.

Preference or ability: Exploring the relations between risk preference, personality, and cognitive abilities

AbstractKey issues in the behavioral sciences are if there exist stable risk preferences that generalize across domains and if these are best measured by revealed risk preference (RRP) in behavioral decision tasks or by surveys eliciting stated risk preference (SRP). We applied network analysis to data from a representative Swedish sample to investigate the relations between RRP, SRP, personality characteristics, and cognitive abilities, using in total over 70 measurements. The results showed that different measures of RRP were poorly intercorrelated and formed a community together with measures of numerical and cognitive abilities. Measures of SRP were weakly correlated with measures of RRP and identified in a distinctly separate community, along with personality characteristics and gender. The ensuing analyses provided support for a model suggesting that RRPs are contaminated by demands on numerical and cognitive abilities. RRPs may thus suffer from poor construct validity, whereas SRPs may better capture people's everyday risk preferences because they are related to more stable traits.

Accountability, Framing Effects, and Risk-Seeking by Elected Representatives: An Experimental Study with American Local Politicians

Risk management underlies almost every aspect of elite politics. However, due to the difficulty of administering assessment tasks to elites, direct evidence on the risk preferences of elected politicians scarcely exists. As a result, we do not know how consistent are politicians’ risk preferences, and under what conditions they can be changed. In this paper, we conduct a survey experiment with 440 incumbent local politicians from across the United States. Using a modified version of the Asian Disease framing experiment, we show that gain/loss frames alter the stated risk preferences of elected officials. We further show that priming democratic accountability increases the tendency to engage in risky behavior, but that this shift in preference only occurs in those politicians who are interested in seeking reelection. These results inform several political science theories that assume stable risk preferences by political elites, or that make no risk assumptions whatsoever. They also provide insights into the role of political ambition and accountability in structuring the behavior of political elites.

DOES GLOBAL SHAPES OF UTILITY FUNCTIONS MATTER FOR INVESTMENT DECISIONS?

ABSTRACTThe study investigates relation between global shapes of utility functions and investor preferences towards particular asset classes for investment decisions. Global shapes that emerge are fully concave, fully convex, Reverse‐S and S‐shaped utility functions, using the certainty equivalence method for eliciting risk preferences. Investor clusters show existence of two types of investors, preference towards financial assets (bank deposits, insurance, pension and provident fund, shares and mutual funds) vs traditional assets (chit funds, gold and precious metals, real estate, postal savings, and government bonds). Investors with reverse‐S and S‐shaped utility functions prefer investment in financial assets, while investors with fully concave and fully convex utility functions prefer traditional assets. Prior studies suggest reverse‐S and S‐shaped category of investors perceive risk in terms of gains and losses, and financial assets with ready price quotes facilitate such buying and selling. In contrast, fully concave and fully convex utility functions prefer investment in traditional assets that requires long term horizon and stable risk preferences. Among demographics, males with reverse‐S shaped utility function are more likely to invest in financial assets, and increase in dependents reduces the possibility to invest in financial assets.

Revisiting risk aversion: Can risk preferences change with experience?

The Holt–Laury measure for risk aversion has been used extensively in economic studies to measure individuals’ risk aversion. The idea behind this measure is that individuals have stable risk preferences when making decisions under risk. We show that having repeated experiences with the Holt–Laury task can move individuals from exhibiting “risk aversion” to displaying “risk neutrality.” This finding suggests that either risk preferences are not robust to a few experiences or that responses to the tasks indicate something else. We show that a simple model of adaptation can capture this behavioral pattern.

Revisiting Risk Aversion and Incentive Effects

The Holt-Laury measure for risk aversion has been used extensively in economic studies to measure individuals’ risk aversion. The idea behind this measure is that individuals have stable risk preferences when making decisions under risk. We show that having repeated experiences with the Holt-Laury task can move individuals from exhibiting “risk aversion” to displaying “risk neutrality.” This finding suggests that either risk preferences are not robust to a few experiences or that responses to the tasks indicate something else. We show that a simple model of adaptation can capture this behavioral pattern.

Risk taking under stress: the role(s) of self-selection. A comment on Buckert et al. (2014).

Risk taking under stress: the role(s) of self-selection. A comment on Buckert et al. (2014).

Introducing Target-Volatility Concepts into Target-Date Funds

Target-date funds (TDFs) attempt to manage risk by setting discrete asset allocation mixes that depend on a participant’s time to retirement. If risk were constant, then this methodology would yield predictable risk levels through time. However, markets regularly cycle over various risk regimes, oscillating between periods of relative calm and extreme distress. Assuming that investors have stable risk preferences, which decline as they move toward retirement, the current target-date framework may be suboptimal. The authors examine whether introducing target-volatility concepts into TDFs can help mitigate mismatches between risk preferences and risk results, thus leading to a more predictable and optimal outcome for investors as they approach retirement.

Hierarchical Maximum Likelihood Parameter Estimation for Cumulative Prospect Theory: Improving the Reliability of Individual Risk Parameter Estimates

Individual risk preferences can be identified by using decision models with tuned parameters that maximally fit a set of risky choices made by a decision maker. A goal of this model fitting procedure is to isolate parameters that correspond to stable risk preferences. These preferences can be modeled as an individual difference, indicating a particular decision maker’s tastes and willingness to tolerate risk. Using hierarchical statistical methods we show significant improvements in the reliability of individual risk preference parameters over other common estimation methods. This hierarchal procedure uses population level information (in addition to an individual’s choices) to break ties (or near-ties) in the fit quality for sets of possible risk preference parameters. By breaking these statistical “ties” in a sensible way, researchers can avoid overfitting choice data and thus better measure individual differences in people’s risk preferences.

Temporal Stability of Risk Preference Measures

We examine the temporal stability of risk preference measures obtained by different elicitation methods in a controlled laboratory experiment at two distinct times. Our results indicate remarkable temporal stability of risk measures at the aggregated level and temporal instability at the individual level. We control for the impact of, first, personality traits, and second, performance realized in a market game. When better market performers demonstrate more stable risk preferences, the impact of personality traits is marginal.

Preference Stability and Memory: Two Unlikely Companions

Preference Stability and Memory: Two Unlikely Companions

The Elusive Search for Stable Risk Preferences

In the early morning hours of June 20, 2011 Ryan Dunn was driving his Porsche 911 GTE up to 140 miles per hour through the Pennsylvania countryside. The car careened over a guardrail and into a wooded area, killing Dunn and a passenger in a fiery crash. A toxicology report later determined that Dunn's blood alcohol level was more than twice the legal limit. Many observers found the accident somewhat unsurprising because Dunn was best known for performing dangerous stunts in the popular Jackass television and movie series. As one blogger put it: “This is the type of person he was. He was a risk-taker”.1 Indeed, the headline in the Philadelphia Daily News later read: “Dunn deal: Death of a risk-taker.” The public's response to the Ryan Dunn tragedy illustrates a prevalent belief that there are consistent individual differences in not only people's risk-taking behavior but also in their underlying appetite for risk. Several industries depend on this assumption. For instance, in financial services the “suitability doctrine” legally requires financial advisors to assess their clients’ risk preference before dispensing advice (Mundheim, 1965). Likewise, most social–science disciplines traditionally assume stable and measurable individual differences in risk preference. However, based on our reading of the empirical literature, the common intuition that risk preference is a stable disposition may reflect more of an attribution error than empirical fact.

Dimensionality of Risk Perception: Factors Affecting Consumer Understanding and Evaluation of Financial Risk

This article describes two studies of the factors affecting consumer understanding of financial risk. The first study investigated factors affecting people's perception and comprehension of information about the risks related to retirement investments. First, we asked respondents to list possible risk factors related to investment in a pension plan. Then we obtained ratings of different factors (e.g., the perceived level of knowledge about an investment) that could affect perception of the risk of financial products and retirement investment decisions. Finally, we asked the subjects to rate 11 different descriptions presenting risk information about the same financial product. The risk information framing that received highest rating presented risk as variation between minimum and maximum values with an average in between. The second study demonstrated the risk framing that received highest ranking also prompted more stable risk preferences over a 3-month testing period in comparison to standard measures of risk aversion. Thus, the second study corroborated the importance of the findings in the first study and also indicated that, although people can exhibit stable risk preferences if we ask them the right questions, these preferences were very specific to the risk domain.

Are Risk Preferences Stable across Contexts? Evidence from Insurance Data

Using a unique dataset, we test whether households' deductible choices in auto and home insurance reflect stable risk preferences. Our test relies on a structural model that assumes households are objective expected utility maximizers and claims are generated by household-coverage specific Poisson processes. We find that the hypothesis of stable risk preferences is rejected by the data. Our analysis suggests that many households exhibit greater risk aversion in their home deductible choices than their auto deductible choices. Our results are robust to several alternative modeling assumptions. (JEL D11, D83)