Stability of risk preferences and the reflection effect of prospect theory

• Published in: Theory and decision Vol. 68; no. 1-2; pp. 193 - 211
• Main Authors: Baucells, Manel, Villasís, Antonio
• Format: Journal Article Conference Proceeding
• Language: English
• Published: Boston Springer US 01.02.2010; Springer; Springer Nature B.V
• Subjects: Applied sciences; Attitudes; Behavioral/Experimental Economics; Conformity; Decision making; Decision theory. Utility theory; Economic Theory/Quantitative Economics/Mathematical Methods; Economics; Economics and Finance; Error; Exact sciences and technology; Finance; Game Theory; Insurance; Loss; Management; Operational research and scientific management; Operational research. Management science; Operations Research/Decision Theory; Preferences; Probability; Prospect Theory; Rational choice; Risikopräferenz; Risk assessment; Risk aversion; Risk management; Risk theory. Actuarial science; Social and Behav. Sciences; Statistics for Business; Stochastic models; Studies; Uncertainty; Utility theory; Stability of preferences; Reflection effect; Risk preferences; Stochastic model; Prospect theory; Decision making; Empirical method; Random error; Individual preference; Risk analysis; Modeling; Risk aversion; Uncertain system; Econometrics; Risk management
• ISSN: 0040-5833; 1573-7187
• DOI: 10.1007/s11238-009-9153-3

Are risk preferences stable over time? To address this question we elicit risk preferences from the same pool of subjects at two different moments in time. To interpret the results, we use a Fechner stochastic choice model in which the revealed preference of individuals is governed by some underlying preference, together with a random error. We take cumulative prospect theory as the underlying preference model (Kahneman and Tversky, Econometrica 47:263–292, 1979; Tversky and Kahneman, Journal of Risk and Uncertainty 5:297–323, 1992). We observe that the aggregate pattern of preferences is very similar in both sessions, and it matches the results reported in the literature. Most subjects are risk averse for gains, and risk seeking for losses. However, the subjects that jointly agree with the reflection effect of prospect theory are around 50%. The percentage of individuals that change their responses across sessions is quite high, 63%. Estimating the stochastic choice model we find that 72% of the subjects have an underlying preference which agrees with the reflection effect of prospect theory. The remaining 28% are mainly classified as risk averse for both gains and losses. The results reinforce the empirical validity of the reflection effect. Deviations from the reflection effect can be attributed to noise, as well as to the existence of a fraction of risk averse subjects.