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An experiment on the influence of individual risk attitudes

An experiment on the influence of individual risk attitudes. by Hermann Trenkel Department for Food and Resource Economics University of Bonn. FUR XII 25.06.2006. Measurement of individual risk attitude.

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An experiment on the influence of individual risk attitudes

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  1. An experiment on the influence of individual risk attitudes by Hermann Trenkel Department for Food and Resource Economics University of Bonn FUR XII 25.06.2006

  2. Measurement of individual risk attitude • Lotteries are commonly considered as a useful method to identify the risk attitude of individuals • Subjects state their reservation price for a specified lottery • Using the BDM-method monetary incentives are installed in a way which elicits real reservation prices if subjects act rational FUR XII 25.06.2006

  3. Measurement of individual risk attitude Hartog,Ferrer-i-Carbonell and Jonker1 asked: “Among 10 people, 1000 guilders are disposed of by lottery. What is the most that you would be willing to pay for a ticket in this lottery?“ in two surveys with about 3600 paricipants. FUR XII 25.06.2006 1: Hartog et al. (2000): On a simple measure of individual risk aversion, tinbergen institute discussion paper TI2000-074/3

  4. Measurement of individual risk attitude In a questionnaire in the Saturday edition of Dutch newspapers, answered by 25.000 people, they included questions for lotteries with • 1000 guilders are alloted among 5 people • 5000 guilders are alloted among 10 people • 1000 guilders are alloted among 100 people • 1000.000 guilders are alloted among 100 people FUR XII 25.06.2006

  5. Measurement of individual risk attitude Even though they didn´t give monetary incentives or use any method like the BDM-method to elicit real reservation prices the results showed • risk aversion is significantly lower for the self-employed • risk aversion is falling with increasing income • risk aversion is negatively related to wealth • risk aversion is significantly reduced by schooling level • Women have a substantially higher degree of risk aversion than men • risk aversion increases with age FUR XII 25.06.2006

  6. Measurement of individual risk attitude • As they „…conclude that a simple lottery question is a promising survey instrument to extract differences in risk attitudes among individuals“ • the lotteries questions are taken into my questionaire to extract risk attitudes • but we ask for € instead of guilders • Conducting an adjacent game the hypothesis „individual risk aversion has a predictable influence on decisions in an uncertain context“ will be tested FUR XII 25.06.2006

  7. The game - participants • All participants are students, most of them freshmen • No monetary incentives are given • Instead, questions and answers of last years exams were offered as award for participation FUR XII 25.06.2006

  8. The experimental game • In a paper and pencil game, participants act as managers • Each round, they produce 10.000 items of a nonspecified good • The price for the good will be randomly choosen from a known distribution • The students have 2 choices: • they can produce for the random market price • they can sell their production (or parts of it) at a fixed contract price FUR XII 25.06.2006

  9. 2x 4x 6x 8x 10x 8x 6x 4x 2x The experimental game • Afterwards the „market price“ was choosen by drawing a card from a deck of cards reflecting the distribution • The game included 3 rounds • On 3 days 127 students took part FUR XII 25.06.2006

  10. The experiment – 1. repetition Contract price =production costs • the distribution now was left-skewed • The game lasted 4 rounds • On 2 occasions 164 students took part FUR XII 25.06.2006

  11. The experiment – test for consistency • As 3 lotteries offer the same prize (1000 €) among different numbers of participants (5, 10 or 100), rationally the reservation price for a lottery with more participants cannot be higher as for a lottery with less participants • Demanding the reservation price for lotterie 1 > lotterie 2 > lotterie 4 in the 2004 experiment only 63 (from 127) and in the 2005 experiment 113 (from 164) remain • Most of the dropouts stated the same reservation price, i.e. 5 € for all lotteries FUR XII 25.06.2006

  12. The experiment – reservation prices FUR XII 25.06.2006

  13. The experiment – reservation price coefficient By dividing the reservation prices for the lotteries by the expected values of the lotteries a Reservation Price Coefficient RPcoeff was calculated For risk neutrality RPcoeff = 1, with increasing risk aversion it moves towards 0. FUR XII 25.06.2006

  14. The experiment – reservation price coefficient FUR XII 25.06.2006

  15. The experiment – core question and hypothesis • Is the RPcoeff as a measure of individual risk aversion a predictor for actions in the game? • Individuals with high risk aversion should contract a higher amount of their production • individuals tending towards risk neutrality should sell on the free market FUR XII 25.06.2006

  16. The experiment – results →no evidence for any relation between the answers to the lotteries and the performance in the game FUR XII 25.06.2006

  17. The experiment – new risk aversion measurement • A question to self-estimate oneselfs risk-attitude was inserted • It was used by FALK et al. (2005)1 with outstanding results Are You someone who accepts risks or do You avoid risk? Avoid risk willing to take risk            0 1 2 3 4 5 6 7 8 9 10 FUR XII 25.06.2006 1: FALK et al. (2000): Individual Risk Attitudes: New Evidence from a Large, Representative, Experimentally-Validated Survey

  18. The experiment with monetary rewards • 4 training rounds, but now contracts were only allowed for 100 % of the production each round • 4 rounds with monetary rewards: 5 students would afterwards be randomly choosen and get their results payed out in 1/20 cents • Instead of selling at a fixed contract price participants had to report their minimum price for selling the whole production • Only the 30 % with the lowest offers would get a contract FUR XII 25.06.2006

  19. The monetary experiment - results • Only 30 consistent participants FUR XII 25.06.2006

  20. The monetary experiment - results FUR XII 25.06.2006

  21. The monetary experiment - results FUR XII 25.06.2006

  22. The monetary experiment - results FUR XII 25.06.2006

  23. The monetary experiment - results • Production costs = 72.000 • Expected value = 84.000 FUR XII 25.06.2006

  24. The monetary experiment - results FUR XII 25.06.2006

  25. The monetary experiment - results FUR XII 25.06.2006

  26. The monetary experiment - results FUR XII 25.06.2006

  27. The monetary experiment - results FUR XII 25.06.2006

  28. Conclusions • Gender difference for risk aversion in lotteries is confirmed • Predictive power of individual risk aversion elicited from lottery reservation prices towards actions in a managerial game seems poor • Instead of risk aversion it seems to be loss aversion: After the students accumulated money in 2 high priced rounds, they started to behave somewhat more consistent • The only way to get a relation is to look the other way round: those, who act risk averse in the game are likely to be risk averse as well in the lottery questions FUR XII 25.06.2006

  29. Open questions • Could different risk categories be a possible explanation? • How to control for an effect of the term „contract“, as some of the students may have an attitude towards contracts? • Is a game with several repetitions to complex? • How to control for „terminal wealth“ effects? FUR XII 25.06.2006

  30. Thank You FUR XII 25.06.2006

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