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Discover the impact of individual risk attitudes on decision-making through lotteries and game simulations. Explore factors influencing risk aversion and test hypotheses for risk estimation methods.
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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 • 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
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
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
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
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
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
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
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
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
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
The experiment – reservation prices FUR XII 25.06.2006
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
The experiment – reservation price coefficient FUR XII 25.06.2006
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
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
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
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
The monetary experiment - results • Only 30 consistent participants FUR XII 25.06.2006
The monetary experiment - results FUR XII 25.06.2006
The monetary experiment - results FUR XII 25.06.2006
The monetary experiment - results FUR XII 25.06.2006
The monetary experiment - results • Production costs = 72.000 • Expected value = 84.000 FUR XII 25.06.2006
The monetary experiment - results FUR XII 25.06.2006
The monetary experiment - results FUR XII 25.06.2006
The monetary experiment - results FUR XII 25.06.2006
The monetary experiment - results FUR XII 25.06.2006
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
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
Thank You FUR XII 25.06.2006