Averting Risk in the Face of Large Losses: Bernoulli Vs. Tversky and Kahneman

Abstract:     
We experimentally question the assertion of Prospect Theory that people display risk attraction in choices involving high-probability losses. Indeed, our experimental participants tend to avoid fair risks for large (up to € 90), high-probability (80%) losses. Our research hinges on a novel experimental method designed to alleviate the house-money bias that pervades experiments with real (not hypothetical) loses. Our results vindicate Daniel Bernoulli's view that risk aversion is the dominant attitude, But, contrary to the Bernoulli-inspired canonical expected utility theory, we do find frequent risk attraction for small amounts of money at stake. In any event, we attempt neither to test expected utility versus nonexpected utility theories, nor to contribute to the important literature that estimates value and weighting functions. The question that we ask is more basic, namely: do people display risk aversion when facing large losses, or large gains? And, at the risk of oversimplifying, our answer is yes.

Number of Pages in PDF File: 18

Keywords: Losses, Risk Attraction, Risk Aversion, Experiments, Prospect Theory, Bernoulli, Kahneman, Tversky, Leex

JEL Classification: C91, D81

working papers series