Direct-Risk-Aversion: Evidence from Risky Prospects Valued Below Their Worst Outcome

Abstract

Why would people pay more for a $50 gift certificate than for the opportunity to receive either a $50 or a $100 gift certificate with equal probability? This paper examines three mechanisms for this recently documented "Uncertainty Effect" (UE): (i) awareness of the better outcome devalues the worse one, (ii) instructions in the original demonstration of the UE were misunderstood, and (iii) people exhibit direct-risk-aversion, that is, actual distaste for uncertainty. Experiment 1 documents the UE in a design where participants in the certainty condition were also aware of the better outcome, eliminating the first explanation. Experiment 2 shows that most participants understand the instruction and that the UE is not caused by the few who do not. Overall, the UE is proven robust, large (prospects are valued at 66% the value of their worst outcome) and widespread (at least 62% of participants exhibit it).