Risk and Rationality: Uncovering Heterogeneity in Probability Distortion

Working Paper No. 414

57 Pages Posted: 9 Jun 2009

See all articles by Adrian Bruhin

Adrian Bruhin

ETH Zürich - CER-ETH - Center of Economic Research at ETH Zurich

Helga Fehr-Duda

ETH Zürich - Center for Economic Research

Thomas Epper

CNRS - Lille Economics & Managment - UMR 9221; Catholic University of Lille - IESEG School of Management

Date Written: May 25, 2009

Abstract

It has long been recognized that there is considerable heterogeneity in individual risk taking behavior but little is known about the distribution of risk taking types. We present a parsimonious characterization of risk taking behavior by estimating a finite mixture regression model for three different experimental data sets, two Swiss and one Chinese, over a large number of real gains and losses. We find two distinct types of individuals: In all three data sets, the choices of roughly 80% of the subjects exhibit significant deviations from linear probability weighting, consistent with prospect theory. 20% of the subjects weight probabilities near linearly and behave essentially as expected value maximizers. Moreover, individuals are cleanly assigned to one type with probabilities close to unity. The reliability and robustness of our classification suggest using a mix of preference theories in applied economic modeling.

Keywords: individual risk taking behavior, latent heterogeneity, finite mixture regression models, prospect theory

JEL Classification: D81, C49

Suggested Citation

Bruhin, Adrian and Fehr-Duda, Helga and Epper, Thomas, Risk and Rationality: Uncovering Heterogeneity in Probability Distortion (May 25, 2009). Working Paper No. 414, Available at SSRN: https://ssrn.com/abstract=1415975 or http://dx.doi.org/10.2139/ssrn.1415975

Adrian Bruhin (Contact Author)

ETH Zürich - CER-ETH - Center of Economic Research at ETH Zurich ( email )

Zürichbergstrasse 18
Zurich, 8092
Switzerland

Helga Fehr-Duda

ETH Zürich - Center for Economic Research ( email )

Weinbergstr. 35
Zurich 8092
Switzerland

Thomas Epper

CNRS - Lille Economics & Managment - UMR 9221 ( email )

Lille
France

Catholic University of Lille - IESEG School of Management ( email )

Socle de la Grande Arche
1 Parvis de la Defense
Puteaux, Paris 92800
France

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
114
Abstract Views
1,131
rank
305,893
PlumX Metrics