An Experimental Study of Attitude towards Compound Lottery

Abstract

This paper examines systematically the attitude towards compound lottery by introducing three variants of symmetric uniform mean-preserving spread into stage-1 risk in a choice-based experimental setting. We do not observe consistent aversion to mean-preserving spread in the stage-1 risk. More importantly, the observed behavioral patterns reject a number of axioms including reduction of compound lotteries, time neutrality, and stage-1 betweenness (independence), which sheds light on related recursive utility models. The overall data support two-stage rank-dependent utility with distinct convex probability weighting functions in two stages.

Keywords: compound lottery, second order risk, non-expected utility

JEL Classification: C91, D81