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Consistency of Higher Order Risk Preferences

41 Pages Posted: 14 Jan 2013  

Cary A. Deck

University of Arkansas - Department of Economics

Harris Schlesinger

University of Alabama; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: October 2012

Abstract

Risk aversion (a 2nd order risk preference) is a time-proven concept in economic models of choice under risk. More recently, the higher order risk preferences of prudence (3rd order) and temperance (4th order) also have been shown to be quite important. While a majority of the population seems to exhibit both risk aversion and such higher-order risk preferences, a significant minority does not. Rather than simply dismissing this behavior, we show how both risk-loving as well as risk-averse behaviors might be generated by a simple type of basic lottery preference for either (1) combining “good” outcomes with “bad” ones, or (2) combining “good with good” and “bad with bad.” We further show that this dichotomy is fairly robust at explaining higher order risk attitudes in the laboratory. In addition to our own experimental evidence, we take a second look at the extant laboratory experiments that measure higher order risk preferences and we find a fair amount of support for this dichotomy. Our own experiment is the first to look beyond 4th order risk preferences and we examine risk attitudes at even higher levels. The consistency of these results with expected utility theory and with a few non-expected utility theories is also examined.

Keywords: risk apportionment, mixed risk aversion, mixed risk loving, prudence, temperance, edginess, laboratory experiments, moment preference, prospect theory

JEL Classification: C900, D800

Suggested Citation

Deck, Cary A. and Schlesinger, Harris, Consistency of Higher Order Risk Preferences (October 2012). CESifo Working Paper Series No. 4047. Available at SSRN: https://ssrn.com/abstract=2198787

Cary A. Deck

University of Arkansas - Department of Economics ( email )

Fayetteville, AR 72701
United States
479-575-6226 (Phone)
479-575-3241 (Fax)

Harris Schlesinger (Contact Author)

University of Alabama ( email )

P.O. Box 870244
200 Alston Hall, Box 870224
Tuscaloosa, AL 35487
United States
205-348-7858 (Phone)
205-348-0590 (Fax)

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

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