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Using Preferred Outcome Distributions to Estimate Value and Probability Weighting Functions in Decisions under Risk

Tinbergen Institute Discussion Paper 13-065/VII

34 Pages Posted: 9 May 2013  

Bas Donkers

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE); Erasmus Research Institute of Management (ERIM); Tinbergen Institute

Carlos J. S. Lourenço

University of South Carolina - Darla Moore School of Business; Netspar - Network for Research on Pensions, Aging, and Retirement; ISCTE - IUL Business Research Unit

Benedict G. C. Dellaert

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE); Erasmus Research Institute of Management (ERIM)

Daniel G. Goldstein

Microsoft Research New York City; London Business School

Multiple version iconThere are 3 versions of this paper

Date Written: May 7, 2013

Abstract

In this paper we propose the use of preferred outcome distributions as a new method to elicit individuals' value and probability weighting functions in decisions under risk. Extant approaches for the elicitation of these two key ingredients of individuals' risk attitude typically rely on a long, chained sequence of lottery choices. In contrast, preferred outcome distributions can be elicited through an intuitive graphical interface, and, as we show, the information contained in two preferred outcome distributions is sufficient to identify non-parametrically both the value function and the probability weighting function in rank-dependent utility models. To illustrate our method and its advantages, we run an incentive-compatible lab study in which participants use a simple graphical interface - the Distribution Builder (Goldstein et al. 2008) - to construct their preferred outcome distributions, subject to a budget constraint. Results show that estimates of the value function are in line with previous research but that probability weighting biases are diminished, thus favoring our proposed approach based on preferred outcome distributions.

Keywords: Decision making, risk preference, distribution builder, rank dependent utility, preference elicitation, micro economics

JEL Classification: G02, D81, D83, M39

Suggested Citation

Donkers, Bas and Lourenço, Carlos J. S. and Dellaert, Benedict G. C. and Goldstein, Daniel G., Using Preferred Outcome Distributions to Estimate Value and Probability Weighting Functions in Decisions under Risk (May 7, 2013). Tinbergen Institute Discussion Paper 13-065/VII. Available at SSRN: https://ssrn.com/abstract=2262344 or http://dx.doi.org/10.2139/ssrn.2262344

Bas Donkers (Contact Author)

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
Rotterdam, NL 3000 DR
Netherlands
+31 10 408 2411 (Phone)
+31 10 408 9169 (Fax)

HOME PAGE: http://people.few.eur.nl/donkers/

Erasmus Research Institute of Management (ERIM) ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands
+31 10 408 2411 (Phone)
+31 10 408 9169 (Fax)

HOME PAGE: http://people.few.eur.nl/donkers/

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Carlos J. S. Lourenço

University of South Carolina - Darla Moore School of Business ( email )

Columbia, SC
United States

Netspar - Network for Research on Pensions, Aging, and Retirement ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

ISCTE - IUL Business Research Unit ( email )

Complexo INDEG/ISCTE
Av. Prof. Anibal Bettencourt
1600-189 Lisboa, 1649-026
Portugal

Benedict G. C. Dellaert

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

Erasmus Research Institute of Management (ERIM) ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Daniel G. Goldstein

Microsoft Research New York City ( email )

641 Avenue of Americas
New York, NY 10011
United States

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
+44 0 20 7000 8611 (Phone)
+44 0 20 7000 8601 (Fax)

HOME PAGE: http://www.dangoldstein.com

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