On the Coefficient of Variation as a Predictor of Risk Sensitivity: Behavioral and Neural Evidence for the Relative Encoding of Outcome Variability

Abstract

Cox and Vjollca (2010) argue that the coefficient of variation (CV) fails as a normative criterion for risk taking in risky choice because it predicts violations of dominance. They suggest that it fails also on descriptive grounds because such violations are not observed in a study they conducted and because people’s choices in two other situations were not predicted by the CV. This paper counters the normative argument by suggesting that occasional violations of dominance might be the price that organisms with only limited processing capacity pay to achieve a broad set of goals. The consistency axioms of rational choice theory have a long history of falling short of accounting for such tradeoffs. The paper then addresses the three instances of descriptive failures of the CV to predict risk taking provided by Cox and Sadiraj, showing them to be inappropriate or inconclusive arguments against the use of the CV as a measure of risk in risk-return models of human and animal risk taking. Finally, the paper reviews new behavioral and neuroscience evidence in support of the CV as a predictor of risk taking, especially in decisions from experience, for which the model was developed.

Keywords: Coefficient of variation, Risk-return models, Risky choice, Axiomatic measurement