Decisions Under Risk Dispersion and Skewness

42 Pages Posted: 13 Feb 2018 Last revised: 13 Sep 2019

See all articles by Oben Bayrak

Oben Bayrak

Swedish University of Agricultural Sciences (SLU) - Centre for Environmental and Resource Economics (CERE), Students ; Centre for Environmental and Resource Economics

John D. Hey

University of York (UK); Università degli Studi di Bari “Aldo Moro” (UNIBA) - Faculty of Economics

Date Written: September 12, 2019

Abstract

When people take decisions under risk, it is not only the expected utility that is important, but also the shape of the distribution of utility: clearly the dispersion is important, but also the skewness. For given mean and dispersion, decision-makers treat positively and negatively skewed prospects differently. This paper presents a new behaviourally-inspired model for decision making under risk, incorporating both dispersion and skewness. We run a horse-race of this new model against six other models of decision-making under risk and show that it outperforms many in terms of goodness of fit and shows a reasonable performance in predictive ability. It can incorporate the prominent anomalies of standard theory such as the Allais paradox, the valuation gap, and preference reversals, and also the behavioural patterns observed in experiments that cannot be explained by Rank Dependent Utility Theory.

Keywords: Decision under Risk, Anomalies, Valuation Gap, Preference Reversals, Allais Paradox, Skewness, Dispersion, Preference Functionals, Experiments, Pairwise Choice, Expected Utility, Non‐Expected Utility, Stochastic Specifications

JEL Classification: D81

Suggested Citation

Bayrak, Oben and Hey, John D., Decisions Under Risk Dispersion and Skewness (September 12, 2019). Available at SSRN: https://ssrn.com/abstract=3120922 or http://dx.doi.org/10.2139/ssrn.3120922

Oben Bayrak (Contact Author)

Swedish University of Agricultural Sciences (SLU) - Centre for Environmental and Resource Economics (CERE), Students ( email )

Umeå
Sweden

HOME PAGE: http://https://sites.google.com/view/obenbayrak

Centre for Environmental and Resource Economics ( email )

Umeå University
Umeå, S-901 87
Sweden

HOME PAGE: http://https://sites.google.com/view/obenbayrak

John D. Hey

University of York (UK) ( email )

Heslington
York YO10 5DD
United Kingdom
44 904 433575 (Phone)
44 904 433575 (Fax)

Università degli Studi di Bari “Aldo Moro” (UNIBA) - Faculty of Economics

Piazza Cesare Battisti 1
Bari, Taranto 70121
Italy

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