Salience and Skewness Preferences

54 Pages Posted: 21 Feb 2019

See all articles by Markus Dertwinkel-Kalt

Markus Dertwinkel-Kalt

University of Cologne

Mats Koester

Heinrich Heine University Dusseldorf - Duesseldorf Institute for Competition Economics (DICE)

Date Written: 2018

Abstract

Whether people seek or avoid risks on gambling, insurance, asset, or labor markets crucially depends on the skewness of the underlying probability distribution. In fact, people typically seek positively skewed risks and avoid negatively skewed risks. We show that salience theory of choice under risk can explain this preference for positive skewness, because unlikely, but outstanding payoffs attract attention. In contrast to alternative models, however, salience theory predicts that choices under risk not only depend on the absolute skewness of the available options, but also on how skewed these options appear to be relative to each other. We exploit this fact to derive novel, experimentally testable predictions that are unique to the salience model and that we find support for in two laboratory experiments. We thereby argue that skewness preferences—typically attributed to cumulative prospect theory—are more naturally accommodated by salience theory.

Keywords: salience theory, cumulative prospect theory, skewness preferences

JEL Classification: D810

Suggested Citation

Dertwinkel-Kalt, Markus and Koester, Mats, Salience and Skewness Preferences (2018). CESifo Working Paper No. 7416. Available at SSRN: https://ssrn.com/abstract=3338770

Markus Dertwinkel-Kalt (Contact Author)

University of Cologne ( email )

Albertus-Magnus-Platz
Cologne, 50923
Germany

Mats Koester

Heinrich Heine University Dusseldorf - Duesseldorf Institute for Competition Economics (DICE) ( email )

Universitaetsstr. 1
Duesseldorf, NRW 40225
Germany

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