Stochastic dominance and absolute risk aversion

In this paper we propose the infimum of the Arrow-Pratt index of absolute risk aversion as a measure of global risk aversion of a utility function. We then show that, for any given arbitrary pair of distributions, there exists a threshold level of global risk aversion such that all increasing concave utility functions with at least as much global risk aversion would rank the two distributions in the same way. Furthermore, this threshold level is sharp in the sense that, for any lower level of global risk aversion, we can find two utility functions in this class yielding opposite preference relations for the two distributions.

Optimal feedback control rules sensitive to controlled endogenous risk-aversion

The objective of this paper is to correct and improve the results obtained by Van der Ploeg (1984a, 1984b) and utilized in the theoretical literature related to feedback stochastic optimal control sensitive to constant exogenous risk-aversion (see, Jacobson, 1973, Karp, 1987 and Whittle, 1981, 1989, 1990, among others) or to the classic context of risk-neutral decision-makers (see, Chow, 1973, 1976a, 1976b, 1977, 1978, 1981, 1993). More realistic and attractive, this new approach is placed in the context of a time-varying endogenous risk-aversion which is under the control of the decision-maker. It has strong qualitative implications on the agent's optimal policy during the entire planning horizon.

Preference intensities and risk aversion in school choice: a laboratory experiment

We experimentally investigate in the laboratory two prominent mechanisms that are employed in school choice programs to assign students to public schools. We study how individual behavior is influenced by preference intensities and risk aversion. Our main results show that (a) the Gale-Shapley mechanism is more robust to changes in cardinal preferences than the Boston mechanism independently of whether individuals can submit a complete or only a restricted ranking of the schools and (b) subjects with a higher degree of risk aversion are more likely to play "safer" strategies under the Gale-Shapley but not under the Boston mechanism. Both results have important implications for the efficiency and the stability of the mechanisms.

Stochastic dominance and absolute risk aversion

In this paper we proose the infimum of the Arrow-Pratt index of absoluterisk aversion as a measure of global risk aversion of a utility function.We then show that, for any given arbitrary pair of distributions, thereexists a threshold level of global risk aversion such that all increasingconcave utility functions with at least as much global risk aversion wouldrank the two distributions in the same way. Furthermore, this thresholdlevel is sharp in the sense that, for any lower level of global riskaversion, we can find two utility functions in this class yielding oppositepreference relations for the two distributions.

Does risk aversion or attraction depend on income? An experiment

Does risk attitude (aversion or attraction) vary with the level of the income at risk? About half of our subjects chose to insure all levels, whereas another half chose instead not to insure low levels, but to insure high levels.

Measuring risk aversion with lists: A new bias

Various experimental procedures aimed at measuring individual risk aversion involve alist of pairs of alternative prospects. We first study the widely used method by Holt andLaury (2002), for which we find that the removal of some items from the lists yields asystematic decrease in risk aversion. This bias is quite distinct from other confoundsthat have been previously observed in the use of the Holt and Laury method. It may berelated to empirical phenomena and theoretical developments where better prospectsincrease risk aversion. Nevertheless, we have also found that the more recent elicitationmethod due to Abdellaoui et al. (2011), also based on lists, does not display anystatistically significant bias when the corresponding items of the list are removed. Ourresults suggest that methods other than the popular Holt and Laury one may bepreferable for the measurement of risk aversion.

Risk aversion and embedding bias

In Selten (1967) ?Strategy Method,? the second mover in the game submits a complete strategy. This basic idea has been exported to nonstrategic experiments, where a participant reports a complete list of contingent decisions, one for each situation or state in a given sequence, out of which one and only one state, randomly selected, will be implemented.In general, the method raises the following concern. If S0 and S1 are two differentsequences of states, and state s is in both S0 and S1, would the participant make the same decision in state s when confronted with S0 as when confronted with S1? If not, the experimental results are suspect of suffering from an ?embedding bias.?We check for embedding biases in elicitation methods of Charles Holt and Susan Laury(Laury and Holt, 2000, and Holt and Laury, 2002), and of the present authors (Bosch-Dom?nech and Silvestre, 1999, 2002, 2006a, b) by appropriately chosen replications of the original experiments. We find no evidence of embedding bias in our work. But in Holt and Laury?s method participants tend to switch earlier to the riskier option when later pairs of lotteries are eliminated from the sequence, suggesting the presence of some embedding bias.

Improving the risk concept: a revision of Arrow-Pratt theory in the context of controlled dynamic stochastic environments

In the literature on risk, one generally assume that uncertainty is uniformly distributed over the entire working horizon, when the absolute risk-aversion index is negative and constant. From this perspective, the risk is totally exogenous, and thus independent of endogenous risks. The classic procedure is "myopic" with regard to potential changes in the future behavior of the agent due to inherent random fluctuations of the system. The agent's attitude to risk is rigid. Although often criticized, the most widely used hypothesis for the analysis of economic behavior is risk-neutrality. This borderline case must be envisaged with prudence in a dynamic stochastic context. The traditional measures of risk-aversion are generally too weak for making comparisons between risky situations, given the dynamic �complexity of the environment. This can be highlighted in concrete problems in finance and insurance, context for which the Arrow-Pratt measures (in the small) give ambiguous.

Do the Wealthy Risk More Money? An Experimental Comparison

Are poor people more or less likely to take money risks than wealthy folks? We find that risk attraction is more prevalent among the wealthy when the amounts of money at risk are small (not surprising, since ten dollars is a smaller amount for a wealthy person than for a poor one), but, interestingly, for the larger amounts of money at risk the fraction of the nonwealthy displaying risk attraction exceeds that of the wealthy. We also replicate our previous finding that many people display risk attraction for small money amounts, but risk aversion for large ones. We argue that preferences yielding risk attraction for small money amounts, together with risk aversion for larger amounts, at all levels of wealth, while contradicting the expected utility hypothesis, may be well-defined, independently of reference points, on the choice space.

Do the eealthy risk more money? An experimental comparison

Are poor people more or less likely to take money risks than wealthy folks?We find that risk attraction is more prevalent among the wealthy when theamounts of money at risk are small (not surprising, since ten dollars is asmaller amount for a wealthy person than for a poor one), but, interestingly,for the larger amounts of money at risk the fraction of the nonwealthydisplaying risk attraction exceeds that of the wealthy.We also replicate our previous finding that many people display riskattraction for small money amounts, but risk aversion for large ones. Weargue that preferences yielding risk attraction for small money amounts,together with risk aversion for larger amounts, at all levels of wealth, while contradicting the expected utility hypothesis, may be well-defined,independently of reference points, on the choice space.

Averting risk in the face of large losses: Bernoulli vs. Tversky and Kahneman

We experimentally question the assertion of Prospect Theory that people display risk attraction in choices involving high-probability losses. Indeed, our experimental participants tend to avoid fair risks for large (up to ? 90), high-probability (80%) losses. Our research hinges on a novel experimental method designed to alleviate the house-money bias that pervades experiments with real (not hypothetical) loses.Our results vindicate Daniel Bernoulli?s view that risk aversion is the dominant attitude,But, contrary to the Bernoulli-inspired canonical expected utility theory, we do find frequent risk attraction for small amounts of money at stake.In any event, we attempt neither to test expected utility versus nonexpected utility theories, nor to contribute to the important literature that estimates value and weighting functions. The question that we ask is more basic, namely: do people display risk aversion when facing large losses, or large gains? And, at the risk of oversimplifying, our answer is yes.

Single period Markowitz portfolio selection, performance gauging and duality: a variation on Luenberger's shortage function

Markowitz portfolio theory (1952) has induced research into the efficiency of portfolio management. This paper studies existing nonparametric efficiency measurement approaches for single period portfolio selection from a theoretical perspective and generalises currently used efficiency measures into the full mean-variance space. Therefore, we introduce the efficiency improvement possibility function (a variation on the shortage function), study its axiomatic properties in the context of Markowitz efficient frontier, and establish a link to the indirect mean-variance utility function. This framework allows distinguishing between portfolio efficiency and allocative efficiency. Furthermore, it permits retrieving information about the revealed risk aversion of investors. The efficiency improvement possibility function thus provides a more general framework for gauging the efficiency of portfolio management using nonparametric frontier envelopment methods based on quadratic optimisation.

Structural inferences from first-price auction experiments

We use structural methods to assess equilibrium models of bidding with data from first-price auction experiments. We identify conditions to test the Nash equilibrium models for homogenous and for heterogeneous constant relative risk aversion when bidders private valuations are independent and uniformly drawn. The outcomes of our study indicate that behavior may have been affected by the procedure used to conduct the experiments and that the usual Nash equilibrium model for heterogeneous constant relative risk averse bidders does not consistently explain the observed overbidding. From an empirical standpoint, our analysis shows the possible drawbacks of overlooking the homogeneity hypothesis when testing symmetric equilibrium models of bidding and it puts in perspective the sensitivity of structural inferences to the available information.

Stock market volatility and learning

Introducing bounded rationality in a standard consumption-based asset pricing model with time separable preferences strongly improves empirical performance. Learning causes momentum and mean reversion of returns and thereby excess volatility, persistence of price-dividend ratios, long-horizon return predictability and a risk premium, as in the habit model of Campbell and Cochrane (1999), but for lower risk aversion. This is obtained, even though our learning scheme introduces just one free parameter and we only consider learning schemes that imply small deviations from full rationality. The findings are robust to the learning rule used and other model features. What is key is that agents forecast future stock prices using past information on prices.

Cognition, Resources, and Institutions in the Explanation of Attitudes to Free Trade

This article proposes a framework for the analysis of attitudes to foreign trade policies that challenges the traditional skill-endowment approach. The traditional approach assumes informed individuals who calculate the costs and benefits of alternative policies. We propose that individuals lack information and that their positions rest on economic vulnerability, as mediated through risk-aversion. We also stress the role of environmental signals and political endorsements in guiding individuals' views on trade policy. We test this alternative approach with a Spanish survey conducted in May 2009 and the ISSP survey conducted in 2003 in a large number of less developed and more developed countries. The Spanish data show that the population is largely uninformed and that their ideas about the consequences of free trade policy do not explain attitudes among different socio-demographic groups. Meanwhile, the ISSP data contradict important aspects of the traditional approach and are consistent with the alternative approach.