How politicians make decisions under risk: a political choice experiment

We report on an experimental study with real-world politicians. These political experts face political choice problems under risk and probability. Thus, we test the frequently observed violations of rational choice theory -the reference point effect, loss aversion, framing effects, and the common ratio effect- with experts from the field. Their choices violate expected utility theory. Nevertheless, they appear to be more rational and less risk averse (loving) in the domain of gains (losses) than student subjects.Subject-pool effect; experts; expected utility; prospect theory.

Recursive Utility with Narrow Framing: Properties and Applications

We study the total utility of an agent in a model of narrow framing with constant elasticity of intertemporal substitution and relative risk aversion degree and with infinite time horizon. In a finite-state Markovian setting, we prove that the total utility uniquely exists when the agent derives nonnegative utility of gains and losses incurred by holding risky assets and that the total utility can be non-existent or non-unique otherwise. Moreover, we prove that the utility, when uniquely exists, can be computed by a recursive algorithm with any starting point. We then consider a portfolio selection problem with narrow framing and solve it by proving that the corresponding dynamic programming equation has a unique solution. Finally, we propose a new model of narrow framing in which the agent's total utility uniquely exists in general. Barberis and Huang (2009, J. Econ. Dynam. Control, vol. 33, no. 8, pp. 1555-1576) propose a preference model that allows for narrow framing, and this model has been successfully applied to explain individuals' attitudes toward timeless gambles and high equity premia in the market. To uniquely define the utility process in this preference model and to yield a unique solution when the model is applied to portfolio selection problems, one needs to impose some restrictions on the model parameters, which are too tight for many financial applications. We propose a modification of Barberis and Huang's model and show that the modified model admits a unique utility process and a unique solution in portfolio selection problems. Moreover, the modified model is more tractable than Barberis and Huang's when applied to portfolio selection and asset pricing

Risk aversion and the long run

This article argues that Lara Buchak’s risk-weighted expected utility (REU) theory fails to offer a true alternative to expected utility theory. Under commonly held assumptions about dynamic choice and the framing of decision problems, rational agents are guided by their attitudes to temporally extended courses of action. If so, REU theory makes approximately the same recommendations as expected utility theory. Being more permissive about dynamic choice or framing, however, undermines the theory’s claim to capturing a steady choice disposition in the face of risk. I argue that this poses a challenge to alternatives to expected utility theory more generally

Prospect Theory: Test on Framing and Loss Aversion Effects on Investors Decision-Making Process At the Nairobi Securities Exchange, Kenya

Twenty years of experimental and empirical research has demonstrated that markets are not as efficient as perceived to be. Investors are not rational and risk preferences are stochastic. In addition to this, prospect theory criticized the standard expected utility hypothesis used to describe utility and investor performance preferences. Kahneman and Tversky in 1979 proposed a new framework to model the utility and risk preferences of investors. This study examined investment scenarios with individual investors indicating that the process of making investment decisions is based on the behavioral economics theory which uses the fundamental aspects of the prospect theory developed by Kahneman and Tversky. The study tested two items: firstly framing which modifies the investment decision depending on the perspective given to the problem and secondly loss aversion which refers to a scenario where greater utility is lost when losing x amount of money than the utility that is gained when obtaining the exact same amount. The study concluded that framing effects influenced the decisions made by individual investors and individual investors had their investment decisions affected by loss aversion. Key words: Investment decisions, prospect theory, framing effects, loss aversion, Nairobi Securities Exchange, Keny

Framing-Based Choice: A Model of Decision-Making Under Risk

In this study we propose an axiomatic theory of decision-making under risk that is based on a new approach to the modeling of framing that focuses on the subjective statistical dependence between prizes of compared lotteries. Unlike existing models that allow objective statistical dependence, as in Regret Theory, in our model the emphasis is on alternative subjective statistical dependence patterns that are induced by alternative descriptions of the lotteries, i.e., by alternative framing. A distinct advantage of the proposed general descriptive model of choice is its ability to adequately explain a wide variety of behaviors and, in particular, several well-known paradoxes of different types.framing, statistical dependence, non-expected utility, expected value of lottery interchange

Rationality on the Rise: Why Relative Risk Aversion Increases with Stake Size

How does risk tolerance vary with stake size? This important question cannot be adequately answered if framing effects, nonlinear probability weighting, and heterogeneity of preference types are neglected. We show that, contrary to gains, no coherent change in relative risk aversion is observed for losses. The increase in relative risk aversion over gains cannot be captured by the curvature of the utility function. It is driven predominantly by a change in probability weighting of a majority group of individuals who exhibit more rational probability weighting at high stakes. These results not only challenge expected utility theory, but also prospect theory.Risk Aversion, Stake-Size Effect, Prospect Theory, Latent Heterogeneity

Walking the Talk in Multiparty Bargaining: An Experimental Investigation

We study the framing effects of communication in multiparty bargaining. Communication has been shown to be more truthful and revealing than predicted in equilibrium. Because talk is preference-revealing, it may effectively frame bargaining around a logic of fairness or competition, moving parties on a path toward or away from equal-division agreements. These endogenous framing effects may outweigh any overall social utility effects due to the mere presence of communication. In two experiments, we find that non-binding talk of fairness within a three-party, complete-information game leads toward off-equilibrium, equal division payoffs, while non-binding talk focusing on competitive reasoning moves parties away from equal divisions. Our two studies allow us to demonstrate that spontaneous within-game dialogue and manipulated pre-game talk lead to the same results.communication, fairness, bargaining

Preferences for One-Shot Resolution of Uncertainty and Allais-Type Behavior, Second Version

Experimental evidence suggests that individuals are more risk averse when they perceive risk that is gradually resolved over time. We address these findings by studying a decision maker (DM) who has recursive, non-expected utility preferences over compound lotteries. DM has preferences for one-shot resolution of uncertainty (PORU) if he always prefers any compound lottery to be resolved in a single stage. We establish an equivalence between dynamic PORU and static preferences that are identified with commonly observed behavior in Allais-type experiments. The implications of this equivalence on preferences over information systems are examined. We define the gradual resolution premium and demonstrate its magnifying effect when combined with the usual risk premium. In an intertemporal context, PORU captures “loss aversion with narrow framing.”Recursive preferences over compound lotteries, resolution of uncertainty, Allais paradox, narrow framing, negative certainty independence