Risk aversion over price variability: experimental evidence

ABSTRACT

Eliciting risk attitudes is of crucial importance in economics. We test whether the degree of risk aversion that an individual exhibits in the context of the direct utility function is equivalent to that elicited in the context of the indirect utility function, as implied by duality theory. Our lab experiment uses payoff-based lottery choices (which are based on the direct utility function) and equivalent price-based lottery choices (which are based on the indirect utility function). We reject the equivalence of risk preferences from these two contexts. Subjects are more sensitive to price uncertainty than to equivalent payoff uncertainty.

KEYWORDS:

• Risk aversion
• laboratory experiment
• direct utility function
• experimental elicitations
• duality

JEL CLASSIFICATION:

• C91
• C90
• D91
• G41

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ The design that we refer to as Holt and Laury (2002) predates their paper, but the reference to their work reflects common practice in the related literature. Cohen, Jaffray, and Said (1987) is a specific early example of this design.

² There is evidence that the elicited degree of risk aversion is not very sensitive to the CRRA assumption (e.g. Zhou and Hey 2017; Heinemann 2008).

³ While the CE design is commonly used, we are not aware of its origins, probably because it has been thought of as a specific implementation of Holt and Laury (2002).

⁴ What we call the BW design is sometimes referred to as the Eckel and Grossman (2002) design.

⁵ Cox and Sadiraj (2008) present a detailed discussion of the importance of within-subjects designs to test questions such as ours on the empirical equivalence of risk preferences in alternative contexts.

⁶ This is done elsewhere, for example Andersen et al. (2006).

⁷ There is evidence elsewhere that elicited risk preferences can be highly variable for a given subject; see Loomes and Pogrebna (2014) or the survey of Charness, Gneezy, and Imas (2013).