ICES Experimental Economics Brown Bag Lecture
Certain Reversals
Friday, November 22, 2024 4:00 PM to 5:00 PM EST
Vernon Smith Hall (formerly Metropolitan Building), Room 5075
The Interdisciplinary Center for Economic Science (ICES) presents an ICES Brown Bag Lecture featuring:
Texas A&M University
Abstract
Under the expected utility paradigm, two behavioral anomalies stand out. First, individuals tolerate risk when the odds are unfavorable but become more averse to risk as the odds approach certainty. Second, individuals exhibit context-dependent reversals in their attitudes towards risk. Understanding how these anomalies interact is critical for adjudicating among competing behavioral theories, but most empirical research examines them in isolation. To address this gap, we conduct a lab-in-the-field experiment with high stakes and expert subjects. We find that reversals persist at higher stakes and among experts and the reversals are affected by the likelihood of a better outcome. In other words, the proximity of a better outcome to certainty affects the direction of preference reversals. Although leading theories from economics and psychology cannot explain these patterns, they can be explained by a model that combines stochastic reference dependence from economics and context-dependent sensitivity from psychology. This new model demonstrates how the interaction of endowment effects and context-dependent sensitivity may be a mechanism behind some of the perplexing inconsistencies in people’s choices, including the so-called overweighting of low probability events.
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