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Measuring Price Risk Aversion through Indirect Utility Functions: A Laboratory Experiment

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  • Ali Zeytoon-Nejad

    (School of Business, Wake Forest University, Winston-Salem, NC 27109, USA)

Abstract

The present paper introduces a theoretical framework through which the degree of risk aversion with respect uncertain prices can be measured through the context of the indirect utility function (IUF) using a lab experiment. First, the paper introduces the main elements of the duality theory (DT) in economics. Next, it proposes the context of IUFs as a suitable framework for measuring price risk aversion through varying prices as opposed to varying payoffs, which has been common practice in the mainstream of experimental economics. Indeed, the DT in modern microeconomics indicates that the direct utility function (DUF) and the IUF are dual to each other, implicitly suggesting that the degree of risk aversion (or risk seeking) that a given rational subject exhibits in the context of the DUF must be equivalent to the degree of risk aversion (or risk seeking) elicited through the context of the IUF. This paper tests the accuracy of this theoretical prediction through a lab experiment using a series of relevant statistical tests. This study uses the multiple price list (MPL) method, which has been one of the most popular sets of elicitation procedures in experimental economics to study risk preferences in the experimental laboratory using non-interactive settings. The key findings of this study indicate that price risk aversion (PrRA) is statistically significantly greater than payoff risk aversion (PaRA). Additionally, it is shown that the risk preferences elicited under the expected utility theory (EUT) are somewhat subject to context. Other findings imply that the risk premium (RP), as a measure of willingness to pay for insuring an uncertain situation, is statistically significantly greater for stochastic prices compared to that for stochastic payoffs. These results are robust across different MPL designs and various statistical tests that are utilized.

Suggested Citation

  • Ali Zeytoon-Nejad, 2022. "Measuring Price Risk Aversion through Indirect Utility Functions: A Laboratory Experiment," Games, MDPI, vol. 13(4), pages 1-43, August.
    • Handle: RePEc:gam:jgames:v:13:y:2022:i:4:p:56-:d:889806
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    References listed on IDEAS

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    1. Hans P. Binswanger, 1980. "Attitudes Toward Risk: Experimental Measurement in Rural India," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 62(3), pages 395-407.
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    5. Chambers,Robert G., 1988. "Applied Production Analysis," Cambridge Books, Cambridge University Press, number 9780521314275, January.
    6. Zeytoon Nejad Moosavian, Seyyed Ali & Hammond, Robert & Goodwin, Barry K., 2018. "Measuring Risk Aversion Using Indirect Utility Functions: A Laboratory Experiment," 2018 Annual Meeting, August 5-7, Washington, D.C. 274033, Agricultural and Applied Economics Association.
    7. Kachelmeier, Steven J & Shehata, Mohamed, 1992. "Examining Risk Preferences under High Monetary Incentives: Experimental Evidence from the People's Republic of China," American Economic Review, American Economic Association, vol. 82(5), pages 1120-1141, December.
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