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Global Shapes of Preference Scaling Functions

Author

Listed:
  • Kavitha Ranganathan

    (Kavitha Ranganathan, School for Securities Information and Research (SSIR), National Institute of Securities Markets (NISM), NISM Bhavan, Plot No. 82, Sector 17, Vashi, Navi Mumbai - 400 703. E-mail: kavitha.ranganathan@nism.ac.in)

  • Srinivas Prakhya

    (Srinivas Prakhya, Associate Professor, Marketing, Indian Institute of Management, Bangalore (IIMB), Bannerghatta Road, Bangalore - 560 076 Phone Number: +91-80-26993186, Fax Number: +91-80-26584050 E-mail: sprakhya@iimb.ernet.in)

Abstract

In the expected utility framework, concavity (or convexity) of the preference scaling function corresponds to risk-aversion (or risk-seeking) preferences. Friedman and Savage ( 1948 ) and Markowitz ( 1952 ) indicate that individuals may be risk-averse at some wealth levels but risk-seeking at others. Prospect theory ( Kahneman & Tversky, 1979 ) proposes an S-shaped utility function exhibiting risk-aversion in the domain of gain and risk-seeking in the loss domain. In this study, we use lottery experiments to infer global shapes of the preference scaling functions that determine risk attitudes in interaction with uncertainty. The global shapes that emerge are—fully concave, fully convex, linear, Reverse-S and S-shaped preference scaling functions. Using annual income as a proxy for wealth, we examine the relationship between global shapes and wealth. The data largely supports the Friedman–Savage hypothesis; we find that at low levels of wealth people are concave, followed by Reverse-S and then a second upper concave segment at higher levels of wealth. JEL: C91, D81

Suggested Citation

  • Kavitha Ranganathan & Srinivas Prakhya, 2012. "Global Shapes of Preference Scaling Functions," Journal of Interdisciplinary Economics, , vol. 24(2), pages 145-172, June.
    • Handle: RePEc:sae:jinter:v:24:y:2012:i:2:p:145-172
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    Cited by:

    1. Kavitha Ranganathan, 2018. "Does Global Shapes Of Utility Functions Matter For Investment Decisions?," Bulletin of Economic Research, Wiley Blackwell, vol. 70(4), pages 341-361, October.

    More about this item

    Keywords

    Experiments; decision making under risk and uncertainty; risk attitudes; individual behaviour;
    All these keywords.

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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