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An experimental methodology testing for prudence and third-order preferences

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  • Ebert, Sebastian
  • Wiesen, Daniel

Abstract

We propose an experimental method to test individuals for prudence (i.e. downside risk aversion) outside the expected utility framework. Our method relies on a novel representation of compound lotteries which allows for a systematic parameterization that captures the full generality of prudence. Therefore, we develop a general technique for lottery calibration in experiments. Since we investigate a very subtle third-order property we test our method in the laboratory employing a factorial design. We find that it yields robust results and that prudence is observed on the aggregate as well as on the individual level. Further we show that preferences based on statistical moments, in particular skewness seeking, can at most approximately explain individuals' behavior in the experiment.

Suggested Citation

  • Ebert, Sebastian & Wiesen, Daniel, 2009. "An experimental methodology testing for prudence and third-order preferences," Bonn Econ Discussion Papers 21/2009, University of Bonn, Bonn Graduate School of Economics (BGSE).
    • Handle: RePEc:zbw:bonedp:212009
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    References listed on IDEAS

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    Cited by:

    1. Luís Santos-Pinto & Adrian Bruhin & José Mata & Thomas Åstebro, 2015. "Detecting heterogeneous risk attitudes with mixed gambles," Theory and Decision, Springer, vol. 79(4), pages 573-600, December.
    2. Jakusch, Sven Thorsten, 2017. "On the applicability of maximum likelihood methods: From experimental to financial data," SAFE Working Paper Series 148, Leibniz Institute for Financial Research SAFE, revised 2017.
    3. Charles N. Noussair & Stefan T. Trautmann & Gijs van de Kuilen, 2014. "Higher Order Risk Attitudes, Demographics, and Financial Decisions," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 81(1), pages 325-355.
    4. D. A. Peel, 2012. "Further examples of the impact of skewness on the expected utility of a risk-averse agent," Applied Economics Letters, Taylor & Francis Journals, vol. 19(12), pages 1117-1121, August.

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    More about this item

    Keywords

    Decision making under uncertainty; risk preferences; prudence; downside risk; statistical moments; laboratory experiment;
    All these keywords.

    JEL classification:

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

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