Econometrica: Jul 2010, Volume 78, Issue 4

Risk and Rationality: Uncovering Heterogeneity in Probability Distortion

https://doi.org/10.3982/ECTA7139
p. 1375-1412

Adrian Bruhin, Helga Fehr‐Duda, Thomas Epper

It has long been recognized that there is considerable heterogeneity in individual risk taking behavior, but little is known about the distribution of risk taking types. We present a parsimonious characterization of risk taking behavior by estimating a finite mixture model for three different experimental data sets, two Swiss and one Chinese, over a large number of real gains and losses. We find two major types of individuals: In all three data sets, the choices of roughly 80% of the subjects exhibit significant deviations from linear probability weighting of varying strength, consistent with prospect theory. Twenty percent of the subjects weight probabilities near linearly and behave essentially as expected value maximizers. Moreover, individuals are cleanly assigned to one type with probabilities close to unity. The reliability and robustness of our classification suggest using a mix of preference theories in applied economic modeling.

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Supplement to "Risk and Rationality: Uncovering Heterogeneity in Probability Distortion"

PDF file containing the estimation of the finite mixture model and additional tables containing data.

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Supplement to "Risk and Rationality: Uncovering Heterogeneity in Probability Distortion"

A zip file containing replication files for the manuscript.

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