Consistency Of Higher Order Risk Preferences
Risk aversion (a second-order risk preference) is a time-proven concept in economic models of choice under risk. More recently, the higher order risk preferences of prudence (third-order) and temperance (fourth-order) also have been shown to be quite important. While a majority of the population seems to exhibit both risk aversion and these higher order risk preferences, a significant minority does not. We show how both risk-averse and risk-loving behaviors might be generated by a simple type of basic lottery preference for either (1) combining “good” outcomes with “bad” ones, or (2) combining “good with good” and “bad with bad,” respectively. We further show that this dichotomy is fairly robust at explaining higher order risk attitudes in the laboratory. In addition to our own experimental evidence, we take a second look at the extant laboratory experiments that measure higher order risk preferences and we find a fair amount of support for this dichotomy. Our own experiment also is the first to look beyond fourth-order risk preferences, and we examine risk attitudes at even higher orders.
Deck, D. and Schlesinger, H. (2014). “Consistency of Higher Order Risk Preferences,”Econometrica 82(5), September 2014, pp. 1913-1943.
This article was originally published in Econometrica, volume 82, issue 5, in 2014. The link above is to the authoritative publisher’s version, as noted by the Economic Science Institute, and may reside behind a paywall.