The Nature of Risk Preferences: Evidence from Insurance Choices

We use data on insurance deductible choices to estimate a structural model of risky choice that incorporates "standard" risk aversion (diminishing marginal utility for wealth) and probability distortions. We find that probability distortions?characterized by substantial overweighting of small probabilities and only mild insensitivity to probability changes?play an important role in explaining the aversion to risk manifested in deductible choices. This finding is robust to allowing for observed and unobserved heterogeneity in preferences. We demonstrate that neither K?szegi-Rabin loss aversion alone nor Gul disappointment aversion alone can explain our estimated probability distortions, signifying a key role for probability weighting.

[1]  Sandra Krueger.  The Nature of Risk Preferences: Evidence from Insurance Choices , 2014 .

[2]  B. Handel,et al.  Health Insurance for "Humans": Information Frictions, Plan Choice, and Consumer Welfare , 2013 .

[3]  Levon Barseghyan,et al.  Are Risk Preferences Stable Across Contexts? Evidence from Insurance Data , 2011 .

[4]  Justin R. Sydnor.  Over)insuring Modest Risks , 2010 .

[5]  Colin Camerer,et al.  Risk and time preferences: linking experimental and household survey data from Vietnam , 2010 .

[6]  Liran Einav,et al.  How General are Risk Preferences? Choices Under Uncertainty in Different Domains , 2010, The American economic review.

[7]  Alma Cohen,et al.  Testing for Adverse Selection in Insurance Markets , 2009 .

[8]  Ori Levy,et al.  Theories of choice under risk: Insights from financial markets , 2009 .

[9]  Adrian Bruhin,et al.  Risk and Rationality: Uncovering Heterogeneity in Probability Distortion , 2009 .

[10]  Nicholas Barberis,et al.  A Model of Casino Gambling , 2009, Manag. Sci..

[11]  Amit Gandhi,et al.  Identifying Preferences under Risk from Discrete Choices , 2009 .

[12]  P. Wakker.  Explaining the characteristics of the power (CRRA) utility family. , 2008, Health economics.

[13]  R. Thaler,et al.  Deal or No Deal? Decision Making under Risk in a Large-Payoff Game Show , 2008 .

[14]  Syngjoo Choi,et al.  Consistency and heterogeneity of individual behavior under uncertainty , 2007 .

[15]  M. Rabin,et al.  Reference-Dependent Risk Attitudes , 2007 .

[16]  Ming Huang,et al.  Stocks as Lotteries: The Implications of Probability Weighting for Security Prices , 2007 .

[17]  M. Rabin,et al.  A Model of Reference-Dependent Preferences , 2006 .

[18]  P. Chiappori,et al.  Moral Hazard and Dynamic Insurance Data , 2003 .

[19]  J. Heckman,et al.  Adverse selection and moral hazard in insurance: Can dynamic data help to distinguish? , 2003 .

[20]  M. Marinacci,et al.  A Smooth Model of Decision Making Under Ambiguity , 2003 .

[21]  Robert Sugden,et al.  A Microeconometric Test of Alternative Stochastic Theories of Risky Choice , 2002 .

[22]  R. Thaler,et al.  Anomalies: Risk Aversion , 2001 .

[23]  D. Prelec,et al.  Compound Invariant Weighting Functions in Prospect Theory , 2000 .

[24]  D. McFadden,et al.  MIXED MNL MODELS FOR DISCRETE RESPONSE , 2000 .

[25]  B. Jullien,et al.  Estimating Preferences under Risk: The Case of Racetrack Bettors , 2000, Journal of Political Economy.

[26]  M. Rabin.  Risk Aversion and Expected Utility Theory: A Calibration Theorem , 2000 .

[27]  Pierre-André Chiappori,et al.  Testing for Asymmetric Information in Insurance Markets , 2000, Journal of Political Economy.

[28]  David Laibson,et al.  Commentary on “Choice Bracketing” by Read, Loewenstein and Rabin , 1999 .

[29]  Richard Gonzalez,et al.  On the Shape of the Probability Weighting Function , 1999, Cognitive Psychology.

[30]  D. Prelec.  The Probability Weighting Function , 1998 .

[31]  Robert Sugden,et al.  Incorporating a stochastic element into decision theories , 1995 .

[32]  David W Harless,et al.  The predictive utility of generalized expected utility theories , 1994 .

[33]  Jeffrey A. Dubin,et al.  A Microeconometric Analysis of Risk Aversion and the Decision to Self-Insure , 1994, Journal of Political Economy.

[34]  A. Tversky,et al.  Advances in prospect theory: Cumulative representation of uncertainty , 1992 .

[35]  A. Witte,et al.  The Influence of Probability on Risky Choice: A Parametric Examination , 1992 .

[36]  Rosa L. Matzkin.  Semiparametric Estimation of Monotone and Concave Utility Functions for Polychotomous Choice Models , 1991 .

[37]  Faruk Gul.  A Theory of Disappointment Aversion , 1991 .

[38]  D. Schmeidler.  Subjective Probability and Expected Utility without Additivity , 1989 .

[39]  Q. Vuong.  Likelihood Ratio Tests for Model Selection and Non-Nested Hypotheses , 1989 .

[40]  H. J. Einhorn,et al.  Expression theory and the preference reversal phenomena. , 1987 .

[41]  Robert Sugden,et al.  Disappointment and Dynamic Consistency in Choice under Uncertainty , 1986 .

[42]  David E. Bell,et al.  Disappointment in Decision Making Under Uncertainty , 1985, Oper. Res..

[43]  J. Kadane.  Structural Analysis of Discrete Data with Econometric Applications , 1984 .

[44]  J. Quiggin.  A theory of anticipated utility , 1982 .

[45]  J. Drèze.  Inferring Risk Tolerance from Deductibles in Insurance Contracts , 1981 .

[46]  A. Tversky,et al.  Decision, probability, and utility: Prospect theory: An analysis of decision under risk , 1979 .

[47]  Harry V. Roberts,et al.  Risk, Ambiguity, and the Savage Axioms: Comment , 1963 .

[48]  W. Fellner.  Distortion of Subjective Probabilities as a Reaction to Uncertainty , 1961 .

[49]  Belen Chavez,et al.  Notes on : Prospect Theory : An Analysis of Decision Under Risk ( Kahneman and Tversky 1979 ) Modigliani Group : , 2012 .

[50]  Angie Andrikogiannopoulou.  Estimating Risk Preferences from a Large Panel of Real-World Betting Choices ∗ , 2010 .

[51]  Aviva Abramovsky,et al.  New Appleman New York Insurance Law , 2009 .

[52]  Charles A. Holt,et al.  Estimating Risk Preferences from Deductible Choice , 2007 .

[53]  Xiaohong Chen.  Chapter 76 Large Sample Sieve Estimation of Semi-Nonparametric Models , 2007 .

[54]  J. Wolfers,et al.  Explaining the Favorite-Longshot Bias : Is it Risk-Love or Misperceptions ? ∗ , 2007 .

[55]  M. Israel,et al.  Do We Drive More Safely When Accidents are More Expensive? Identifying Moral Hazard from Experience Rating Schemes , 2004 .

[56]  Jeffrey M. Woodbridge.  Econometric Analysis of Cross Section and Panel Data , 2002 .

[57]  C. Plott.  psychology and economics , 1990 .

[58]  I. Gilboa,et al.  Maxmin Expected Utility with Non-Unique Prior , 1989 .

[59]  David Schmeidleis.  SUBJECTIVE PROBABILITY AND EXPECTED UTILITY WITHOUT ADDITIVITY , 1989 .

[60]  D. McFadden.  Econometric Models of Probabilistic Choice , 1981 .

[61]  D. McFadden.  Conditional logit analysis of qualitative choice behavior , 1972 .

[62]  G. Loewenstein,et al.  READ , LOEWENSTEIN AND RABIN , 2022 .