Working Paper: NBER ID: w15453
Authors: John List; Charles Mason
Abstract: Are individuals expected utility maximizers? This question represents much more than academic curiosity. In a normative sense, at stake are the fundamental underpinnings of the bulk of the last half-century's models of choice under uncertainty. From a positive perspective, the ubiquitous use of benefit-cost analysis across government agencies renders the expected utility maximization paradigm literally the only game in town. In this study, we advance the literature by exploring CEO's preferences over small probability, high loss lotteries. Using undergraduate students as our experimental control group, we find that both our CEO and student subject pools exhibit frequent and large departures from expected utility theory. In addition, as the extreme payoffs become more likely CEOs exhibit greater aversion to risk. Our results suggest that use of the expected utility paradigm in decision making substantially underestimates society's willingness to pay to reduce risk in small probability, high loss events.
Keywords: expected utility theory; risk aversion; CEOs; lotteries; public policy
JEL Codes: C9; C91; C93; Q5; Q58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| CEO risk aversion (D81) | departures from expected utility theory (D81) |
| student risk aversion (D81) | departures from expected utility theory (D81) |
| likelihood of extreme payoffs (D81) | CEO risk aversion (D81) |
| likelihood of extreme payoffs (D81) | student risk aversion (D81) |
| CEO risk aversion (D81) | society's willingness to pay to reduce risks (J17) |
| student risk aversion (D81) | society's willingness to pay to reduce risks (J17) |