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American Economic Review: Vol. 97 No. 4 (September 2007)
AER Volume. 97, Issue 4 | Next Article
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Reference-Dependent Risk Attitudes
Article Citation
Kőszegi, Botond, and
Matthew Rabin. 2007. "Reference-Dependent Risk Attitudes."
American Economic Review,
97(4): 1047-1073.
DOI: 10.1257/aer.97.4.1047
DOI: 10.1257/aer.97.4.1047
Abstract
We use Koszegi and Rabin's (2006) model of reference-dependent utility, and an
extension of it that applies to decisions with delayed consequences, to study preferences
over monetary risk. Because our theory equates the reference point with
recent probabilistic beliefs about outcomes, it predicts specific ways in which the
environment influences attitudes toward modest-scale risk. It replicates "classical"
prospect theory—including the prediction of distaste for insuring losses—when
exposure to risk is a surprise, but implies first-order risk aversion when a risk,
and the possibility of insuring it, are anticipated. A prior expectation to take on
risk decreases aversion to both the anticipated and additional risk. For large-scale
risk, the model allows for standard "consumption utility" to dominate reference-dependent
"gain-loss utility," generating nearly identical risk aversion across situations.
(JEL D81)
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Authors
Kőszegi, Botond
Rabin, Matthew
Rabin, Matthew
