Risk Taking with Left- and Right-Skewed Lotteries.

Abstract

While much literature has focused on preferences regarding risk, preferences over skewness also have significant economic implications. An important and understudied aspect of skewness preferences is how they affect risk taking. In this paper, we design a novel laboratory experiment that elicits certainty equivalents over lotteries where the variance and skewness of the outcomes are orthogonal to each other. This design enables us to cleanly measure both skewness seeking/avoiding and risk taking behavior, and their interaction, without needing to make parametric assumptions. Our experiment includes both left- and right-skewed lotteries. The results reveal that the majority of subjects are skewness avoiding risk takers who correspondingly also take more risk when facing less skewed lotteries. Our second contribution is to link these choices to individual rank-dependent utility preference parameters estimated using a separate lottery choice protocol. Using a latent-class model, we are able to identify two classes of subjects: skewness avoiders with the classic inverse s-shaped probability weighting function and skewness neutral subjects that do not have an inverse s-shaped probability weighting function. Our results thus demonstrate the link between probability distortion and skewness seeking/avoidance choices. They also highlight the importance of accounting for individual heterogeneity.

Supplementary information: The online version contains supplementary material available at 10.1007/s11166-021-09345-w.