The rich get richer and the poor get poorer: On risk aversion in behavioral decision-making

The point about this paper is that reference points in prospect theory mirror wealth positions. So, based on Kahneman & Tversky’s  discoveries, wealthy people (or those experiencing gains relative to a reference point) are likely to become risk averse preserving capital and getting richer while poor people (those experiencing losses relative to a reference point) are likely to become risk seeking and thus risk capital impairment.

Abstract (Via SJDM)

Some studies have found that choices become more risk averse after gains and more risk seeking after losses, although other studies have found the opposite. The latter tend to use hypothetical cases that encourage deliberation. In the current study, we examined the effects of prior gains and losses on a task designed to encourage less reflective decision making, the Iowa Gambling Task (IGT). Fifty participants conducted a manipulated decision-making task in which one group gained money, whereas the other group lost money, followed by the IGT. Participants who experienced a prior monetary loss displayed more risky choice behavior on the IGT than subjects who experienced a prior gain. These effects were not mediated by a positive or negative affect, although the sample size may have been too small to detect a small effect.

Introduction & Excerpts (Via SJDM)

Kahneman and Tversky (1979) noted that people are often risk averse for gains and risk seeking for losses. Whether people consider a consequence of their choice as a loss or as a gain is dependent on their point of reference. This reference point, which is often equivalent to the current wealth position, plays a key role in the theory of choice.

Hypothesis (Via SJDM)

The main hypothesis was that people who experienced a prior gain on a gambling task performed better (i.e., made more advantageous choices as a consequence of risk aversion) on the IGT as compared to persons who experienced a prior loss. Furthermore, we asked whether this effect was influenced by subjective affect, and various other individual differences.

Click Here To Read About Risk Aversion, Decision Making, & Wealth Effects

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03. July 2009 by Miguel Barbosa
Categories: Behavioral Economics, Curated Readings | Leave a comment

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