Project description
Seeking or avoiding risks: the case of skewed preferences
Left skewed risks feature a small probability of large losses whereas, in contrast, right skewed risks feature a small probability of large gains. The EU-funded SkewPref project will shed light on humans’ skewness preferences towards rare, high-impact risks and demonstrate how they are much more influential on behaviour than previously thought. In doing so, the project will illustrate their important role in the economic analysis of risk and help uncover the reasons behind penny picking or the underweighting-overweighting paradox, amongst others.
Objective
“Penny-picking in front of a steamroller” describes the behavior of repeatedly taking risks with an unlikely but extreme downside in order to secure a small but likely benefit. Examples of penny-picking include risking one’s life by driving too fast or blowing up financial bubbles by speculating that they will not burst just yet. Penny-picking suggests that people underweight rare, high-impact events when making their decisions. On the other hand, individuals overpay for lottery gambles and insurances alike, suggesting just the opposite—that people overweight rare, high-impact events.
The goal of this project is to provide a fundamental understanding of humans’ skewness preferences—our attitudes toward rare, high-impact risks. I show that skewness preferences are much more influential on behavior than previously realized and thus must take a central place in the economic analysis of risk. The reason is that skewness preferences have unexpected and far-reaching implications in dynamic decision situations, and I will study their complex interaction with time.
I pursue this research agenda in three steps. First, I focus on static, one-time decision situations and define skewness preferences formally. I show that the leading economic theories—often implicitly—assign first-order importance to skewness preferences and that this observation explains much of these theories’ success. Second, I study skewness preferences in dynamic settings and analyze their complex interaction with time preferences. I propose a new model that identifies the role of skewness for repeated risk-taking. Third, I test my theoretical contributions through experiments on rare, high-impact risks in static and repeated decision situations, using a relatively novel experimental technique to implement rare, high-impact events. Out of the theoretical explanations established, I seek to identify the fundamental reasons behind phenomena such as penny-picking or the underweighting-overweighting paradox.
Fields of science
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Funding Scheme
ERC-STG - Starting GrantHost institution
69117 Heidelberg
Germany