Journal of Risk and Uncertainty

, Volume 36, Issue 1, pp 19–41

The effect of the background risk in a simple chance improving decision model

Article

Abstract

We experimentally investigate the effect of an independent and exogenous background risk to initial wealth on subjects’ risk attitudes and explore an appropriate incentive mechanism when identical or similar tasks are repeated in an experiment. Taking a simple chance improving decision model under risk where the winning probabilities are negatively related to the potential gain, we find that such a background risk tends to make risk-averse subjects behave more risk aversely. Furthermore, we find that risk-averse subjects tend to show decreasing absolute risk aversion (DARA), and that a random round payoff mechanism (RRPM) would control the possible wealth effect. This suggests that RRPM would be a better incentive mechanism for an experiment where repetition of a task is used.

Keywords

Background risk Risk aversion Opportunity effect Wealth effect Random round payoff mechanism 

JEL classification

D81 C90 C91 

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Copyright information

© Springer Science+Business Media, LLC 2007

Authors and Affiliations

  1. 1.Department of EconomicsKyonggi UniversityKyonggi-DoSouth Korea

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