Journal of Risk and Uncertainty

, Volume 38, Issue 2, pp 143–158

Learning from mistakes: What do inconsistent choices over risk tell us?

Article

Abstract

We implement a risk experiment that allows for judgment errors to investigate who makes mistakes and whether it matters. The experiments are conducted with a random sample of the adult population in Rwanda, and data on financial decisions are collected. We find a high proportion of inconsistent choices, with over 50% of the participants making at least one mistake. Importantly, errors are informative. While risk aversion alone does not explain financial decisions, risk aversion and inconsistent choices interact in significant and sensible ways. As we would expect, risk-averse individuals are more likely to belong to a savings group and less likely to take out an informal loan. For those more likely to make mistakes, however, as they become more risk averse, they are less likely to belong to a savings group and more likely to take up informal credit, suggesting that mistakes correlate with less than optimal behavior.

Keywords

Risk preferences Inconsistent choices Financial decisions Experiments 

JEL Classification

C91 D81 

References

  1. Andersen, S., Harrison, G. W., Lau, M. I., & Rutström, E. E. (2006). Elicitation using multiple price list formats. Experimental Economics, 9(4), 383–405.CrossRefGoogle Scholar
  2. Ashraf, N., Karlan, D., & Yin, W. (2006). Tying Odysseus to the mast: evidence from a commitment savings product in the Philippines. Quarterly Journal of Economics, 121(2), 673–697.CrossRefGoogle Scholar
  3. Bellemare, C., & Shearer, B. (2006). Sorting, incentives and risk preferences: evidence from a field experiment. IZA Working Paper No. 2227.Google Scholar
  4. Benjamin, D., Brown, S. A., & Shapiro, J. M. (2006). Who is ‘behavioral’? Cognitive ability and anomalous preferences. Working Paper, University of Chicago.Google Scholar
  5. Binswanger, H. P. (1980). Attitudes toward risk: experimental measurement in rural India. American Journal of Agricultural Economics, 62(3), 395–407.CrossRefGoogle Scholar
  6. Camerer, C. F., & Hogarth, R. M. (1999). The effects of financial incentives in experiments: a review and capital–labor–production framework. Journal of Risk and Uncertainty, 19(1–3), 7–42.CrossRefGoogle Scholar
  7. Carbone, E., & Hey, J. (2000). Which error story is best? Journal of Risk and Uncertainty, 20(2), 161–176.CrossRefGoogle Scholar
  8. Castillo, M., Ferraro, P., Jordan, J., & Petrie, R. (2008). The today and tomorrow of kids. Working Paper, Georgia State University.Google Scholar
  9. Chakravarti, D., Krish, R., Paul, P., & Srivastava, J. (2002). Partitioned presentation of multicomponent bundle prices: evaluation, choice and underlying processing effects. Journal of Consumer Psychology, 12(3), 215–229.CrossRefGoogle Scholar
  10. Dohmen, T., Falk, A., Huffman, D., Sunde, U., Schupp, J., & Wagner, G. (2005). Individual risk attitudes: new evidence from a large, representative, experimentally-validated survey. IZA Working Paper No. 1730.Google Scholar
  11. Dohmen, T., Falk, A., Huffman, D., & Sunde, U. (2007). Are risk aversion and impatience related to cognitive ability? IZA Discussion Paper No. 2735.Google Scholar
  12. Eckel, C. C., Johnson, C., Montmarquette, C., & Rojas, C. (2007). Debt aversion and the demand for loans for postsecondary education. Public Finance Review, 35(2), 233–262.CrossRefGoogle Scholar
  13. Harless, D. W., & Camerer, C. F. (1994). The predictive utility of generalized expected utility theories. Econometrica, 62(6), 1251–1289.CrossRefGoogle Scholar
  14. Harrison, G., List, J., & Towe, C. (2007). Naturally occurring preferences and exogenous laboratory experiments: a case study of risk aversion. Econometrica, 75(2), 433–458.CrossRefGoogle Scholar
  15. Harrison, G., & Rutström, E. (2007). Risk aversion in the laboratory. Working Paper 07-03, Department of Economics, University of Central Florida.Google Scholar
  16. Heckman, J. J., Stixrud, J., & Urzua, S. (2006). The effects of cognitive and noncognitive abilities on labor market outcomes and social behavior. Journal of Labor Economics, 24(3), 411–482.CrossRefGoogle Scholar
  17. Hey, J. (2005). Why we should not be silent about noise. Experimental Economics, 8(4), 325–345.CrossRefGoogle Scholar
  18. Hey, J., & Orme, C. (1994). Investigating generalisations of expected utility theory using experimental data. Econometrica, 62(6), 1291–1326.CrossRefGoogle Scholar
  19. Holt, C. A. (1986). Preference reversals and the independence axiom. American Economic Review, 76, 508–515.Google Scholar
  20. Holt, C., & Laury, S. (2002). Risk aversion and incentive effects. American Economic Review, 92(5), 1644–1655.CrossRefGoogle Scholar
  21. Holt, C., & Laury, S. (2006). Further reflections on prospect theory. Working Paper, Georgia State University.Google Scholar
  22. Langer, T., & Weber, M. (2001). Prospect theory, mental accounting, and differences in aggregated and segregated evaluation of lottery portfolios. Management Science, 47(5), 716–733.CrossRefGoogle Scholar
  23. Loomes, G., Moffatt, P., & Sugden, R. (2002). A microeconometric test of alternative stochastic theories of risky choice. Journal of Risk and Uncertainty, 24(2), 103–130.CrossRefGoogle Scholar
  24. Meier, S., & Sprenger, C. (2007). Impatience and credit behavior: evidence from a field experiment. Federal Reserve Bank of Boston Working Paper Series, No. 07-3.Google Scholar
  25. Petrie, R. (2002). Rwanda credit unions member & non-member survey 2002. World Council of Credit Unions, Research Monograph Series, No. 20.Google Scholar
  26. Ortmann, A., & Hertwig, R. (2006). Monetary incentives: usually neither necessary nor sufficient? CERGE-EI Working Paper 307, Prague.Google Scholar
  27. Prasad, K., & Salmon, T. C. (2007). Self selection and market power in risk sharing contracts. Working Paper, Florida State University.Google Scholar
  28. Segal, C. (2006). Misbehavior, education, and labor market outcomes. Working Paper, Universidad Pompeu Fabre.Google Scholar
  29. Stockman, C. (2006). Differences and similarities in health risk preferences across two subject cohorts. Working Paper, University of Pittsburgh.Google Scholar
  30. Tanaka, T., Camerer, C. F., & Nguyen, Q. (2007). Risk and time preferences: experimental and household survey data from Vietnam. Working Paper, California Institute of Technology.Google Scholar
  31. Westen, D. (1996). Psychology: mind, brain and culture. New York: Wiley.Google Scholar

Copyright information

© Springer Science+Business Media, LLC 2009

Authors and Affiliations

  1. 1.Georgia State UniversityAtlantaUSA
  2. 2.Georgia State UniversityAtlantaUSA

Personalised recommendations