Seminar_Morten Lau_Dynamic Choice Behavior in a Natural Experiment.

Title: Dynamic Choice Behavior in a Natural Experiment.

Abstract:

We examine dynamic choice behavior in a natural experiment with large stakes and a demographically divers sample. The television game show
Deal Or No Deal offers a rich paradigm to examine the latent decision processes that people use to make choices under uncertainty when they face future options linked to current choices. We have three major findings. First, we show that popular utility functions that assume constant relative or absolute risk aversion and expected utility theory defined over the prizes cannot characterize these choices, which exhibit increasing relative risk aversion over prizes ranging from a penny to nearly half a million U.S. dollars. Second, the argument of the utility function under expected utility theory reflects the integration of game show prizes with regular income. These decision makers do not segregate the income from the lotteries they face on the game show from the income that they bring to the game show. Allowing for this integration of income and game show prizes leads to choice behavior consistent with constant relative risk aversion. Third, we examine the effects of allowing contestants to make choices characterized by non-standard decision models. We find evidence of some probability weighting, but no loss aversion. Hence we identify two senses in which this large-stakes, naturally occurring behavior differs from behavior characterized in a small-stakes, laboratory setting: individuals appear to integrate prizes with some broader measure of baseline income or consumption, and individuals do not appear to exhibit systematic loss aversion.