Bougherara, Douadia, Friesen, Lana and Nauges, Céline (2020) Risk Taking with Left- and Right-Skewed Lotteries. TSE Working Paper, n. 20-1085, Toulouse

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Abstract

While much literature has focused on preferences regarding risk, preferences over
skewness also have significant economic implications. An important and understudied aspect of
skewness preferences is how they affect risk taking. In this paper, we design a novel laboratory
experiment that elicits certainty equivalents over lotteries where the variance and skewness of
the outcomes are orthogonal to each other. This design enables us to cleanly measure both
skewness seeking/avoiding and risk taking behavior, and their interaction, without needing to
make parametric assumptions. Our experiment includes both left- and right-skewed lotteries. The
results reveal that the majority of subjects are skewness avoiding risk takers who
correspondingly also take more risk when facing less skewed lotteries. Our second contribution
is to link these choices to individual rank-dependent utility preference parameters estimated
using a separate lottery choice protocol. Using a latent-class model, we are able to identify two
classes of subjects: skewness avoiders with the classic inverse s-shaped probability weighting
function and skewness neutral subjects that do not distort probabilities. Our results thus
demonstrate the link between probability distortion and skewness seeking/avoidance choices.
They also highlight the importance of accounting for individual heterogeneity.