Abstract:
The standard parameterizations of the probability weighting function confound
the estimation of its fixed point and its shape as well as control its curvature with a single
parameter. We derive a three-parameter probability weighting function based on Lorenz
curves. This parameterization allows for independent estimation of the fixed point and for
separate curvature estimates of the "bulge" and the "sag." We then test our probability
weighting function in an experimental setting and analyze which factors influence
individuals' probabilistic risk attitudes. The probability weighting function of our sample,
in aggregate, follows the dominant empirical pattern of an inverse-S shape. As an
individual's numeracy increases though, the curvature of her probability weighting
function decreases. The fixed point differs with gender, with whether an individual is
liquidity constrained, and with numeracy. Our sample of individuals does not appear to
display more sensitivity to probability changes within the region of the bulge relative to
probability changes within the region of the sag. Therefore, a single curvature parameter
appears to be sufficient to characterize a heterogeneous probability weighting function in
this choice context.
Description:
88 pages. A thesis presented to the Department of Economics and the Clark Honors College of the University of Oregon in partial fulfillment of the requirements for degree of Bachelor of Science, Spring 2016.