Predictive powers of tests of risk and loss Aversion in a principal-agent context: an Experiment

Abstract

The goal of this experimental study is to demonstrate that the test of loss-aversion has a superior predictive power than the standard test of risk-aversion over behavior in risky situations that involve potential losses, e.g. agent's decision in a principal-agent context. Since participant's loss-aversion and risk-aversion affect the results of the loss-aversion test in one direction, the results of that test contains combined information on agent's preferences regarding risks and losses. On the other hand, test of risk- aversion only reflects the attitude towards risks and becomes redundant for prediction of agent's behavior in principal-agent setting when test of loss-aversion is conducted. A three-stage experiment consisted of eliciting a proxy for the curvature of agent's utility curve over wealth, eliciting a proxy for the loss-aversion of an agent, and eliciting the willingness of an agent to take a costly action for an uncertain reward.