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.
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Notes
Psychologists call this internal consistency (for an example, see Westen 1996).
Harless and Camerer (1994) assume homogeneity.
Further, one may infer from the comparison of unexpected subject “switch-backs” in Holt and Laury (2002) with Prasad and Salmon (2007) that people make fewer inconsistent choices when lotteries are presented all at once, rather than sequentially. This has been found in the literature in psychology and marketing (e.g. Langer and Weber 2001, and Chakravarti et al. 2002). Decisions made together are thought of as a “bundle,” and thus reconciled with each other. Decisions made in a sequence are viewed separately, each with its own independent chance of error.
We were not able to replicate background risk in this research so cannot address this hypothesis.
Unfortunately, the data we have do not distinguish between these two general forms.
Credit unions are more accessible for the poor since the membership fee is far lower than the minimum balance at a formal bank. Many poor people become credit union members precisely so they can have access to credit.
Since 2000, the country has experienced relative political stability. While many still do not trust the government, the credit union and banking sector is used and trusted somewhat.
For a complete description of the data and survey design, refer to Petrie (2002).
While they were not paid, subjects in the hypothetical treatments were interested in the outcome of the coin toss. That is, they were interested in the outcome of their decisions. This suggests they paid attention to what they chose.
Ortmann and Hertwig (2006) state that financial incentives may be important in motivating economic behavior. Importantly, they emphasize the importance of a “do-it-both-ways” rule, so that experimenters can compare results of financially motivated and non-motivated treatments. This is what we do in this paper.
There are two aspects of the experiment that could cause some unexpected behavior, but neither should cause inconsistent “switching-back.” First, since two decisions will be implemented, subjects could make their decisions as if putting together a risk portfolio. This should make subjects choose riskier options, but consistently. Second, since one gain and one gain-loss lottery are implemented at random, errors may occur due to faulty compounding of lotteries. However, that should simply make people behave in a consistent, but more risk-averse, fashion (Holt 1986).
The percent of inconsistent choices in the Peru sample is similar in both hypothetical and paid lotteries. The instrument in Peru allowed for indifference, and subjects reviewed their choices and were allowed to change them before the coin toss. In the hypothetical lotteries, around 52% made inconsistent choices over gains and 44% made inconsistent choices over gain-loss. In other research, Holt and Laury (2002) found 13% in hypothetical choices with students, Stockman (2006) found 11% in hypothetical choices with adults, Meier and Sprenger (2006) found 12% in paid choices with adults, Castillo et al. (2008) found 33% in paid choices with 13-year-olds, and Prasad and Salmon (2007) found 30% in paid choices with students (presenting lotteries sequentially as we did).
A Fisher’s exact test for equal distributions over gains has a p-value = 0.431 and over gains-loss, p-value = 0.439.
Similarly, due to limited observations per individual, it would be difficult to derive a risk measure based on the parameterization of a utility function, so we are unable to compare risk aversion in our sample to that estimated in other experiments. We look at sample-level error estimation in the next section.
For the simultaneous five-pair lottery, subjects are shown five lotteries with a 50–50 chance of either payoff and asked to choose one. The five lotteries over gains are (500, 500), (800, 400), (1,100, 300), (1,400, 200), (1,700, 100). The five lotteries over gain-loss are (0, 0), (300, −100), (600, −200), (900, −300), (1,200, −400).
A Tobit regression was also tried and yielded the same results. OLS results are reported for ease of interpretation.
If a dummy variable for the real payment treatment is included, it is not significant, and the results do not change.
Results are robust to alternative specifications, such as Logit and Dprobit.
Because we are using the estimated probability of making at least one mistake as an independent variable, this gives us a generated regressor and we therefore chose not to use OLS. Instead, the estimates were done by sampling with replacement 10,000 times to generate estimates and bootstrapped standard errors. The estimates are significant if they fall within the confidence interval specified in the table.
If we just control for mistakes or risk and mistakes (not interacted), there is no significant effect. That is, mistakes alone, risk alone, and risk and mistakes do not correlate with financial decisions. It is the interaction of the two that is important.
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Acknowledgment
Petrie thanks the World Council of Credit Unions (WOCCU) for funding the survey and allowing us the use of the data. We also thank Marco Castillo, James Cox and Vjollca Sadiraj for the helpful comments. Suggestions from an anonymous referee and the editor greatly improved the paper.
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Jacobson, S., Petrie, R. Learning from mistakes: What do inconsistent choices over risk tell us?. J Risk Uncertain 38, 143–158 (2009). https://doi.org/10.1007/s11166-009-9063-3
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DOI: https://doi.org/10.1007/s11166-009-9063-3