Behavioral Biases and Firm Behavior: Evidence from Kenyan Retail Shops

Many subjects in lab experiments show considerable risk aversion in small-stakes gambles. This is counter to the predictions of expected utility theory for any reasonable degree of risk aversion (Rabin 2000) but is consistent with loss aversion in prospect theory. Benjamin, Brown, and Shapiro (forthcoming) show that math skills reduce small-stakes risk aversion, consistent with broader evidence that mathematical skills can help debias decision making (Burks et al. 2007). In this paper, we show that acceptance of small risky gambles and scores on math tests is associated with inventory accumulation among Kenyan shopkeepers. More broadly, we argue that loss aversion may be one factor helping explain the broader puzzle of why high rates of return on capital among small firms in developing countries are not arbitraged away and do not lead to the high growth rates of consumption that the Euler equation would predict. The development literature has documented that, across a wide range of contexts, small