Perceptions of Risk: An Experimental Approach

We investigate the structure of individuals’ rankings of uncertain prospects in terms of risk and their relationship to individual preferences. We examine three interlinked propositions that are fundamental to the standard economic approach to risk: (i) that risk-rankings respect the principle of mean-preserving spreads; (ii) that rankings by risk are simply the reverse of ranking by preference over distributions with a given mean; (iii) that risk-rankings are independent of whether the individual is personally involved in the gains/losses associated with the uncertain prospects. To do this we use a set of questionnaires implemented through the Virtual Laboratory, a novel experimental setting for the study of normative issues in experimental economics. The experimental design allows the identification of the effect of different types of questionnaire on the likelihood of answers in accordance to the theoretical axioms. It also helps identify the individual characteristics that might affect perceptions of risk. We find that a non-neglibigle minority of our respondents reject the mean-preserving spreads principle. Moreover, there are significant differences between rankings by preference and risk. We fail to find any effect of personal envolvement in risk comparisons. JEL Classification: C13, D63