Are high-ability individuals really more tolerant of risk? A test of the relationship between risk aversion and cognitive ability

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Abstract

A body of literature based primarily on experiments suggests that cognitive ability and risk aversion are inversely related. In contrast, studies using observational data often find that lower ability, or lower income, is positively related to risky behaviors. One potential explanation for the conflicting conclusions is that experimental studies tend to measure risk attitudes by presenting subjects with choices between an option with a certain outcome and an option characterized by risk, which requires computation and, hence, cognitive effort. Additionally, these studies have primarily relied on the use of hypothetical choices. I use an experiment to test whether this frequently-used method of measuring risk preferences is biased toward finding results that indicate that individuals with lower cognitive ability are more risk averse than individuals with higher cognitive ability. I find that the inverse relationship between risk aversion and cognitive ability is not robust and that high-ability subjects may misrepresent their preferences when they face hypothetical choices. Also, similar to earlier studies, I find that low-ability subjects are more likely to make errors and show that the availability of a certain option reduces errors for the lowest-ability subjects.

Original languageEnglish
Pages (from-to)136-147
Number of pages12
JournalJournal of Behavioral and Experimental Economics
Volume63
DOIs
StatePublished - Aug 1 2016

Keywords

  • Cognitive ability
  • Decision making
  • Hypothetical bias
  • Risk

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