Global shapes of preference scaling functions

Abstract

In the expected utility framework, concavity (or convexity) of the preference scaling function corresponds to risk-aversion (or risk-seeking) preferences. Friedman and Savage (1948) and Markowitz (1952) indicate that individuals may be risk-averse at some wealth levels but risk-seeking at others. Prospect theory (Kahneman & Tversky, 1979) proposes an S-shaped utility function exhibiting risk-aversion in the domain of gain and risk-seeking in the loss domain. In this study, we use lottery experiments to infer global shapes of the preference scaling functions that determine risk attitudes in interaction with uncertainty. The global shapes that emerge are—fully concave, fully convex, linear, Reverse-S and S-shaped preference scaling functions. Using annual income as a proxy for wealth, we examine the relationship between global shapes and wealth. The data largely supports the Friedman–Savage hypothesis; we find that at low levels of wealth people are concave, followed by Reverse-S and then a second upper concave segment at higher levels of wealth.