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, respectively. We wish to thank Ron Cummings for helpful suggestions and for funding the human subjects payments. In addition, we are especially grateful to John List and Brett Katzman for setting up the sessions at the Universities of Central Florida and Miami respectively. This work was also funded in part by the National Science Foundation (SBR-9753125, SBR-9818683, and SBR-0094800). We wish to thank Loren Smith for research assistance, and John Kagel, Dan Levin, Andrew Muller, Tom Palfrey, Peter Wakker, seminar participants at the Federal Reserve Bank of Atlanta, and an anonymous referee for helpful suggestions. Risk Aversion and Incentive EffectsCharles A. Holt and Susan K. Laury * April, 2002 A menu of paired lottery choices is structured so that the crossover point to the high-risk lottery can be used to infer the degree of risk aversion. With "normal" laboratory payoffs of several dollars, most subjects are risk averse and few are risk loving. Scaling up all payoffs by factors of twenty, fifty, and ninety makes little difference when the high payoffs are hypothetical. In contrast, subjects become sharply more risk averse when the high payoffs are actually paid in cash. A hybrid "power/expo" utility function with increasing relative and decreasing absolute risk aversion nicely replicates the data patterns over this range of payoffs from several dollars to several hundred dollars.Keywords: lottery choice, risk aversion, incentive effects, hypothetical payoffs. Risk Aversion and Incentive EffectsAbstract: A menu of paired lottery choices is structured so that the crossover point to the high-risk lottery can be used to infer the degree of risk aversion. With "normal" laboratory payoffs of several dollars, most subjects are risk averse and few are risk loving. Scaling up all payoffs by factors of twenty, fifty, and ninety makes little difference when the high payoffs are hypothetical. In contrast, subjects become sharply more risk averse when the high payoffs are actually paid in cash. A hybrid "power/expo" utility function with increasing relative and decreasing absolute risk aversion nicely replicates the data patterns over this range of payoffs from several dollars to several hundred dollars.Although risk aversion is a fundamental element in standard theories of lottery choice, asset valuation, contracts, and insurance (e.g. Daniel Bernoulli, 1738;John Pratt, 1964;Kenneth Arrow, 1965), experimental research has provided little guidance as to how risk aversion should be modeled. To date, there have been several approaches used to assess the importance and nature of risk aversion. Using lottery choice data from a field experiment, Hans Binswanger (1980) concluded that most farmers exhibit a significant amount of risk aversion that tends to increase as payoffs are increased. Alternatively, risk aversion can be inferred from bidding and pricing tasks. In auctions, overbidding relative to Nash predictions has been attributed to risk aversion by some and to noisy decision-making by others, since the pay...

This paper reports laboratory data for games that are played only once. These games span the standard categories: static and dynamic games with complete and incomplete information. For each game, the treasure is a treatment in which behavior conforms nicely to predictions of the Nash equilibrium or relevant refinement. In each case, however, a change in the payoff structure produces a large inconsistency between theoretical predictions and observed behavior. These contradictions are generally consistent with simple intuition based on the interaction of payoff asymmetries and noisy introspection about others' decisions.JEL Classifications: C72, C92

This paper reports the results of a private-values auction experiment in which expected costs of deviating from the Nash equilibrium bidding function are asymmetric, with the implication that upward deviations will be more likely in one treatment than in the other. Overbidding is observed in both treatments, but is more prevalent in the treatment where the costs of overbidding are lower. We specify and estimate a noisy (quantal response) model of equilibrium behavior. Estimated noise and risk aversion parameters are highly significant and consistent across treatments. The resulting two-parameter model tracks both the average bids and the distribution of bids remarkably well. Alternative explanations of overbidding are also considered. The estimates of parameters from a nonlinear probability weighting function yield a formulation that is essentially equivalent to risk aversion in this context. A model in which players experience a "joy of winning" provides a reasonable fit of the data but does significantly worse than the risk aversion model.

Kaushik Basu (1994) introduced a traveler's dilemma in which two people must independently decide how much to claim for identical objects that have been lost on a flight. The airline, in an attempt to prevent fraud, agrees to pay each the minimum of the two claims, with a penalty for the high claimant and a reward for the low claimant. The Nash equilibrium predicts the lowest possible claim no matter how small the penalty and reward. The intuition that claims may be high is confirmed by laboratory experiments. Average claims are inversely related to the size of the penalty/reward parameter, which is explained by a stochastic generalization of the Nash equilibrium.