Risk aversion, path dependency and financial economic decision-making in low-income communities: Experimental evidence from South Africa

Abstract

Recent literature asserts that risk preferences differ amongst individuals based on many factors, and the degree of risk aversion can help understand differences in well-being (Banerjee & Ewing 2004;Concina 2014;Harrison 2019;Thomas 2016; World Bank 2015). In addition, there are many information processing errors and biases that affect decision-making by individuals and households, more severe in failed markets. Information asymmetry leads to market failure which Orientation: Poverty is deeply entrenched in South Africa, and various initiatives to reduce it have not been successful. Behavioural economics may help explain this by testing whether individuals exhibit path dependence when making decisions under uncertainty. Research purpose:The aim of this article was to test the presence of path dependence and the determinants of risk aversion.Motivation for the study: This study was conducted in Eastern Cape province of South Africa, which is largely rural, with a high level of poverty, where 36% of households depend on social security grants, and unemployment is higher than the national average.Research approach/design and method: An experimental design approach was applied, eliciting risk under different prospects. Descriptive statistics was used to determine path dependency, with random effects regression used to investigate the determinants of risk aversion. Main findings:The results show the existence of path dependence, with individuals who are more risk averse unwilling to change their choices even if they stand to win or lose more than in the previous period.Practical/managerial implications: Policymakers need to consider these behavioural characteristics in formulating policies to reduce poverty. Information and how that information is presented (framing) are central for impactful policy formulation. Contribution/value-add:The results here have policy implications on addressing triple challenges bedeviling South Africa and many developing countries.