Joint Measurement of Risk Aversion, Prudence, and Temperance

Risk aversion — but also the higher-order risk preferences of prudence and temperance — are fundamental concepts in the study of economic decision making. We propose a method to jointly measure the intensity of risk aversion, prudence, and temperance. Our theoretical approach is to define risk compensations of different orders, and in an experiment we elicit these compensations with a price list technique. We find evidence for risk aversion, prudence, and temperance. These traits correlate within subjects. The compensations elicited for prudence are significantly larger than those for risk aversion and temperance. In contrast to commonly used utility functions, prospect theory can predict this behavioral pattern. In our experiment, both risk averters and risk lovers are prudent, which supports an important theoretical observation made by Crainich, Eeckhoudt, and Trannoy (forthcoming): Prudence may be a more universal trait than previously realized