A Behavioral Perspective on Risk Mitigation Investments
Decisions concerning risk mitigation generally involve tradeoffs between immediate versus delayed outcomes and certain versus risky ones. The decision in adopting a risk mitigation measure illustrates an intertemporal choice problem under uncertainty. This study explores this relationship between delay and uncertainty in risky intertemporal decision-making. In particular, we focus on the following questions: (1) Do risk preferences depend on the time period over which the outcomes are evaluated? (2) Does the discount factor (rate of time preference) depend on the riskiness of the outcomes being evaluated? (3) Is there an interaction between the effect of delay and uncertainty and, if so, in what direction is this interaction? Contrary to normative predictions, we find that delay and risk discounting are not independent from each other. In particular, the delay discount rate increases for uncertain future outcomes and the risk discount rate decreases with an increase in delay. Thus individuals are more impatient for gambles than for certain outcomes and less risk-averse (more risk-neutral) for delayed outcomes than for immediate ones. The findings also suggest that the simultaneous presence of delay and uncertainty leads to a higher discounting of risky future outcomes than predicted by either effect separately.
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