Impact of Academic Experience in Economics on Risk Preferences and Rationality: An Empirical Investigation

Abstract

When we model human choices under risk, the standard is to apply a rational choice model such as Expected Utility Theory (EUT). However, humans are not always rational, and Kahneman and Tversky developed Prospect Theory (PT) to account for peopleÕs cognitive limitations in decision-making. However, both EUT and PT do not differentiate among individuals, nor discuss factors that lead to different risk preferences and rationality for different individuals. This study examines whether academic experience in economics reduces risk aversion and irrationality. A survey was administered to economics and non-economics majors in Occidental College. The survey was design as pairs of gambling choices to detect subjectsÕ risk preferences and responses when induced to display certainty, framing, reflection and lottery effect as defined in PT. It was found that economics majors had lower risk aversion, and generally behaved differently from non-economics majors in rationality tests, although their behaviors were not always more consistent with EUT than those of non-economics majors. Academic experience in economics, in most cases, significantly reduced risk aversion and irrationality among non-economics students, but this learning effect was not observed among economics majors. A further test of self-selection among economics and non-economics major with little economics training showed that economics majors were born rather than made. It is further shown that the monetary incentives used in this study reduced risk aversion, but did not have much impact on rationality. It is also found that risk aversion and irrationality were positively correlated, and math/science majors were more rational than humanities majors.