Estimation of Risk and Time Preferences: Response Error, Heterogeneity, Adaptive Questionnaires, and Experimental Evidence from Mortgagers

Abstract

We develop a methodology for the measurement of the parameters of cumulative prospect theory and time discounting models based on tools from the preference measurement literature. These parameters are typically elicited by presenting decision makers with a series of choices between hypothetical alternatives, gambles or delayed payments. We present a method for adaptively designing the sets of hypothetical choices presented to decision makers, and a method for estimating the preference function parameters which capture interdependence across decision makers as well as response error. We apply our questionnaire design and estimation methods to a study of the characteristics of homeowners who owe more on their mortgage than the current value of the underlying real estate asset. Our estimates indicate that such homeowners have larger discount rates and present bias than others, but do not differ in their risk preferences.

Keywords: Prospect Theory, Time Discounting, Bayesian Statistics, Adaptive Experimental Design, Revealed Preference