By Erica Ryan, Economics Association of Maryland
On Saturday, April 29th, the university hosted the 19th annual celebration of Maryland Day, an open house that shows off all of the exciting things students are doing on campus. The Economics Department had a table with information about the department, our professors’ research, and the Economics majors. Many of our staff and faculty, including Professors Maureen Cropper and Jessica Goldberg, came out to support the event and talk to visitors and returning alumni. Several undergraduate Economics students were also there to run a risk-aversion experiment and explain the results.
Understanding risk aversion is important to understanding the decisions people make about investments, savings, and consumption. One way that economists measure risk aversion is through incentivized “games.” EAM demonstrated one of these games to the community. The risk-aversion game offered the player the choice between six different lotteries, with six different sets of payouts. Each of the six lotteries represented a different level of riskiness. For example, the first lottery gave out 5 pieces of candy for heads or tails, so it involved no risk at all, but a relatively small payoff. The lotteries got progressively riskier, with the sixth lottery offering no candy for heads, and 22 pieces of candy for tails. It was risky, but had high expected value. By choosing a lottery, a player revealed his or her tolerance for risk — and then came the fun part. EAM students flipped a coin, and awarded candy to players whose luck paid off.
This game isn’t a perfect measure of risk aversion, particularly because it is only offering candy. Not getting a piece of candy has far less of an impact than say, not getting a large amount of money. But this exercise does help to gain some information about risk preferences, and to demonstrate how economists measure preferences and use them to understand behavior that people might not immediately recognize as economic decision making.