Cultural Finance

Cultural Economics and
Finance
Prof. Marc Oliver Rieger 
University of Trier 
www.banking-finance.uni-trier.de
Zürich, August/September 2021

About the lecturer
Prof. Marc Oliver Rieger, mrieger@uni-trier.de, banking-finance.uni-trier.de

Chair of Banking and Finance at University of Trier, Germany (since
2010), director of the Confucius Institute Trier (since 2018) adjunct
professor at NCCU in Taipei (2018-2019).
Born 1974 in Berlin, Germany

2001 PhD in mathematics at the Max-Planck-Institute for Mathematics
in the Sciences, Leipzig, Germany
2001-2003 Carnegie Mellon University, Pittsburgh, USA
2003-2004 Scuola Normale Superiore, Pisa, Italy
2004-2010 University of Zurich, Switzerland
Research areas:
Behavioral Finance, structured financial products, decision theory
About geography
Prof. Marc Oliver Rieger, mrieger@uni-trier.de

Chair of Banking and Finance at University of Trier, Germany
(since April 2010), director of the Confucius Institute Trier
(since July 2018) and adjunct professor at NCCUTrier (since
any
September 2018).
Germ
2001 PhD in mathematics at the Max-Planck-Institute for
Mathematics in the Sciences, Leipzig, Germany
3
Research areas:
About Trier

(since July 2018) and adjunct professor at NCCU (since
any
September 2018).
Germ
Founded2004-2010
by the Romans, Northern
University capital
of Zurich, of the Roman empire, residence
Switzerland
of the archbishop of Trier, now a medium sized city (pop. 100000), on the
4
border toResearch
Luxembourg.
areas:
About University of Trier

(since July 2018) and adjunct professor at NCCU (since
any
September 2018).
Germ
Founded in the middle age, but closed down by Napoleon.
5
Reopened in 1970,areas:
Research today approx. 12000 students, located outside town.
And where are you from?
(Please turn on your camera!)
6
What are Cultural
Economics and Finance?
Culture, in particular  Economcis and Finance, i.e.

differences and similarities  everything related to
between different countries economic/financial decisions
Cultural
Economics and
Finance
7
Why do we study  
Cultural Economics and Finance?
‣ To understand differences between financial markets

and generally between economies.
‣ To understand differences between investors and

other economic agents from different cultural
backgrounds.
‣ To understand the world. (At least a little bit.)
8
Main Research
Methodologies
‣ Surveys
‣ Experiments
‣ Empirical analysis of financial market data
9
Table of Content
1. Foundations: Classical and Behavioral Preferences

2. How Culture Affects Economic Behavior
3. How Culture Affects Game Theory
4. A Closer Look at East Asian Cultures
5. Cultural Finance on the Market Level
6. Group Projects
10
Schedule
Week 1
‣ Lectures will be Mon/Tue/Wed/Thu/Fri, 4x45 min.,
including discussions on group projects
Week 2
‣ Mon/Tue/Wed/Thu: time for the work on the group
project
‣ Friday: group discussions on projects
Saturday, September 18
‣ presentations of group projects, concluding discussion
11
Information on  
Group Project (1)
‣ Please register for a topic on Wednesday during

class. (Topics will be presented tomorrow.)
‣ Each group consists of two students.  
(One group with three, in case of an odd number.)
‣ Each topic can only be chosen by one group.
‣ Please check in the Dropbox for topics, data and
references: 
https://tinyurl.com/CulturalEconomicsFinance
‣ If there are questions later, please send an email.
12
Information on  
Group Project (2)
‣ Each group project has 30 minutes to present (plus

discussion).  
‣ You can decide who is presenting. (Not everybody

must talk: maybe somebody is better at preparing,
others better at giving the talk. That’s perfectly fine.)  
‣ Please submit your slides as PDF at least two days

before your presentation to me by email. Please use
as file name TopicA.pdf, TopicB.pdf etc. and the
subject line UZH Seminar
13
Information on  
Group Project (3)
‣ Do not make slides with fluff (blinking stuff,

animations, colorful whatever). In academia, more is
less. We do not want to distract our audience! (Think
about these slides here.)
‣ Remember what everybody in the audience knows
and what not:  
only talk about what’s new for the audience!
‣ Focus on:
• your hypotheses,
• the variables that are important for your research
question,
• your own analysis!
14
Information on  
Group Project (4)
A good structure is:

‣ What do we want to study and why?
‣ Why do we expect a certain relation?  
(Maybe because of previous academic literature?)
‣ What variables did the survey measure to this aim and
how?
‣ How did we do the data analysis?
‣ What were the results? (Statistical significance!)
‣ Potentially, you can mention ideas what else to do, or
other interesting observations you made on the way.
15
Further Information on
Group Project
‣ Most topics are from ongoing research projects.
‣ Sometimes I already know what should come out of the data
analysis, sometimes I do not know yet. (In any case, feel free
to surprise me with new observations!)
‣ You are quite free regarding your precise research
methodology. OLS Regressions are often a good choice.
Make sure that the method fits the problem and is not
unnecessarily complicated.
‣ You may use any software for the analysis (SPSS, Stata,
SAS, R, Mathlab), but not only Excel!
‣ Make sure to consider statistical significance of your findings!
‣ Written report on presentation (including bibliography) to
be submitted by the official deadline via email, please
16
use the subject: UZH Seminar
Chapter 1
Foundations: 
Classical and Behavioral
Preferences
17
1.1 Expected Utility Theory
Important remark:
We first discuss only preferences regarding risk, not
regarding time.
The classical theory here has two historical roots:

‣ Bernoulli (18th century)
‣von Neumann-Morgenstern (1930s and 1940s)
18
St. Petersburg paradox
Imagine the following lottery:

‣Flip a coin until “head” falls.
‣If it comes the n-th time, you get 2n Euro.
How much would you maximally pay to participate?
19
Expected value of the lottery
Computing the expected value gives infinity (exercise!), so

why not paying more?
The reason is obviously the risk involved in this.

A good explanation to this “St. Petersburg puzzle” has first
been found by Bernoulli using an expected utility function...
20
Expected utility (1)
Daniel Bernoulli (1738) states: 

 
“Es gibt keinen Zweifel, dass der Gewinn von Tausend
Dukaten für einen Bettler bedeutender ist als für einen
reichen Mann, obgleich beide denselben Betrag
gewinnen.”
Nutzen
Vermögen
21
Expected utility (2)
Decision criterion: expected utility, i.e. expected value of u

with respect to p.
In the case of a lottery with discrete outcomes this yields
the formula:
U (p) = Ep (u) = u(x1 )p1 + u(x1 )p2 + . . .
In the case of a continuous lottery we obtain:

!
U (p) = Ep (u) = u(x)p(x) dx
22
following way:
Definition 2.6 (Concavity and risk-averse behavior). We call a
function u : R ⌅ R concave on the interval (a, b) (which might be R) if
for allRisk x2 ⇧ (a,and
x1 , aversion b) and
the utility (0, 1) the following inequality holds:
⇧function
Howu(x can1) +
we(1describe
)u(x2 )risk
⇥ u( x1 + (1with)x
aversion 2 ). utility function?
the (2.1)
We call uTheorem: 
strictly concave if the above inequality is always strict (for
x1 ⌃= x2 ).AWeconcave utility function
call a person risk-averseu describes a risk
if he prefers averse value
the expected
behavior.
of every lottery overAtheconvex
lotteryutility
itself.function
5 u describes risk seeking
2.2 Expected Utility Theory 17
behavior.  
We see that the application of Expected Utility Theory leads to quite
realistic results. We also u(x0see
) that a crucial factor for the explanation
of the attractiveness
u(x1 ) + (1 of insurances
)u(x 2)
and the solution of the St. Peters-
burg Paradox is the concavity of the utility function. Roughly spoken,
concavity corresponds to risk-averse behavior. We formalize this in the
following way:
Definition 2.6 (Concavity and risk-averse behavior). We call a
function u : R ⌅ R concave
x1 on the interval
x0 (a,xb)2 (which might be R) if
0 =1) xthe
for all x1 , x2 ⇧ (a, b) and ⇧x(0, 1 + following
(1 )x2 inequality holds:
Fig. 2.6. A strictly concave function. 23
u(x1 ) + (1 )u(x2 ) ⇥ u( x1 + (1 )x2 ). (2.1)

Axiomatic approach
Rational preferences between lotteries should satisfy

certain axioms.
Von Neumann and Morgenstern (1940) defined four
axioms:
The first two axioms are simple: 
(1) Completeness: We can always either say what we
prefer or we are indifferent.
(2) Transitivity: If I prefer B over A and C over B then I
also should prefer C over A. 
(Compare the fairy tale „Hans im Glück” or “Lucky Hans”)
24
Further axioms
(3) Independence: If I prefer A over B and if A’ and B’ correspond

with probability p with A and B and otherwise are indentical, than I
should prefer A’ over B’. 
(4) Continuity: If B is better than A and C is better than B, then

there is a probability p, such that pA and (1-p)C are equally good
as B. 
 
Example: There is a probability p that makes me indifferent
between 50 Euro and a lottery, where I get nothing with probability
p and 100 Euro with probability (1-p).
25
von Neumann-Morgenstern Theorem
These axioms are intersting because of the following theorem:

Theorem (von Neumann and Morgenstern):  
If the axioms (1)-(4) are satisfied, then the preferences can be
described by expected utility theory, i.e. there is a utility function u
that describes the preferences.
Remarks:
‣ u does not have to be concave!
‣expected utility is about final wealth, not about changes in
wealth, although it is often (falsely) applied to that!
26
1.2 Framing effect
When describing actual behavior, we find many violations

of the predictions made by expected utility theory.
We will discuss an important type of these violations in this
section.
27
Examples
We start with the classical example, the “Asian disease”:
Asian disease is expected to kill 600 people.

Two alternative programs, A and B, to fight the disease.
Scientific estimate of the consequences of adopting each
program:
A: 200 people will be saved [72 percent]
B: there is 1/3 probability that 600 will be saved, and 2/3
probability that no people will be saved [28 percent]
‣Majority is risk averse in this problem
28
Examples
A different formulation of this problem:
Asian disease is expected to kill 600 people.

Two alternative programs, C and D, to fight the disease.
Scientific estimate of the consequences of adopting each
program:
C: 400 people will die [22 percent]
D: there is 1/3 probability that nobody will die, and 2/3
probability that 600 people will die [78 percent]
‣Majority in this problem is risk taking.
‣Decisions depend on framing.
29
Examples
Another example:
Decision (i). Choose between:

A. a sure gain of 240 [84 percent]
B. 25 percent chance to gain 1000, and
75 percent chance to gain nothing [16 percent]
Decision (ii). Choose between:

C. a sure loss of 750 [13 percent]
D. 75 percent chance to lose 1000, and
25 percent chance to lose nothing [87 percent]
30
Examples
Since (i) and (ii) were presented together, respondents had

to choose one prospect from the sets:
‣A and C
‣ B and C [3 percent]
‣A and D [73 percent]
‣ B and D
However, B and C is superior to A and D!
‣Decisions are not integrated, framing occurs again.
When the choices are combined into one lottery, then it

becomes obvious and 100% choose B and C.
31
Examples
You have decided to see a play where admission is  

10 Euro per ticket.
As you enter the theater you discover that you have lost a
10 Euro bill.
Would you still pay 10 Euro for a ticket for the play?
‣Yes [88 percent]
‣ No [12 percent]
‣
32
Examples
You have decided to see a play where admission is  

10 Euro per ticket.
As you enter the theater you discover that you have lost
the ticket. Would you pay 10 Euro for another ticket?
‣Yes [46 percent]
‣ No [54 percent]
The difference between responses to problems 8 and 9 is

an effect of psychological accounting.
33
Examples
Two versions of this problem were presented to different

groups of subjects. One group was given the values that
appear in parentheses, the other group the values shown
in brackets.
You are about to purchase a jacket for (125)[15], and a
calculator for (15)[125]. The calculator salesman informs
you that the calculator you wish to buy is on sale for (10)
[120] at the other branch of the store, located 20 minutes
drive away. Would you make the trip to the other store?
‣68 percent of the respondents were willing to make an
extra trip to save 5 euro on a 15 euro calculator.
‣Only 29 percent were willing to exert the same effort
when the price of the calculator was 125 euro.
‣
34
Examples
What happened is that people seem to evaluate the

savings in relative, rather than in absolute amounts: they
are willing to travel for a 30% discount, but not for a mere
4% discount – even if the total sum saved is the same.
How about you? Are you going to another shop to save

20% on a liter of milk, but do not bother to save 5% on a
new jacket? – Maybe you have learned something useful
for your life here...?
35
1.3 Prospect Theory
We will present some more phenomena that contradict the

assumption that people behave according to expected
utility theory.
A decision model that can describe these phenomena is
prospect theory as introduced by Daniel Kahneman and
Amos Tversky (1979, 1992). We summarize these two
important papers in this section.
(Following slides thanks to Pengfei Sun)
36
making under risk for a long period
Decision
Prospect under
Theory Risk: A choice between prospects or gambles.
n
A Prospect is a contract (x1 , p1 ; ...; xn , pn ) with i=1 pi =1
where
xi denotes the outcomes i = 1...n;
pi denotes the probabilities i = 1...n;
(x,p) denotes the prospect (x,p;0,1-p).
We present now some experimental evidence that was the

starting point for the introduction of prospect theory.
QEM 2 Pengfei Sun Seminar “Behavioral Decision Theory and Finance”
37
Certainty Effect
People always overweight certain outcomes in comparison with
outcomes merely probable.
Prospect Theory
Problem 1: Choose between

A: 2,500 with p=0.33, B: 2,400 with p=1.
2,400 with p=0.66,
0 with p=0.01;
N = 72 [18] [82]*
Problem 2: Choose between
C: 2,500 with p=0.33, D: 2,400 with p=0.34,
0 with p=0.67; 0 with p=0.66.
N = 72 [83]* [17]
38
Violation from EUT: Several Counter Phenomena
Certainty Effect
Prospect Theory
With u(0) = 0, the first and second preference implies

0.34u(2, 400) > 0.33u(2, 500) and 0.34u(2, 400) < 0.33u(2, 500)
Problem 3:
A: (4,000,0.80), B: (3,000),
N = 95 [20] [80]*
Seminar “Behavioral Decision Theory and Finance”
Problem 4:
Prospect Theory: An Analysis of Decision under Risk
C: (4,000,0.20), D: (3,000,0.25),
Certainty
N = 95
Effect
[65]* [35]
Substitution Axiom of EUT: If B is preferred to A, then any

Certainty Effect
probability mixture (B, p) must be preferred to (A, p).
People always overweight certain outcomes in comparison with
outcomes merely probable. 39
Certainty Effect
Prospect Theory
Choice problems illustrate Certainty effect with non-monetary

outcomes
Problem 5:
A: 0.50 chance to win a B: A one-week tour of UK
three week tour of UK, with certainty.
France and Italy;
N = 72 [22] [78]*
Problem 6:
C: 0.05 chance to win a D: 0.10 chance to win a
three week tour of UK, one-week tour of UK with
France and Italy; certainty.
N = 72 [67]* [33]
40
Certainty Effect
Prospect Theory
Problem 7:
A: (6,000,0.45), B: (3,000,0.90),
N = 66 [14] [86]*
Problem 8:
C: (6,000,0.001), D: (3,000,0.002),
N = 95 [73]* [27]
Note: Problem 7,8 is another case which violate the substitution

axiom in EUT
41
rom EUT: Several Counter Phenomena
ection Effect
Prospect Theory
Reflection effect:
Preferences revert when losses instead of gains are

studied. (Remark: these are hypothetical decisions!)
Reflection Effect: the reflection of prospects around 0
reverses the preference order 42
Implication of Reflection Effect

Probabilistic Insurance
Prospect Theory
Probabilistic
Probabilistic insurance:
Insurance
People pay part of the premium and also have part of the chance
People pay part of the premium and also have part of the chance
to gettoallgetcover of the
all cover losses.
of the losses.
Problem 9: Now
Problem 9: Now youyou
cancanpay payhalf
halfof of the premium,inincase
the premium, case of of
damage, you you
damage, havehave0.50
0.50 chance
chancetotopay pay the other otherhalf halfofofthethe
premium
premium to covers
to covers all all
thethelosses;or
losses;or have
have 50 50 percent
percentchance chance to to
get back
get back insurance
insurance paymentand
payment andsuffer
suffer all
all the
thelosses.
losses.Would Would
you buy this insurance?
you buy this insurance?
N = 95 Yes[20] No[80]*
N = 95 Yes[20] No[80]*
If (w x, p; w , 1 p) ⇤ (w y ), then
If (w (w x,x, w ⇤y(w
p;(1w , 1r )p;p) , rp; w y ),rythen
, 1 p) ⇥ (w y ), 0 < r <
(w 1.x,⌅, (1 u isr )p; w y , rp; w ry , 1 p) ⇥ (w y ), 0 < r < 1
concave.
1. ⌅,This
u iscase
concave.
is inconsistent with concavity of u
This case is inconsistent
QEM 2
with concavity
Pengfei Sun
of u

43
Isolation Effect
Isolation Effect
Prospect Theory
Isolation Effect
PeopleIsolation
alwaysEffect
disregard the same components shared by the
Peopleand
prospects, always disregardwith
concerned the same components shared
the components by the them.
distinguish
prospects, and concerned with the components distinguish them.
Problem 10: Consider the two-stage game. In the first stage,

Problem 10: Consider the two-stage game. In the first stage,
therethere
is a isprobability of 0.75 to end the game without winning
a probability of 0.75 to end the game without winning
anything, andand
anything, a probability
a probabilityofof.25
.25to
tomove
move into thesecond
into the second
stage. In the
stage. second
In the stage
second stageyouyouhave
havechoice between(4,000,
choice between (4,000,
.80) .80)
and and
(3,000). Your
(3,000). choice
Your choicemust
mustbebe made beforethe
made before thegame
game
starts.
starts.
(4,000,
(4,000, 0.20) (3,000,0.25)
0.20) (3,000,0.25)
N=141 N=141 [22][22] [78]*
[78]*
44
Isolation Effect
Prospect Theory
Note: A pair of prospects can be decomposed into common and

distinctive components in more than one way, which leads to
preference inconsistency.
45
Isolation Effect
Prospect Theory
Framing effect again:
Problem 11: If you have been give 1,000. Now choose between
A: (1,000,0.50), B: (500),
N = 70 [16] [84]*
Problem 12: If you have been give 2,000. Now choose between
C: (-1,000,0.50), D: (-500),
N = 68 [69]* [31]
We get A = (2, 000, 0.50; 1, 000, 0.50) = C , B = (1, 500) = D

Remark: The common bonus is neglect. The carriers of value
or utility are change of wealth rather than final asset positions.
46
Prospect Theory
Prospect theory models the decision process in two steps:

‣Editing phase: Simplify representation of prospects.
‣Evaluation phase: The edited prospects are evaluated
and the prospect with higher “value” is chosen.
47
Prospect Theory
Editing phase (typical effects, not well-defined!):

‣Coding. Gains and losses are defined relative to the
reference point, which usually corresponds to the
current asset position Combination. e.g.(200, 0.25; 200,
0.25) reduced to (200, 0.50)
‣Segregation. e.g.(300, 0.80; 200, 0.20) is naturally
decomposed into a sure gain 200 and the risky prospect
(100, .80).
‣Cancelation. e.g. Isolation Effect
‣Simplification and the detection of dominance
48
Prospect Theory
Valuation Phase
Prospect Theory
Valuation phase:
The overall value of the edited prospects is calculated by value

function and weighting function.
Weighting function( ): for each p, (p) reflects the impact
of p on the overall value of the prospect, normally (p) ⇥= p
Value function(v): for each outcome x, v measures the value
of deviations from reference point, i.e.,gains and losses
Reference point:the x0 , such that v (x0 ) = 0
A simple prospect (x, p; y , q) with p + q 1 is strictly positive
if x, y > 0; is strictly negative if x, y < 0; is regular otherwise
49
Valuation Phase
Prospect Theory
(1) V (x, p; y , q) = (p)v (x) + (q)v (y ) where v (0) = 0,

(0) = 0, (1) = 1, either p + q < 1, or x ⇥ 0 ⇥ y , or y ⇥ 0 ⇥ x
(2) V (x, p; y , q) = v (y ) + (p)[v (x) v (y )]

if p + q = 1 and x, y > 0 or x, y < 0
Based on Axiomatic analysis, satisfy specific conditions ensure

the existence of a unique and v satisfying equation (1)
From (2), valuation of strictly positive and negative prospects
follows the riskless component and risky component
(2) reduces to (1) if (p) + (1 p) = 1.

50
Prospect Theory
Properties of Value Function

Prospect Theory
Properties of value function:

Defined on deviations from the reference point;
Concave for gains and convex for losses; for x > 0, v ”(x) < 0;
for x < 0, v ”(x) > 0
The differences of gains(losses) between 100 and 200 appears

greater than the differences of gains between 1100 and 1200.
Steeper for losses than for gains.v (x) < v ( x);

v (x) < v ( x) for x > 0
Most people find (x, 0.50; x, 0.50) unattractive. and

(y , 0.50; y , 0.50) is preferred to (x, 0.50; x, 0.50) if
51
x >y ⇥0
Prospect Theory
Properties
Prospect Theory of Weighting Function
Properties of weighting function:
(p) is the ratio of of the weight associated with p to the weight

associated with certain event.
⌅ 0 with (0) = 0 and (1) = 1
Sub-Additivity: For small p, (rp) > r (p) with r ⇥ (0, 1)
Overweighing for small p, (p) > p
SubCertainty: p ⌥ (0, 1), (p) + (1 p) < 1
Not well behaved near the end-points
(pq) (pqr )
SubProportionality: (p) ⇤ (pr ) ,0 < p, q, r ⇤ 1
If (x, p) ⌃ (y , pq) then (x, pr ) ⇧ (y , pqr ), 0 < p, q, r ⇤ 1
52
Prospect Theory
Graphics
Prospect Theory
Value function
Weighting function
53
Prospect Theory
Overweighting
Prospect Theory
Small Probabilities
Overweighting of small probabilities:
Problem 13:
A: (5,000,0.001), B: (5),
N = 72 [72]* [28]
Problem 13’:
C: (-5,000,0.001), D: (-5),
N = 68 [17] [83]*
Problem 13 explains people prefer what is in effect a lottery

ticket over the expected value of that ticket.
Problem 13’ explains they prefer a small loss, which can be
viewed as the payment of an insurance premium.
54

Risk Attitudes
Prospect Theory
An Allais-type violation will occur whenever the v-ratio of the

two non-zero outcomes is bounded by the corresponding
ratios. In Problems 1,2: (0.33)
(0.34) > v (2,400)
v (2,500) > (0.33)
1 (0.66)
Preferences for regular insurance over probabilistic insurance

if ( x, p) ⇤ ( y ), then
( y ) ⇥ ( x, p/2; y , p/2; y /2, 1 p)
Overweighting of small p is necessary for risk seeking in the

positive domains and risk aversion in negative domains.

55
So far the reference point was taken to be the current assets.
Prospect Theory
Reference
What aboutpoint
if the Shifts of the reference happened?
A change of reference point alters the preference order for

prospects. e.g. if (x, p; y , 1 p) is just acceptable then
(x z, p; y z, 1 p) is preferred over ( z) for
x, y , z > 0, x > z
56
Prospect theory
x x
p p
1-p 1-p
y 0
Risk taking: Risk taking:

v(px + (1
<latexit sha1_base64="PrzxyhlEUYZEB0RFmW/WzWHKh30=">AAACCXicbZDLSgMxFIYzXmu9jbp0EyzCDMUyI4IuXBTduKxgL9CWkknTNjSTCUmm7VC6deOruHGhiFvfwJ1vY9rOQlt/CHz85xxOzh8IRpX2vG9rZXVtfWMzs5Xd3tnd27cPDisqiiUmZRyxSNYCpAijnJQ11YzUhCQoDBipBv3bab06IFLRiD/oRJBmiLqcdihG2lgtGw4cMco7/plwE/d66Ah34Izc/HDmDJzEbdk5r+DNBJfBTyEHUpVa9lejHeE4JFxjhpSq+57QzTGSmmJGJtlGrIhAuI+6pG6Qo5Co5nh2yQSeGqcNO5E0j2s4c39PjFGoVBIGpjNEuqcWa1Pzv1o91p2r5phyEWvC8XxRJ2ZQR3AaC2xTSbBmiQGEJTV/hbiHJMLahJc1IfiLJy9D5bzgG76/yBVv0jgy4BicAAf44BIUwR0ogTLA4BE8g1fwZj1ZL9a79TFvXbHSmSPwR9bnD5RulxE=</latexit>
p)y) < w(p)v(x) + w(1 p)v(y) v(px) < w(p)v(x)
<latexit sha1_base64="PSV+cmmB3LCLzbDK80kHbvz9LDA=">AAAB9XicbZDLSsNAFIZPvNZ6q7p0M1iEdFMSEXThoujGZQV7gTaWyXTSDp0kw8ykF0Lfw40LRdz6Lu58G6dtFtr6w8DHf87hnPl9wZnSjvNtra1vbG5t53byu3v7B4eFo+O6ihNJaI3EPJZNHyvKWURrmmlOm0JSHPqcNvzB3azeGFKpWBw96omgXoh7EQsYwdpYT0NbjEs3I1uUhva41CkUnbIzF1oFN4MiZKp2Cl/tbkySkEaacKxUy3WE9lIsNSOcTvPtRFGByQD3aMtghEOqvHR+9RSdG6eLgliaF2k0d39PpDhUahL6pjPEuq+WazPzv1or0cG1l7JIJJpGZLEoSDjSMZpFgLpMUqL5xAAmkplbEeljiYk2QeVNCO7yl1ehflF2DT9cFiu3WRw5OIUzsMGFK6jAPVShBgQkPMMrvFkj68V6tz4WrWtWNnMCf2R9/gDTaZFo</latexit>
(Often the probability weighting function is abbreviated with w instead of 𝜋.)

57
Prospect theory
We obtain the condition:
w(p) > p
Losses Gains
Small no risk taking risk taking

Probability
Moderate risk taking no risk

Probability taking
58
Prospect Theory –
Four-fold pattern of risk attidues
Losses Gains
Medium probabilities Risk-seeking: Risk-averse:
Gambling after losses Safe investments
Low probabilities Risk-averse: Risk-seeking:
Buying insurances Playing at lotteries
59
Prospect theory – an exercise
Daniel Bernoulli, one of the founders of expected utility

theory, and Daniel Kahneman, one of the founders of
Prospect Theory go on vacation.
Both have two credit cards and two purses where to keep
them. Suppose the chance of loosing a purse is
independent of the chance of loosing the other purse and
the loss of one card is as bad as the loss of the other card.
‣ Who will put both credit cards into the same purse and
who will put one credit card into each purse?
60
Prospect theory
Examples for reference points:

‣buying price
‣initial wealth x risk-free rate
‣ wealth x benchmark return
Reference points do not contradict rationality if they are not
fixed, but in the above (typical) cases, they are!
Consider these investments in two frames:

Market
Absolute reference point: aspirations level
10% -5%
Relative reference point: market return
Hedge Fund 2% 1%
Which one is better? Index Fund 10% -5%
61
1.4 Cumulative Prospect
Theory (CPT)
Main problems left in the formulation of prospect

theory (PT):
‣ It is not easy to extend it to prospects with large number
of outcomes. The usual approach would be to define: 
  n
X
  V (xi ; pi ) := ⇡(pi )v(xi )
<latexit sha1_base64="NFov2dx0y0dILafaHa+NIVjBVi4=">AAACEHicbVDLSsNAFJ3UV62vqEs3g0VsNyURQVEKRTcuK9gHNDFMppN26GQSZibFEvoJbvwVNy4UcevSnX/jpO1CWw8MHM45lzv3+DGjUlnWt5FbWl5ZXcuvFzY2t7Z3zN29powSgUkDRywSbR9JwignDUUVI+1YEBT6jLT8wXXmt4ZESBrxOzWKiRuiHqcBxUhpyTOPm6UHj17GHi1fVB2ZhF5Kq/b4nkMnpqVMHmaBsmcWrYo1AVwk9owUwQx1z/xyuhFOQsIVZkjKjm3Fyk2RUBQzMi44iSQxwgPUIx1NOQqJdNPJQWN4pJUuDCKhH1dwov6eSFEo5Sj0dTJEqi/nvUz8z+skKjh3U8rjRBGOp4uChEEVwawd2KWCYMVGmiAsqP4rxH0kEFa6w4IuwZ4/eZE0Tyq25renxdrVrI48OACHoARscAZq4AbUQQNg8AiewSt4M56MF+Pd+JhGc8ZsZh/8gfH5A3J0m5I=</latexit>
i=1
‣ PT does not always satisfy stochastic dominance:

‣Discuss the following example in groups: 
What is better: a sure outcome of 10 CHF or a lottery
where you win 9.90 CHF, 9.91 CHF, …, 9.99 CHF,
each with probability 10%? What does PT say about
this problem?
Cumulative prospect theory can be used to solve these two
62
problems.
Stochastic dominance
Definition:
If for any given amount x, the lottery A has a higher (or at least
equally good) chance to yield x or more than B, then we say
“A stochastically dominates B”.
It’s quite rational to chose A in this case!
PT, however, does not always predict this, see the example in
the group discussion or this, even more extreme, one:
A: certain payoff of 100€
B: lottery with 1/100 probability each for 99€, 99.01€, 99.02€..
Here, the small probabilities will be overweighted, resulting in
a total PT-utility exceeding that of A.
This is certainly a problem of the theory! 63

Limits to stochastic dominance
How about stochastic dominance in real life situations?

Consider the following example:
Lottery A Lottery B
Prize Probability Prize Probability
96 Euro 90% 96 Euro 85%
14 Euro 5% 90 Euro 5%
12 Euro 5% 12 Euro 10%
Which lottery do you prefer?

64
Cumulative prospect theory
Another example:
One of four teams — the Cleveland Indians or Seattle
Mariners from the American League, or the Atlanta Braves
or Cincinnati Reds from the National League — will win the
1995 World Series.
The prospect below offers hypothetical amounts of money
depending on the outcome of the World Series.
Choice A: If an American League team wins the World
Series, You win $220. Otherwise You win $0.
Choice B: If the Cleveland Indians win the World Series,
You win $220. If the Seattle Mariners win the World Series,
You win $200. Otherwise You win $0.
Which one do you choose?
65
We see: there is some evidence against first order

stochastic dominance as descriptive criterion...
We will also see that it is possible to extend PT to lotteries

with many outcomes, but for now we discuss the “classical”
extension, cumulative prospect theory (CPT).
66
Decision Theory
Prospect Theory
Cumulative
Cumulative Prospect
Prospect TheoryTheory
Key idea: Replace the probabilities by differences of cumulative

probabilities.
Definition (Cumulative Prospect Theory)
For a lottery A with n outcomes x1 , . . . , xP
n and the probabilities
p1 , . . . , pn where x1 < x2 < · · · < xn and ni=1 pi = 1 we define
n
X
CPT (A) := (w (Fi ) w (Fi 1 )) v (xi ), (1)
i=1
Pi
where F0 := 0 and Fi := j=1 pj for i = 1, . . . , n.
How this formula is connected to Prospect Theory is written in the 67

book on page 60.
Decision Theory
Prospect Theory
Cumulative Prospect Theory

Cumulative Prospect Theory
On average, events are neither over- nor underweighted in CPT,

see page 61 in the book. “Financial Economics” (Hens/Rieger).
Prototypical example of a value function v :
(
x↵ , x 0,
v (x) := (2)
( x) , x < 0,
Value and weighting function:
68
us first extend CPT violation of stochastic
to arbitrary dominance,
lotteries. Since we lack of continuity) and p
all the
sume state-independent modified theory still
preferences, a good
we can descriptive
describe model of behavior
lotteries
Let us first
bability measures, see Appendix A.4 extend CPT to arbitrary lotteries. Since
for details.
timetheory
Cumulative prospect assume state-independent preferences, we can descri
tion 2.35. Let p be by an probability
arbitrary probability
measures,measure,
see Appendixthen theA.4 for details.
ized form ofCPTCPTfor 17 continuous
reads as distributions:
Definition
! +∞ ⇤ " 2.35. Let ⇥ p#be an arbitrary
⇤ probability measur
generalizedd d form of CPT17 reads as ⇥
CP T (p) := v(x) w± (F (x))
w(F (t))|t=x
v(x)dx,dx = w± (F (x))v(x)p(x) dx
(2.9)
−∞ dxdt ! +∞ " #
d
‣Here we have redefined CP T (p) w, :=
since−∞ v(x) wew(F
otherwise (t))|
have to t=x dx,
dt
write two integrals:
! t one for gains and one for losses...
(Exercise:
Fwhere
(t) :=how dodp. we have to transform w?) 
−∞ ! t
cognoscenti we‣F remark
is the cumulative
that the formula (2.6)   for
probability: F (t) :=
lotteries dp.
with
−∞
many outcomes is just a special case of (2.9) when choosing p
‣ The second
ite sum of Diracs. For theformulation
cognoscentiis we only valid ifthat
remark certain
the formula (2.6) for lo
nition 2.35 pathsmathematical
the way to
finitely conditions
applications
many holdof(smoothness,
outcomes isCPT
just in decay
financial
a special caseatof (2.9) when
infinity).
ics and other areas as aIt finite
where ismodels
derived using
sumrequire partial
more than
of Diracs. integration.
just a cou-
otential outcomes. Although it looks
Definition 2.35atpaths
first glance
the way muchto more
applications of CPT
69
d than its finite counterpart
economics(compare
and other Definition
areas where ??),models
a closerrequire more than
Advances in Prospect Theory - Cumulative Prospect Theory
Value Function and Cumulative Weighting Function
Qualitative Properties
Qualitative features of functions:
Value Function
Diminishing Sensitivity.x ⇤ 0, v ”(x) < 0; x ⇥ 0, v ”(x) > 0
Loss Aversion.v (x) < v ( x) for x > 0 (in the case 𝛼=𝛽)
Cumulative Weighting Function.

Two boundaries: Certainty and impossibility.
Diminishing Sensitivity. Concave near 0 and convex near 1.
Subadditivity for very unlikely and Superadditivity near
certainty.
Behaves not well near the end points, may either overweight or
neglect the very small probabilities.
70
suggest the reader to try Exercise 2.6, given at the end of this chapter.
We turn our attention now to stochastic dominance. Does CPT
violate stochastic dominance? The answer is given by the following
proposition:
Proposition 2.36.
2.39 CPT does not violate stochastic dominance, i.e. if
A is stochastic dominant over B then CP T (A) > CP T (B).
17
Here we consider again only the form defined in this book. In the original for-
mulation we would need to write down two integrals for negative and positive
outcomes and invert the direction of integration on the latter one. Compare the
remark after Def. 2.34
71
ulting function v has a “kink” at zero, a marginal loss is considere
robability events in than
lot more important the mid-range
a marginalofgain. outcomes play ameasured a
λ is usually
mewhere between 2 and 2.5.
Cunmulative prospect theory – classical form of value
her related theory,
and weighting functionsRank Dependent Utility (RDU),
CPT and shares the cumulative probability weighting

ver, it does not use the framing of PT and CPT, but
utility function in units of finite wealth, compare ??.
e CPT for applications, in particular in financial eco-
to choose specific forms for v and w.
cal example of a value function v has been given in
(0, 1) and λ >561: 2 Decision Theory
p γ
α,
"
x x ≥ 0 function
Fig. 2.13. Value and weighting w(p) :=suggested by [TK92] ,
v(x) := β (p + (1(2.7)
γ γ
− p) )1/γ
−λ(−x) , x < 0,
compare Fig. 2.13. It is possible to assign different w
3.The
The parameter
probability λ reflects
forweighting
gains the (denoted
andfunction
losses experimentally
w has been
by wgiven
+
ob-
and by
w− , where
people react tothelosses stronger
constant γ is than to gains:
replaced the re-are also diff
by δ). There 72
Other forms have been suggested.

‣Problems with large losses: people become risk-averse
again!
‣ Mathematical difficulties with value function.
‣Problems with St.Petersburg paradox: we will discuss
this point in details.
73
1.5 CPT and the St.Petersburg
paradox
St. Petersburg paradox had been resolved by expected

utility theory.
However, not completely: there is the so-called “Super-St.
Petersburg paradox” by Menger:
‣ Flip a coin until “head” falls.
‣If it comes the n-th time, you get 22^n Euro.
In this case, even a standard concave utility function yields
an infinite utility.
Two possible solutions (exercise!):
‣ Allow only for lotteries with finite expected value.
‣Take bounded utility functions.
74
Petersburg Paradox”. He concluded that unless the utility function is bounded, it is
impossible to discriminate all possible probability distributions. One could argue,
however, it is not necessary to discriminate all possible probability distributions,
because no individuals or organizations can offer a lottery with unlimited EV.
Arrow result
Actually, Arrow [2] pointed out that if we only consider distributions with finite
EV, we can still guarantee finite expected utility even though the utility function is
Arrow (1974) gives the following precise result:
unbounded. More precisely he found the following result:
Proposition 1 Let p be a probability measure with finite EV E(p) < ∞ and let
! : R → R be a strictly increasing, concave utility function, then the utility U (p) :=
u
u dp is finite.
(We remark again that this statement is a generalization of the case of discrete
outcomesIn prospect
where the theory
integral there is a by
is replaced potential problem:
a sum. Hence the usual formulation of
the St.probability weighting
Petersburg problem gives
in terms of amore weight
discrete lotterytoisextreme
included.)events,
In thus
other the utility
words, the might still become
St. Petersburg paradoxinfinite.
can be resolved by allowing only
for “realistic” lotteries, i.e., under the assumption of a finite EV, a (not necessarily
strictly) concave utility function is sufficient to guarantee that the expected utility
In the following we will discuss this problem in details.
is finite.
Even though this fundamental statement is mathematically easy in the frame-
work of expected utility theory, it turns out to be false in the context of CPT. In fact,
we will show in the Section 2 that in cumulative prospect theory a gamble with a
finite EV can have an infinite subjective value – independent of the concavity75 of the
value function u.
The central result of this section is the following Theorem 1. It provides precise
conditions under which the St. Petersburg paradox in CPT occurs. We will later
derive several results from this theorem which are more accessible and which cover
General result
situations of particular interest, compare Theorems 3–5.
Theorem 1 (General result) Let U be a CPT subjective utility given by
! 0 ! +∞
d d
U (p) := u(x) (w− (F (x))) dx + u(x) (w+ (F (x))) dx,
−∞ dx 0 dx
where the value function u is continuous, monotone, convex for x < 0 and concave
for x > 0. Assume that there exist constants α, β ≥ 0 such that
u(x) |u(x)|
lim = u1 ∈ (0, +∞), lim = u2 ∈ (0, +∞), (3)
x→+∞ xα x→−∞ |x|β
and that the weighting functions w± are continuous, strictly increasing functions
from [0, 1] to [0, 1] such that w± (0) = 0 and w± (1) = 1. Moreover assume that
w± are continuously differentiable on (0, 1) and that there are constants δ, γ > 0
such that
′
w− (y) 1 − w+′
(y)
lim = w1 ∈ (0, +∞), lim = w2 ∈ (0, +∞). (4)
y→0 y δ−1 y→1 (1 − y)γ−1
Let p be a probability distribution with E(p) < ∞. Then U (p) is finite if α <γ
and β < δ. This condition is sharp as can be seen from Theorem 2 below.
76
In particular, the subjective utility may be infinite for distributions with 2006)
(Rieger, Wang, finite
Cumulative
Exampleprospect theorywith
for a lottery and the St.expected
finite Petersburgvalue,
paradox
but 671
infinite subjective utility
Theorem 2 (Finite EV, but infinite subjective utility) Let γ, α ∈ (0, 1), q > 2.
Let the probability density p of possible outcomes be given by
!
0, x≤1
p(x) :=
Cx−q , x > 1,
"∞
where C := 0 x−q dx.
Let the weighting function w+ : [0, 1] → [0, 1] be given by (2) and the
value function on u : R+ → R be given by (1), i.e. value- and weighting func-
tion are "chosen as in the original work by Tversky and Kahneman [15]. Let
x
F (x) := −∞ p(x) dx be the total probability for an outcome less than x. Then we
have E(p) < +∞ and u strictly concave, but for α >γ and q sufficiently close to
2 the subjective utility is infinite, i.e.
#
d
U (p) := u(x) (w(F (x))) dx = +∞.
dx
77
This result shows that it is not possible to resolve the St. Petersburg paradox in
U (p) = u(x) w(F (x)) dx ≤ u(b) w(F (x)) dx
directly.
We firstWeconsider
assume afor conditionsdx
simplicityon that w := w− =
the probability dx
w+a, use the
distribution of monotonicity
the outcomes.of Theu
and
St. Petersburg ∈=[0u(b)(w(F
that w(F ) paradox (b)) − w(F
, 1]: can obviously not(a)))
occur≤if u(b) < ∞.ourselves to a finite
we restrict '
⊓
set of possible outcomes, ! b but even a bounded set of !possibleb
outcomes suffices to
preventMany
Special interesting
infinite
cases utility: d distributions (e.g. normald Gauss distributions) do
probability
U (p) = u(x) w(F (x)) dx ≤ u(b) w(F (x)) dx
not have a boundedasupport.dxTherefore the following extension a dx is useful:
Theorem 3 (Finiteness = u(b)(w(F for (b))
special
− w(Fdistributions
(a))) ≤ u(b) I) Let
< U∞.be a CPT subjective
Theorem 4 (Finiteness foraspecial distributions II) with
Let Ubounded
be a CPT subjective '
⊓
utility functional and p be probability distribution support, i.e.
utilitypfunctional
supp :=interesting
{x ∈ R; andp(x) p be >a probability
[a, b],distribution
0} ⊂distributions
where(e.g. with
−∞exponential
a >normal and +∞.decay
Then
b < distributions) +∞,
at U (p)
Many probability Gauss do
there exist a, b, c > 0such that p(x) ≤ ae
i.e.finite.
is
−bx
for all x ≥ c. Moreover, assume
not have a bounded support. Therefore the following extension is useful:
that (4) holds. Then U (p) < +∞. (The corresponding condition for −∞ would
ensure This
Proof.
Theorem (p) > −∞.)
that4 Ufollows
(Finiteness fromfor thespecial
general result, Theorem
distributions 1, U
II) Let butbeit acan
CPTalso be seen
subjective
directly.
utility We assume
functional andfor p besimplicity
a probability w := w− =with
that distribution w+ ,exponential
use the monotonicity
decay at +∞,of u
Proof.
and that This
w(F result
) ∈ [0 is, 1]:
an immediate consequence −bxof Theorem 6. '
⊓
i.e. there exist a, b, c > 0such that p(x) ≤ ae for all x ≥ c. Moreover, assume
that If(4)one holds.
wantsThento!allowUb (p)for +∞. (The
<arbitrary corresponding
probability ! b condition
distributions, a for −∞
general would
finiteness
d d
ensure thatU (p)
U (p)
= >
result can be given for bounded −∞.)u(x) w(F (x))
value dx ≤
functions: u(b) w(F (x)) dx
a dx a dx
Proof.
Theorem This5 result= u(b)(w(F
(Bounded value(b))
is an immediate w(F (a)))
−consequence
functions) Let U≤of Theorem
beu(b)
a CPT 6.
∞.
< subjective utility func-'
⊓
'
⊓
tional with bounded value function |u(x)| ≤ C and let p be a probability distribu-
If one wants to allow for arbitrary probability distributions, a general finiteness
tion.Many
Theninteresting
U (p) is finite. probability distributions (e.g. normal Gauss distributions) do
result
not have canabe given for
bounded bounded
support. value functions:
Therefore the following extension is useful:
Proof. Again, this is a corollary of Theorem 1, but a direct proof, following the
Theorem 5 (Bounded value functions) Let U be a CPT subjective utility78 func-
Theorem
ideas of the 4 proof
(Finiteness
of Theorem for special distributions
3 is also easy. II) Let U be a CPT subjective '
⊓
tional with bounded value function |u(x)| ≤ C and let p be a probability distribu-
utility functional and p be a probability distribution with exponential decay at +∞,
674 M.O. Rieger and M. Wang
Parameter
T estimates
able 1. Experimental for prospect
values of α, β andtheory from
γ, δ from various
various studies, compare (3) and (4) for the precise
¯definition of α, β, γ, δ
stuides
Study Estimate Estimate α <γ

for α,β for γ, δ β<δ
Tversky and Kahneman [15]

gains: 0.88 0.61 no
losses: 0.88 0.69 no
Camerer and Ho [6] 0.37 0.56 yes
Tversky and Fox [14] 0.88 0.69 no
Wu and Gonzalez [18]

gains: 0.52 0.71 yes
Abdellaoui [1]
gains: 0.89 0.60 no
losses: 0.92 0.70 no
Bleichrodt and Pinto [5] 0.77 0.67/0.55 no
Kilka and Weber [10] 0.76–1.00 0.30–0.51 no
79
Possible solutions – summary
1. If we allow only for probability distributions with

exponential decay at infinity (or even with bounded
support), the problem does not occur, as we have proved in
Theorem 4 and Theorem 3. In many applications, this is
the case. However, it seems to be somehow dissatisfying
to work with this restriction. In particular in problems where
we are interested in finding the optimal probability
distribution (subject to some constraints), it might well
happen that we obtain a “solution” with infinite subjective
utility.
80
2. It is possible to assume that γ > α and δ > β , where γ , δ

are the parameters of the weighting function and α, β are
the growth rates of the value functions. By Theorem 1 this
is sufficient to ensure finite subjective utility. Unfortunately,
this assumptions seems to contradict many of the
measured parameters in experiments.
81
3. The value function can be modified for large gains and

losses such that it is globally bounded. This again ensures
a finite subjective utility (compare Theorem 5).
4. The final idea is to modify the weighting function w such

that its slope at zero is finite. This guarantees a finite
subjective utility, independently of the choice of the value
function (as long as it has a convex-concave structure).
82
1.6 Continuity and
prospect theory
We have seen that CPT can be extended to continuous

outcomes (important, e.g. in finance).
How about PT?
We will see: it is possible to extend PT to continuous
outcomes and the resulting model is substantially easier
than CPT (Rieger, Wang, 2008).
However: we need some mathematical machinery to make
this happen...
83
problem of continuity: a small change of a lottery (e.g. splitting a single
outcome into two similar outcomes) changes the PT-value often substantially.
This is the cause of several theoretical problems of PT that could only be
resolved using cumulative prospect theory. Already Kahneman and Tversky
(1979) suggest a so-called “editing phase” before the evaluation of the formula
for the
Approximation PT-value. In the editing phase in particular nearby outcomes are
idea
combined. We formalize this process and call the resulting modified theory
smooth prospect theory (SPT). We show that this theory is in fact continuous.
Mathematical idea:
Its key idea is to approximate
make the outcomes “fuzzy”,ai.e.probability distribution
replacing an outcome at, say, by
discrete probabilities
x by an (“histograms”):
outcome-distribution around x. Nearby outcomes are then handled
as something in between two separate outcomes and one combined outcome,
Fig. 1 Non-discrete outcome distributions are approximated by finer and finer histograms of
uniform width
84
and Tversky (1979) was only defined for lotteries with, at most, two non-zero
outcomes, it can be generalized to n outcomes. Generalizations have been
used by various authors, e.g., Fennema and Wakker (1997), Camerer and Ho
(1994), Wakker
Karmarkar (1989), Schneider and Lopes (1986). In this article, we study
formulation
the original formulation for n outcomes by Karmakar (1978). The value of a
We need to use a “normalized” form of PT, introduced by
lottery with outcomes xi , each of probability pi , is then given by
Karmarkar (1978):
!n
i=1 w( pi )v(xi )
PT = !n . (1)
i=1 w( pi )
In difference to Kahneman and Tversky (1979) the PT-value is here nor-

malized Reason:
by the sumthe Kahneman-Tversky form attachesWe
of the weighted probabilities. larger
willand
see later why
larger utilityistonecessary
this normalization an increasing
whennumber of small
studying probability
a large or infinite number of
events. (We will see this later.)
outcomes.
Since Tversky and Kahneman (1992), the value function in PT is often
chosen as
"
xα , x≥0
v(x) :=
−λ(−x)β , x < 0,
where λ ≈ 2.25 is called “loss-aversion” coefficient, and α, β describe the risk-
85
attitudes for gains and losses. The choice for the weighting function given by
use the extension of PT as given in Eq. 1. For some refreshment on
athematical background of the related concepts, we refer the reade
ppendix 1.
Naive approach
To extend PT to continuous distributions, we first consider a naive appro
ere we simply
But whydefine the PTusing
not simply utility
theof a continuous
naive distribution
approach and define: p on R
! "
v(x)w( p(x)) dx,
v(x)w( p(x)) dx, or " ,
w( p(x)) dx,
ere v is the value
Doesn’t thisfunction and w the weighting function as specifie
look right?
. 2.
Why do those “natural” attempts for extensions not work? First of
e probability density p(x) might take values larger than one, but w is
fined for values in [0,1]. Moreover, both formulas do not satisfy one of
ost natural requirements for a decision theory: they are not invariant un
anges of the coordinate system. If we “relabel” the monetary units f
ros to cents, for example, it will lead to lower values of p and hence
ferent over- or underweighting of the probability distribution:
86
most natural requirements for a decision theory: they are not invariant under
changes of the coordinate system. If we “relabel” the monetary units from
euros to cents, for example, it will lead to lower values of p and hence to a
different over- or underweighting of the probability distribution:
Counterexample to naive approach
Example 1 Let x be first given in euros and let p be an outcome distribution

that attaches uniform probability for all outcomes between 0 and 1, i.e.
#
1, for x ∈ [0, 1],
p(x) :=
0, elsewhere.
The PT-value therefore depends on w(1) = 1. For v(x) = x we have PT = 1/2.
Now let us consider the same lottery in cents. Then p becomes:
#
1/100, for x ∈ [0, 100],
p(x) :=
0, elsewhere.
The PT-value in the first formulation depends now on w(1/100) which is
overweighted and therefore larger than 1/100. For v(x) = x/100 (which gives
the same value function as before after conversion into cents) we hence have
PT = 50 · w(1/100) > 1/2.
To show a contradiction to the second possible formulation, a slightly more
complicated example would be needed, but the idea is the same.
87
of convergence. In other words: we want to define when a measure p is
approximated by a sequence of measures ( pn )n∈N . In order to motivate the
mathematical definition, let us consider first the naive approach: we define
an approximation by requiring that pn (x) converges to p(x), i.e. that the
probability pn (x) of every outcome xconverges to p(x). This seemingly natural
Math background
approach fails for two reasons: first, we are dealing with probability measures
Definition
for which 0 (Dirac
it is difficult measure,
to define p(x) in abs. cont. measure)
a reasonable way. ( p is not simply a
A Dirac
function.) measure
Second, we wouldonexclude
R is a that
measure
pn = δδ x with
1/n δx(A)=1 piff=xδ0is, thus
approximates
the convergence
in A and zeroproperty would be too strong.
otherwise.
There is a better approach: We could say that pn converges to p if every
A measure is absolutely continuous if it can be written as
expected utility of pn converges to the expected utility of p. This would imply
with rational
that, in the limit, every a continuous function
person would p.
be indifferent between p and pn .
p(x) dx
ThisAidea motivates the mathematical concept of weak-⋆-convergence:
Definition 1 (Weak-⋆-convergence of probability measures) We say that a se-

quence ( pn ) of probability measures on R N converges weak-⋆ to a probability
measure p if for all bounded continuous functions f
" "
f (x)dpn (x) → f (x)dp(x)
RN RN
⋆
holds. We write this as pn ⇀ p. The function f is sometimes called a test
function.
88
To see the correspondence to the intuitive approach sketched above, con-

possible outcomes into intervals of size 1/n, we arrive at a lottery pn . This
process can be interpreted as the construction of a histogram from a probability
distribution. When n → ∞, this approximation becomes better and better, and
our hope is that the associated PT-values of pn will eventually converge to a
Definition
PT-value of represents
that approximation
the continuous distribution given by p.
Mathematically
We define the spoken, we decompose
following R intoofintervals
approximation of equal
a measure by size 1/n
and replace on each interval p by a Dirac measure of corresponding weight.
finite weighted sums of Dirac measures:
More precisely, we define
! z+1
"
n
pz,n := dp, p̄n := pz,n δz/n .
z
n z∈Z
The measures p̄n are still infinite# sums of Diracs, but since p is a probability
measure, it is easy to see that [z/n,(z+1)/n) dp → 0 for |z| →∞ , thus we can
neglect all, but finitely many intervals by making an arbitrarily small error.
We call the resulting measure pn . By a small lemma (McCann 1995), this
⋆
approximates in fact p; in mathematical language: pn ⇀ p.
Generally, we can use any decomposition of R into equally sized intervals
[xi , xi+1 ) where the size hn := |xi − xi+1 | → 0 and the union of these intervals
89
natural possible choice that we can make.2
We will demonstrate in the next section how incorporating the editing phase
of prospect theory into our consideration makes it possible to derive this limit
for arbitrary approximating
Convergence sequences.
theorem for prospect theory
Theorem 1 Let p be a probability distribution on R with exponential decay

at infinity and let pn be defined as above. Assume that v ∈ C1 (R) has at most
polynomial growth and that for the weighting function w : [0, 1]→[0, 1]there
exists some α ∈ (0, 1) and some finite number C > 0 such that
w(ε)
lim α = C (4)
ε→0 ε
for ε → 0. Then the PT utility as formulated by Karmakar (1978)

!
z w( pn,z)v(z/n)
PT( pn ) = !
z w( pn,z)
converges to "
v(x) p(x)α dx
lim PT( pn ) = PT( p) := " . (5)
n→∞ p(x) dx
α
The proof is given in Appendix 2. It can be easily generalized to the following

90
case, which is important in many applications:
functional form of w, which can also be seen as a conceptual advantage.
Let us now explain why it is essential to use the formulation
# of n-outcome
lotteries by Karmarkar and not the formulation " PT( p) = w( pn )v(xn ), as in-
troduced
Resultimplicitly in Schneider and
for the Kahneman-Tversky Lopes (1986). We will show the following
formulation
(at first glance slightly surprising) result:
Why do we use the Karmarkar formulation?
Theorem 2 Let p be a continuous probability distribution on R with expected
utility
$
EU( p) := v(x) p(x) dx ̸= 0
and let pn be defined as above. Assume v ∈ C1 (R). Moreover, assume that for
the weighting function w : [0, 1]→[0, 1]there exists some α ∈ (0, 1]. Then the
"
PT utility of Schneider and Lopes (1986)
%
J Risk Uncertainty (2008) 36:83–102
" 91
PT( pn ) = w( pn,z)v(z/n)
z
converges to
"
∞, if α < 1,
lim !PT( pn ) = !
n→∞
3 The assumption can be weakened, e.g. to Cp(x)
· EU( p),
α dx < +∞ ififv isαbounded.
= 1, 91
1.7 SP/A
SP/A theory
‣introduced by Lopes and Oden (1999)
‣ based on studies on emotions
‣Security, potential and aspiration
92
Goal
We want to show that SP/A theory and CPT are

mathematically closely related.
This leads to interesting applications for the modeling of
investor preferences.
‣We will use this in the next chapter when studying
optimal payoff structures.
‣This a summary of the following article: 
M. Rieger: SP/A and CPT: A reconciliation of two
behavioral decision theories, Economics Letters 108
(2010) 327–329
93
SP/A theory
We first consider SP/A theory: let a lottery be given by N outcomes

xi (i = 1,...,N) with probabilities p i. SP/A theory combines the following
opes expressions for SP and A:
rsky
that SP = ∑ðhðDi Þ−hðDi + 1 ÞÞuðxi Þ;
i
SP/A
from where Di = ∑ N n = i p n is the decumulative probability, h is a weighting
logy. function (typically S-shaped) satisfying h(0) = 0 and h(1) = 1, and u is
that a concave utility function.
riate
A = Probðx ≥ αÞ;
mics
been where x denotes the outcome of the lottery and α is a certain
94
bout aspiration level.
Lopes expressions for SP and
We first consider SP/AA:theory: let a lottery be given by N outcomes
ersky xi (i = 1,...,N) with probabilities p i. SP/A theory combines the following
kpes
that SP = ∑ðhðD
expressions fori Þ−hðD
SP and 1 ÞÞuðxi Þ;
i +A:
SP/A
sky
Author's
i
SP/A theory
personal copy
from
that = ∑DðhðD
SPwhere i=∑
N
i Þ−hðD 1 ÞÞuðx
n = i p in+is i Þ;
the decumulative probability, h is a weighting
ology. i
P/A function (typically S-shaped) satisfying328 h(0) = 0 and h(1) = 1, and u is
romthat a concave utility
N function.
where D =∑
i n=i np is the decumulative probability, h is a weighting
priate
ogy. M.O. Rieger / Economics Letters 108 (2010) 327–329
function (typically S-shaped) satisfying
domainsh(0) = 0w
with and h(1) = 1, and u is
±(0) = 0 and w±(1) = 1. P
A = Probðx ≥ αÞ;
that a concave utility function.
omics w are defined such that the relative influence
wiate
± (1) = 1. Psychologically, v and
been where x denotes the outcome and ofprobability
the lotterydiminishes
and α is aforcertain
large values, a
ve influence ≥ αÞ; in outcome
of changes
A = Probðx
about aspiration level. of psychophysics.
rge values, SP
mics according to the ideas
and A are combined, such that the final decision criterion is a
dings
een where x denotes the outcome of the lottery and α is a certain
2006) function f (SP,A) where f is increasing in both variables.
out aspiration level. 2. Bridging2the gap
en to CPT on the other hand assigns a utility
ngs SP and A are combined, such that the final decision criterion is a
utility
06) function f (SP,A)
N where f is increasing We in
nowboth variables.
study a specific formulation of SP/
y has CPTðAÞ =the∑other
ðw# ðF Þ; 2
nlation
to CPT on i Þ−wassigns
hand # ðFi−1
be
ÞÞvðx
a utility
connected
i to CPT. Let us assume
ð1Þ
that the fun
blem of SP/A and show
i=1 how it can
eility
that the function Nf is given by f(SP, A) = SP + h(A). Since the probability weightin
i
has
lity where
cally,weighting
CPTðAÞ = F =
h0 is 0 and F
∑increasing, = ∑
ðw# ðFiiÞ−w#this j for i = 1,...,N
= 1pfunction
jðF and w± means
is admissible that ð1Þ
for SP/A. the
i−1 ÞÞvðxi Þ;
lem
an be function iw=+1 is applied for all positive outcomes and w− for all
Let us denote the resulting “utility” by SPA,
95
negative
lity” by SPA, thenoutcomes. Here v isita convex–concave shaped value function
we can rewrite i as
in an appropriate A = Probðx ≥ αÞ;
ioral economics A = Probðx ≥ αÞ;
wever, has been
avioral economics where x denotes the outcome of the lottery and α is
decisions
owever, has
CPTabout
been aspiration
(cumulativewhere level. the outcome of the lottery and α is a cer
denotes
prospectxtheory)
r decisions
mpirical about
findings SP andlevel.
aspiration A are combined, such that the final decision cri
empirical
Silvestre findings
(2006) SP andfA(SP,A)
function are combined,
where f is such that the final
increasing decision
in both criterion
variables.
d Silvestre (2006) function
CPT f (SP,A)
on the where hand
other f is increasing
assigns inutility
a both variables.
2
ms had been to 2
ems had been to CPT on the other hand assigns a utility
expected utility
expected utility N
SP/A theory has CPTðAÞ = N∑ ðw# ðFi Þ−w# ðFi−1 ÞÞvðxi Þ;
d SP/A theory has CPTðAÞ = ∑
w this problem i = 1ðw# ðFi Þ−w# ðFi−1 ÞÞvðxi Þ;
how this problem i=1
i
mathematically, where F = 0 and F = ∑i p j for
where F0 0= 0 and Fi =i ∑ j = 1j p=j 1for i = 1,...,N
i = 1,...,N and
and w w± mean
± means that
s mathematically,
e ofofSP/A
ase SP/Acan
can be
be functionww
function ++is isapplied
appliedforforall all positive
positive outcomes
outcomes and wand w
− for
negativeoutcomes.
negative outcomes. Here
Here v isvaisconvex–concave
a convex–concave shaped
shaped value valu
func
and
and ww±±areareprobability
probability weighting
weighting functions in the
functions in gain
the and
gain
2
2 CPT is usually defined by a decumulative weighting in gains and a cumul
CPT is usually defined by a decumulative weighting in gains and a
weighting in losses, but redefining w± can be used to arrive at our more com
weighting in losses, but redefining w± can be used to arrive at our m
more details. formulation. 96
ore details. formulation.
A) = SP + h(A). Since the probability weighting h is increasing, t
function is admissible for SP/A.
Let us denote the resulting “utility” by SPA, then we can rewrit
asReformulating SP/A Theory
SPA = ∑½ðhðDi Þ−hðDi + 1 ÞÞuðxi Þ$ + hðProbðx ≥ αÞÞ

i ! "
= ∑½ðhðDi Þ−hðDi + 1 ÞÞuðxi Þ$ + h Dminfi:xi ≥ αg
i
= ∑½ðhðDi Þ−hðDi + 1 ÞÞuðxi Þ$ + ∑ ½hðDi Þ−hðDi + 1 Þ$
i fi:xi ≥ αg
# $
= ∑ ðhðDi Þ−hðDi + 1 ÞÞðuðxi Þ + aðxi ÞÞ ;
i
with
%
0; x b α;
aðxÞ =
1; x ≥ α:
97
Let us denote v(x) = u(x) + a(x) and w(D) = h(D), then we ha

risk-aversion. and of th
2. Medium probabilities in losses: v has a jump at zero, so as long as (1992), w
there is a chance to avoid losses and as long as potential losses are difference
not too big, people tend to be risk-seeing. If there are only losses concavity
possible,
Value function theyfrom
resulting would
SP/Abe risk-averse, unless the reference point losses the
illustrate t
3. Conclus
We se
psycholog
think at fi
within on
gives som
should loo
different m
Acknowle
I am gr
related to
Fig. 1. The function v implied by SP/A is the sum of a concave function u and a jump at α Wang for
(which we set to zero for convenience). Centre of
98
with
%
0; x b α; 3.
aðxÞ =
x≥
Connecting1;SP/A andα:
CPT
Let us denote v(x) = u(x) + a(x) and w(D) = h(D), then we have
reached Eq. (1), just that value and weighting functions are defined
slightly differently: av
1. v is no longer convex–concave, but a piecewise concave function as

with a jump at x = α, compare Fig. 1. We call α the reference point In
which can be set to zero for simplicity. sm
2. In order to copy the cumulative weighting in losses in CPT, we ar
need to define h(D) = 1 − w(1– − D) in the loss region (below the th
reference point α) and h(D) = w(D)
+
in the gain region (above α). If fu
we use the symmetric weighting function suggested by Karmarkar re
(1978), this doesn't change anything. its
What are the similarities and dissimilarities of this formulation M
compared to standard CPT? Let us discuss the four-fold pattern of risk
attitudes:
99 in
Comparing SP/A and CPT
Similarities and differences to standard CPT:

1. Medium probabilities in gains:  
v is still concave, so we get mild risk-aversion.
2. Medium probabilities in losses:  
v has a jump at zero, so people tend to be risk-seeing in
losses, but if there are only losses possible, they are risk-
averse. 
If potential losses are very big: risk-averse behavior due to
the concavity of v in the loss region (compare: Bosch-
Doménech & Silvestre, 2006). 
3. Small probabilities in losses and gains:  
behavior similar to CPT: risk-averse behavior in losses and
risk-seeking behavior in gains arises.
100
Uncertain aspiration levels
Aspiration levels are not always precise:

‣Example: investment goals have price uncertainties
Therefore we want to model an aspiration level A which
follows a probability distribution.
How does that affect the effective value function?
101
hor's personal copy
Considering uncertain aspiration levels

ger / Economics Letters 108 (2010) 327–329
ally, v and
in outcome
o the ideas
w how it can
ven by f(SP,
easing, this Again we obtain a
concave–convex–
n rewrite it concave shape.
Fig. 2. The function v implied by SP/A when we use a “fuzzy” aspiration level resembles
for small payoffs the convex–concave shape of standard CPT.
102
1 Þ$
1.8 Quasi-hyperbolic time
discounting
Previous studies
‣ Discount rate reflects the marginal rate of substitution
between current and future consumption.
‣ In a perfect market, discount rate should be consistent with

the market interest rate.
‣ Since the discount rate should be determined by the market
rate, personal taste should not matter. Time discounting
should be homogenous among populations.
‣ Consistent time preference: The discount factor between any
adjacent periods is constant.
103
Homogeneous or not?
Frederick, Shane, George Loewenstein, Ted O’Donoghue: Time discounting and time
preference: a critical review. Journal of Economic Literature, 40:350–401, 2002.
104
Time consistent or not?
Frederick, Shane, George Loewenstein, Ted O’Donoghue: Time discounting and time
preference: a critical review. Journal of Economic Literature, 40:350–401, 2002.
105
Quasi-hyperbolic time discounting
People are more patient for the far future than for the near
future.
Discount rate between t=0 and t=1:
Discount rate between t and t+1 (when t>1):
This corresponds neatly to the System I / System II concept

and its neuroscience foundation.
106
Endogenous time preference
What correlates with time preferences?
‣ Wealth (Becker & Mulligan, 1997)

‣ Education (Becker & Mulligan, 1997)
‣ Risk preference (Andersen et al., 2008)
‣ Age (Green, et al., 1994)
‣ Culture (Mahajna, 2008; Chen, 2005)
‣ Intelligence or thinking style (Shamosh et al., 2008; Frederick, 2005)
‣ Innovation (Chemarin & Orset, 2008)
107
Chapter 2
How Culture Affects
Economic Behavior
2.1 What is culture?
什什么是⽂文化？
Culture is something stable over time that
120 distinguishes different groups.
Example: Hofstede culture dimensions
Power Distance Index (PDI):  
80 inequality of power and wealth.
Individualism (IDV):  
degree the society reinforces individual or
40
collective achievement.
Masculinity (MAS):  
dominance of traditional “male” values
0
PDI IDV MAS UAI LTO over traditional “female” values.
Uncertainty Avoidance Index (UAI):  
USA Germany China
intolerance for uncertainty and ambiguity
Long-Term Orientation (LTO):  
(Hofstede, 1980/2003) long-term commitments vs. respect 109
for
traditions.
What is culture?
110
What is culture?
111
Example: Uncertainty avoidance index
high UAI low UAI no data
112
Other concepts of cultural dimension
关于⽂文化维度的其它概念
Environmental distinctions (Douglas & Wildavsky,1982):

环境差别（市场 ↔ 等级）
Market environment vs. Hierarchical environment
Cognitive Patterns (Nisbett et al., 2001):

认知差别（整体分析）
Holistic (e.g. in East Asia) vs. Analytic (e.g. in the West)
Similar to Hofstede dimensions: World Value Survey

113
2.2 Early studies how culture
affects economic decisions
‣ Starting from the 1990s, the question has been

studied how cultural differences affect human decision
making.
‣ Most studies from that time compared East Asians
and Americans.
‣ Studies where most likely motivated by the increasing
number of East Asian (and in particular Chinese)
students in the US.
‣ The studies were limited in the number of investigated
countries. This did not allow for controlling other
factors that varied between the countries.
114
Culture and risk attitudes
⽂文化与⻛风险态度
General findings:
Chinese are more risk tolerant than Americans  
(or Westerners), but only to the financial domain.  
In the social domain, the pattern is reversed.
(Weber & Hsee, 1998 ; Hsee & Weber, 1999; Fan & Xiao,
2006)
Possible Explanations:
1. Cushion hypothesis:
Financial risk of Chinese is mitigated by family and friends.
2. (Lack of) experience with financial products.
115
How to study risk attitudes?
怎样研究⻛风险态度？
Typical question:
After one year you will either get a return of 1500 CHF  
or of 0 CHF, both with a 50-50 chance.
How risky (on a scale from 0 to 100) do you rate this investment?
How much would you be maximally willing to pay for participating on this
investment?
From such questions, risk attitudes can be determined

using models like Cumulative Prospect Theory.
116
Perceived risk vs. risk-taking tendency
⻛风险认知与冒险倾向
Experimental cushion hypothesis (Weber & Hsee)

Chinese were willing to pay more because they perceive less risk.
They have financial support from family members or friends to
alleviate financial risks.
60 500
250
Americans
Germans
Polish
0 0
Chinese
Perceived risk Willingness to pay
The results of the study by Hsee & Weber  
can be summarized as follows:
Chinese perceive a slightly lower risk and are willing to pay much more.
117
This
supports the cushion hypothesis.
Risk attitudes may depends on how you frame it
Scenario: a simple example of portfolio insurance
Client invests 20’000 CHF. Possible ways to frame the

At end of the year: decision:
Gain Frame:
80% chance to get 22’000 CHF; The worst case (lose 5000 CHF) as
20% chance to get 15’000 CHF. reference point;
Loss Frame:
The best case (gain 2000 CHF) as
Portfolio insurance decision: reference point;
The client may buy a portfolio Status-quo Frame:
insurance that covers potential Current status (with vs. without
losses fully, but costs a certain insurance) as reference point;
annual premium. Final Wealth Frame:
Zero wealth as reference point
(Expected Utility Theory).
118
Risk attitudes may depends on how you frame it
When asked about such a decision (in the context of health insurance),
subjects self-reported different frames:
60
Americans
Chinese
0
Gain frame Final wealth frame Loss frame Status-quo frame
Differences are not strong between Chinese and Americans.
However, none of the Chinese in the loss frame bought an insurance, but 71% of
the Americans did!
(Wang & Fischbeck, 2004) 119

Another cultural difference
in framing
Depending on whether an item is found or lost, the value

estimation of Chinese differed much more than that of
Americans:
Americans
Chinese
Found the item Lost the item

(Levinson & Peng, 2006) 120
Summary: findings on the framing effect
框架效应的⽂文化差异
General findings on framing effect:

Chinese are more sensitive to framing and situational
variables.
(Wang & Fischbeck, 2004; Levinson & Peng, 2006)
Possible Explanations:
1. Holistic vs. analytical cognitive style:  
East Asians are more focused on the context, whereas
Westerners are not distracted by it.
2. (Lack of) experience with financial products:

Knowledge prevents (misguided) framing.
121
2.3 INTRA: a closer look at
time discounting
International test of
risk attitudes
122
122
INTRA: How to organize a large-scale international survey?
Questionnaire
e we ask you to answer two types of questions: 👮

😰
u are asked to make some hypothetical decisions.
we ask you some questions regarding your personal attitudes
eral.
are no right or wrong answers. We are interested in your own

titudes.
🤪 👮 😀
😮
😴
International test of
risk attitudes 123
List of countries
Countries included (N=53)
Angola Germany Norway
Argentina Greece Poland
Australia Hong Kong Portugal
Austria Hungary Romania
Azerbaijan India Russia
Belgium Ireland Slovenia
Bosnia-Herz. Israel South Korea
Canada Italy Spain
Chile Japan Sweden
China Lebanon Switzerland
Colombia Lithuania Taiwan
Croatia Luxembourg Tanzania
Czech Rep. Malaysia Thailand
Denmark Mexico Turkey
Estonia Moldova UK
Finland Netherlands USA
France New Zealand Vietnam
Georgia Nigeria
Total number of participants worldwide: 6912
124
Tendency to wait
Part I. Decisions
Please imagine the following offers and mark your choice:
Question 1. Which offer would you prefer:

A. a payment of 3400$ this month
B. a payment of 3800$ next month
I prefer ! A ! B
____________________________________________________________
Depending on his choice, a subject has
“Interest rate” per month would be 11.7%
generally either high or
ences. A fill
Please subject
in thewith lowfor
amount time preferences
which (patient
you consider participant)
the alternatives A aw
attractive: 125
answer B than A. Part I. Decisions

Who chooses to wait?
Proportion of subjects willing to wait is

highest in Germanic/Nordic countries.
126
Proportion of subjects willing to wait
(red=low, green=high)
Choropleth Map of the World Population
127
Waiting tendency
10 3 RESULTS
$!""#
!,"#
percentage choosing to wait
!+"#
!*"#
!)"#
!("#
!'"#
!&"#
!%"#
!$"#
!""#
-./012345 92:;75 <388;.#=1>?# 9>31# =1>?#=@/7A.# B1C2# B1C2#=@/7A.# 9D/341#
67/834# 90./3412# 90./341#
Figure 1: The percentage of choosing to wait grouped by cultural origin

128
Note: The column shows the percentage of participants who chose to the $3800
Matching questions
129
Some theory
What factors should influence answers to these questions

(on rational grounds)?
Classical answer: “only interest rate”
This, however, requires a complete financial market without
transaction costs for investments and loans, as we will
see...
130
umption in period t and t + 1, respectively, we can display the possible
Whatever the reason, we have to consider the possibility that people d
umption streams induced by a decision for obtaining A at time t or X
not have the possibility to arrange the money in a free way between the tw
me t + 1.Rational
Figuretime discounting
1 shows the following cases:
time periods, but indeed have to stick to what is offered.
Complete market
In thisIncase, without
the
a perfect restrictions:
choice
market,between
the answerboth
an optionsA
Xamount
follows are only
atthe
with time equally
t and X at tim
formula:
good
t + 1 ifis both lines coincide,
(applying i.e. ifutility
the classical X = model
RA, where R is the market
for intertemporal decisions) th
interest. On the other hand, without a financial market, we would
choice between
have tothe utilitiesthe expected utilities
compare
U1 = u(wt + A) + u(wt+1 ) and U2 = u(wt ) + u(wt+1 + X),

and X were the value that makes both equally large.
where wt denotes the wealth at time t, u is the utility function and is th
endogenous time discounting that is in itself independent of the interest rate
but might depend, e.g., on the probability to live up to the time t + 1.
Finding the value X for which a person is indifferent between both op
131
ct+1 ct+1
Illustration: w+X w+X
(a): perfect
market
(b): without
(a) ct (b) ct
market w+A w+A
(c): differing
interest rates ct+1 ct+1
(d): no loans
w+X w+X
The cases (c)

and (d) tend to
be more similar
(c) ct (d) ct
to (b)! w+A w+A
132
Figure 1: Choices between a gain at time t or a delayed, but larger gain at
Predictions
12 2 METHODOLOGY
Financial market access: Variable: Effect on time discounting:

Full Market interest Increasing
Growth rate Increasing
Risk aversion Increasing
Limited
Wealth level Decreasing
Inflation rate Increasing
Table 1: Theoretical influence of various factors on time discounting depend-

ing on access to a financial market.
133
UAI (country) -0.046*** -0.008
(-3.187) (-0.503)
3.2 UAITimeind.preferences,
dif. culture and economics -0.012 -0.013 3
(-0.949) (-1.085)
LTO (country) 0.026** 0.078***
Empirical results from our study:
Table 2: Linear Regression of Waiting Tendency
(2.016) (4.764)
LTO ind. diff. 0.049*** 0.048***
Independent variables Model 1 Model 2 (3.971)Model 3 (3.933)Model 4
age
Africa -0.038*** -0.031** -0.045*** -0.06***
0.006
(-2.967) (-2.416) (-3.538) (0.429)
(-4.499)
gender
Anglo/American -0.006 -0.015 -0.0120.058*** -0.019
(-0.464) (-1.21) (-0.96) (3.029)
(-1.472)
Interest rate 1 month
Germ./Nordic -0.008 0.2***
(-0.563) (8.713)
EastPrivate
Asia debt/GDP 0.146*** 0.092***
(8.263) (4.7)
easyness to obtain loan
L.America 0.102*** -0.007
(6.38) (-0.418)
inflation rate
L.Europe -0.1*** -0.091***-0.046***-0.086***
(-5.899) (-5.279) (-2.98)(-4.46)
Log(growth rate)
E.Europe -0.058*** -0.049*** 0.046** -0.068***
(-3.949) (-3.356) (2.156)
(-4.578)
log(GDP/capita)
Middle East 0.156*** 0.137***0.091***
0.073***
(8.492) (7.361) (5.547) (3.26)
R2 RRP
(%) 4.9 -0.021*
7.2 -0.013
8.6 -0.016
10.9
Delta F 2 100.2 (-1.645)
11.7 (-1.057)
15.4 (-1.295)
18.9
IDV (country)
* =significant on 10% level, **significant on 5% level, 0.084*** 0.04**
***significant on 1% level (5.868) 134 (2.514)
IDV ind. diff. 0.029** 0.03**
Implicit annual interest rate for
1 year and 10 year horizons
Bosnia
0.70 & Herz.
Romania
implicit interest rate (10 year horizon)
0.60
Lithuania
Lithuania
Estonia
Greece
Russia
0.50
Malaysia
Moldova Azerbaijan
China
Nigeria
0.40
Italy
Colombia Croatia
Turkey
Slovenia Mexico
Israel
0.30 Germany Hong Kong
Austria Angola
Canada Ireland
Taiwan Japan
Australia Denmark Czech Rep.
Portugal US UK Sweden
Vietnam Hungary South Korea Chile
Switzerland Argentina
New Zealand
0.20 Norway
Lebanon
Spain
Thailand
0.10
0.00 2.50 5.00 7.50 10.00 12.50
implicit interest rate (1 year horizon) 135
Quasi-hyperbolic discounting parameters
136
Waiting tendency vs.
time pace
Linear Regressi
The waiting tendency is .90 Austria
Germany
consistent with Switzerland

methodologically very
percentage choosing to wait one month

different methods of .80 Czech Republic
Canada
Hong Kong
measuring the “pace of time” Hungary
Sweden
Japan
in a country: South Korea
UK
.70 Ireland
Taiwan
A Geography of Time USA
(Robert Levine, 1997) China
defines pace of time by: .60 Mexico

Romania
•Walking speed
•Postal service speed
•Clock accuracy .50
Greece R Sq Linear = 0.
.40
-6.00 -4.00 -2.00 .00 2.00 4.00
137
time pace
Waiting tendency vs.
time pace
138
GDP per capita vs.
Waiting tendency
Linear Regression
1.00
Switzerland
Germany Norway
Austria
Frage 1 gender weighted native Denmark Canada
.80 Estonia Japan
Hungary Israel
South Korea Ireland
Lebanon Slovenia
USA
China Colombia Malaysia Taiwan
Portugal
Turkey
.60 Lithuania
Moldova Argentina Croatia Australia
Angola Romania Greece
Azerbaijan Italy
Chile Russia
.40
Bosnia.Herzegovina
.20
R Sq Linear = 0.452
Nigeria
.00
*N>40 .00 1.00 2.00 3.00 4.00
logGDPcapita
139
Growth rate vs. Present bias
Linear Regression
1.00 Australia
Lebanon
Denmark
.80 USA Spain

Ireland
New Zealand South Korea
Japan Taiwan
Norway
median present bias
Hungary Austria Czech Rep.

Turkey
Italy Hong Kong
Canada UK Israel Argentina
.60 Portugal
SwitzerlandColombia China
Germany Slovenia
Mexico
Nigeria
Moldova
.40
Croatia
Greece
Malaysia Azerbaijan
Chile
Russia Angola
.20
Romania
Lithuania
Estonia
R Sq Linear = 0.351 Bosnia.Herzegovina
Georgia
.00
-2.00 -1.00 .00 1.00 2.00 3.00
140
Ln(growth rate)
Application (1)
Innovation
Macroeconomic view:
‣Paul Romer: technological innovation as
endogenous variable in economic models.
‣ Small time discounting is an important factor. 
(Thomas Edison: “Inventions are 1% inspiration
and 99% transpiration.”)
Do time preferences indeed play a role for
innovations? 
We can test this empirically with our INTRA data...
141
Tendency to wait vs. Innovation factor
Linear Regression
6.00
USA
Japan Switzerland
Germany
Taiwan Denmark
Israel
Austria
South Korea
5.00 UK Canada
Norway
Ireland Hong Kong
Australia Malaysia Czech Rep.

Innovation
New Zealand
Spain China Slovenia
Chile Italy
Portugal Estonia
4.00
Thailand
Lithuania
Nigeria Azerbaijan Croatia
Russia Turkey Hungary
Greece Mexico Colombia
Romania
Argentina
Georgia
3.00
Bosnia.Herzegovina Moldova
R Sq Linear = 0.442
2.00
.00 .20 .40 .60 .80 1.00 142
Percentage choosing to wait
Regression results
143
Application (2)
Environmental Protection
‣“The biggest uncertainty of all in the economics of

climate change is the uncertainty about which
interest rate to use for discounting.” (Weizman,
2007)
‣ Hardisty & Weber (2009) find environmental

outcomes are discounted in a similar way to
financial outcomes.
144
Environmental Sustainability
145
Discussion
‣ We split into groups now.

‣In each group, please come up with at least three (better
five) more things (on country or personal level) that might
be influenced by time preferences!
‣ Afterwards we collect these ideas.
146
UP Time
‣ In the meanwhile, there are not only the INTRA data,

but various other data sets that measure “time
preferences” (in a generalized sense).
‣ Question: do they correlate? Or are time preferences
maybe so domain-specific that a concept of general
time preferences is of limited use?
‣ In a recent paper (Rieger, Wang, Hens, PLOS One,
2021), we find that different measures indeed
correlate. This allows to construct a common factor
(“Universal Preferences for Time”).
147
3.5
Fig 2. Bubble plots of 20 various variables and universal preferences for time (UP time, on the
3.0
x-axis). In most cases, we can see a clear dependence. The sizes of the bubbles correspond to the
0 2.5
weight
-1.5 of the
-1.0 country
-0.5 data.
0.0 Weighted
0.5 regression
1.0 1.5 lines
-1.5 in red.
-1.0 -0.5 0.0 0.5 1.0 1.5
UP Time results
Gasoline price per liter Body mass index
Average
2.5credit rating Innovation
30 factor
6.0
2.0
100 28
5.5
1.5
80 26 5.0
1.0
60 24 4.5
4.0
40
0.5 22
3.5
20
0.0 20
3.0
-1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5
0 2.5
-1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5
Resilience index
Average years in school
Gasoline14price per liter 110 mass index
Body
2.5 100 30
90
12
80 28
2.0
10 70
60
1.5 26
8 50
40
1.0 24
6 30
20 148
0.5 22
4 10
-1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5
2.4 INTRA: risk preferences
and culture
We summarize results from:
Rieger, Wang, Hens: Risk Preferences Around the World,

Management Science, 2014
149
6 3 METHODOLOGY
were translated into the local languages following the same procedure as the
INTRA: risk preferences and culture
questionnaires and were then read aloud by the local lecturer.
How
We to measure
measured risk risk preferences?
preferences by eliciting the participants’ willingness
to pay for hypothetical lotteries. Six of the lotteries were solely about gains
Standard method: hypothetical lotteries, e.g.
with di↵erent probabilities (where one of the lotteries had a very high gain),
two were solely about losses, and two mixed-outcome lotteries were included
to elicit loss aversion (not reported in this paper). The gain lotteries were
formulated similar to the following:2
Imagine you are o↵ered the lotteries below. Please indicate the maximum
amount you are willing to pay for the lottery:
40% chance win $0

60% chance win $100
I am willing to pay at most $ to play the lottery.
The loss lotteries were formulated as:

150
The following lotteries involve losses. Imagine you have to play these lotteries,
amount you are willing to pay for the lottery:
40% chance win $0

60% chance win $100
I am
Or inwilling
losses: to pay at most $ to play the lottery.
The loss lotteries were formulated as:
The following lotteries involve losses. Imagine you have to play these lotteries,
unless you pay a certain amount of money beforehand. What is the maximum
amount you would be willing to pay to avoid playing the lottery? This corresponds
to buying insurance that saves you from su↵ering potential losses.
40% chance loss of $80

60% chance no loss, no win
I am willing to pay at most $ to avoid the lottery.
Table 1: Payo↵s for the lotteries in our survey.

151
Lottery Outcome A($) Prob(A) Outcome B($) Prob(B) Expected Value ($)
40% chance loss of $80
60% chance no loss, no win
I am willing to pay at most $ to avoid the lottery.

Table study
For the INTRA 1: Payo↵s
the for the lotteries
following in our
lotteries survey.
have been used:
Lottery Outcome A($) Prob(A) Outcome B($) Prob(B) Expected Value ($)
1 10 0.1 100 0.9 91
2 0 0.4 100 0.6 60
3 0 0.1 100 0.9 90
4 0 0.4 10,000 0.6 6000
5 0 0.9 100 0.1 10
6 0 0.4 400 0.6 240
7 0 0.4 80 0.6 48
8 0 0.4 100 0.6 60
‣Some lotteries are in gains only (#1-6), some in losses (#7+8).

‣In
Table 1 summarizes
gains, the eight
some lotteries lotteries
with in the questionnaire.
low probability They have
gains (#1,3,5) were
chosen
beento added.
cover the main decision situations (lotteries in gains or losses).
In the gain domain, the winning probabilities (low/medium/high) and the
‣One question (#1) involves only outcomes in gains.
stakes (low/high) were varied and one question with only strictly positive
2
The versions given in local currencies were based on this US dollar version. 152
These questions allow to measure:
‣Risk preferences in gains,

‣Risk preferences in losses,
‣ Probability weighting (only in gains).
Additionally, loss aversion have been measured, but we will

summarize these results in a later section.
153

Additionally, loss aversion and ambiguity aversion have been

measured. We will summarize the results on loss aversion in a
later section. For ambiguity aversion we refer to the original
paper.
154

Additionally, loss aversion and ambiguity aversion have been

measured. We will summarize the results on loss aversion in a
later section. For ambiguity aversion we refer to the original
paper.
155
Violations of internatlity and data quality
‣ Numerical questions are demanding for many participants.

‣Probabilities are even more challenging!
‣In the PANDA survey (see below), the question where most
respondents stoped the survey, was about risk preferences!
‣Therefore, it is pivotal to check for data quality.
‣ One method: assume that violations of internality point to
errors of understanding, example:
• How much would you be willing to pay at most to play a
lottery where you can win 100 with probability 90% and 10
with probability 10%.
• Answers below 10 or above 100 violate weak internality.
• Answers of 10 or 100 violate at least strict internality.
• Kick out, e.g., subjects who violate internality (weakly or
strongly) more than once in the survey.
156
Robustness of CPT parameters
To estimate CPT-parameters on an individual level in a reliable

way, one needs many questions.
Reasons:
‣CPT is highly nonlinear,
‣ sometimes similar predictions with very different parameters,
‣Even only rounding errors can lead to big differences in
estimated parameters.
Things get better if one estimates parameters for average
answers (possible on a winsorized sample) or median answers.
‣ This is what Kahneman and Tversky did!
If we want to estimate risk preferences for subjects with only few
questions, we need to find more robust (and more rough)
measurements, e.g. relative risk premium.
157
3.4 Relative Risk Premium (RRP)
To asses risk preferences in a robust way, we compute relative risk pre
Relative Risk Premium
or the lotteries and derive two indices, corresponding to risk aversion
gains and Letrisk
CE denote
seekingtheincertainty
losses. equivalent of a we
To do this, lottery (as stated
compute thebyrelative
the subject in the survey) and EV the expected value of the
premiumlottery,
(RRP) for each lottery question via the standard formula:
then define the relative risk premium (RRP):
EV CE
RRP = ,
|EV |
5 If this
In fact, is positive,
subjects the person
who violated weakisinternality
risk averseat in thisonce
least lottery,
alsoand if
showed, on aver
an inferiornegative,
responserisk seeking.
to other items in our questionnaire: the number of missing ans
‣ Advantage:
or these subjects simple
was nearly linear
twice as model
high aswith
for high stability
subjects who todiderrors.
not have intern
violations. ‣If,
Thee.g.,
di↵erence
EV=100wasand
significant with has
the answer p < an
0.001.
error e, then RRP has
an error of e/100 (always of the “same order” as e).
The data strongly suggests to estimate different RRP for gain and
loss lotteries – consistent with CPT (confirmed by factor analysis).
158
Are there country differences?
Are differences between countries/cultures just random?

‣One-way ANOVA test reveals significant between-country
differences for both RRP in gains (F(52,5834) = 9.77, p <
0.001) and RRP in losses (F (52, 6020) = 7.43, p < 0.001).
‣ Variations between cultural clusters are also large, as an
ANOVA test on the level of cultural clusters of countries (e.g.
Anglo-American, Latin Europe etc.) reveals, both for RRP in
gains (F (8, 5878) = 11.47, p < 0.001) and RRP in losses (F (8,
6064) = 5.41, p < 0.05).
‣Substantial cross-country and cross-cultural variation large.
159
General findings: risk aversion in gains, risk seeking losses
‣ Female subjects tend to be more risk averse in gains.

‣Females are more risk-seeking in losses. However, smaller
magnitude of gender difference in losses than in gains.
‣ Participants from richer countries tended to be more risk
averse.
‣Participants from wealthier countries tend to be more risk
seeking in losses, but only after controlling for cultural
dimensions.
160
Gender differences
Wealth effects
Table 3: Regression results for risk preferences in gain lotteries.
RRP for gain lotteries

Model 1 Model 2 Model 3 Model 4
Age 0.070⇤⇤⇤ 0.062⇤⇤⇤ 0.040⇤⇤⇤ 0.041⇤⇤⇤
( 5.271) ( 4.649) ( 3.044) ( 3.087)
Gender (male=1) 0.144⇤⇤⇤ 0.146⇤⇤⇤ 0.129⇤⇤⇤ 0.129⇤⇤⇤
( 10.879) ( 11.053) ( 9.834) ( 9.747)
log GDP/capita 0.068⇤⇤⇤ 0.082⇤⇤⇤ 0.106⇤⇤⇤ 0.104⇤⇤⇤
(5.106) (5.950) (7.837) (7.510)
IDV, country average 0.050⇤⇤⇤ 0.009
( 3.569) (0.610)
IDV, ind. Di↵erence 0.004 0.001
( 0.313) ( 0.076)
UAI, country average 0.154⇤⇤⇤ 0.158⇤⇤⇤
(11.189) (10.610)
UAI, ind. Di↵erence 0.049⇤⇤⇤ 0.049⇤⇤⇤
(3.741) (3.738)
N 5587 5587 5587 5587
Adjusted R2 (%) 2.9 3.1 5.2 5.2161
Gender differences
Wealth effects
Table 4: Regression results for risk preferences in loss lotteries.
RRP for loss lotteries

Age 0.006 0.015 0.021 0.023⇤
( 0.486) ( 1.115) ( 1.623) ( 1.734)
Gender (male=1) 0.084⇤⇤⇤ 0.085⇤⇤⇤ 0.075⇤⇤⇤ 0.076⇤⇤⇤
(6.357) (6.439) (5.683) (5.730)
log GDP/capita 0.000 0.019 0.026⇤ 0.030⇤⇤
(0.010) ( 1.362) ( 1.907) ( 2.164)
(4.830) (1.488)
(0.976) (0.855)
( 7.994) ( 6.506)
UAI, ind. Di↵erence 0.032⇤⇤ 0.031⇤⇤
( 2.409) ( 2.389)
N 5770 5770 5770 5770
Adjusted R2 (%) 0.7 1.0 1.8 1.8 162
Cultural dimensions: IDV
‣ There is no robust relation between IDV and RRP in gains or

losses.
‣There are effects, but they become insignificant when
controlling for UAI.
163
Cultural dimensions:
Table 3: IDV
Regression results for risk preferences in gain lotteries.

Age 0.070⇤⇤⇤ 0.062⇤⇤⇤ 0.040⇤⇤⇤ 0.041⇤⇤⇤
( 5.271) ( 4.649) ( 3.044) ( 3.087)
Gender (male=1) 0.144⇤⇤⇤ 0.146⇤⇤⇤ 0.129⇤⇤⇤ 0.129⇤⇤⇤
( 10.879) ( 11.053) ( 9.834) ( 9.747)
log GDP/capita 0.068⇤⇤⇤ 0.082⇤⇤⇤ 0.106⇤⇤⇤ 0.104⇤⇤⇤
(5.106) (5.950) (7.837) (7.510)
( 3.569) (0.610)
( 0.313) ( 0.076)
(11.189) (10.610)
UAI, ind. Di↵erence 0.049⇤⇤⇤ 0.049⇤⇤⇤
(3.741) (3.738)
N 5587 5587 5587 5587
Adjusted R2 (%) 2.9 3.1 5.2 5.2164
Table 4: IDV
Regression results for risk preferences in loss lotteries.

Age 0.006 0.015 0.021 0.023⇤
( 0.486) ( 1.115) ( 1.623) ( 1.734)
Gender (male=1) 0.084⇤⇤⇤ 0.085⇤⇤⇤ 0.075⇤⇤⇤ 0.076⇤⇤⇤
(6.357) (6.439) (5.683) (5.730)
log GDP/capita 0.000 0.019 0.026⇤ 0.030⇤⇤
(0.010) ( 1.362) ( 1.907) ( 2.164)
(4.830) (1.488)
(0.976) (0.855)
( 7.994) ( 6.506)
( 2.409) ( 2.389)
N 5770 5770 5770 5770
Adjusted R2 (%) 0.7 1.0 1.8 1.8 165
Cultural dimensions: UAI
‣ UAI is a robust factor explaining RRP in gains: higher UAI

corresponds to higher risk aversion in gains.
‣But UAI also corresponds to more risk seeking behavior in
losses!
‣ This shows that equalizing UAI with risk aversion is an
oversimplification, see already Hofstede (2001).
‣Instead, higher degree of UAI is associated with a higher
degree of irrational preferences (since risk aversion for gains
and risk seeking for losses can be considered as irrational
(Rabin 2000)).
166
Table 3: UAI
Regression results for risk preferences in gain lotteries.

Age 0.070⇤⇤⇤ 0.062⇤⇤⇤ 0.040⇤⇤⇤ 0.041⇤⇤⇤
( 5.271) ( 4.649) ( 3.044) ( 3.087)
Gender (male=1) 0.144⇤⇤⇤ 0.146⇤⇤⇤ 0.129⇤⇤⇤ 0.129⇤⇤⇤
( 10.879) ( 11.053) ( 9.834) ( 9.747)
log GDP/capita 0.068⇤⇤⇤ 0.082⇤⇤⇤ 0.106⇤⇤⇤ 0.104⇤⇤⇤
(5.106) (5.950) (7.837) (7.510)
( 3.569) (0.610)
( 0.313) ( 0.076)
(11.189) (10.610)
UAI, ind. Di↵erence 0.049⇤⇤⇤ 0.049⇤⇤⇤
(3.741) (3.738)
N 5587 5587 5587 5587
Adjusted R2 (%) 2.9 3.1 5.2 5.2167
Table 4: UAI
Regression results for risk preferences in loss lotteries.

Age 0.006 0.015 0.021 0.023⇤
( 0.486) ( 1.115) ( 1.623) ( 1.734)
Gender (male=1) 0.084⇤⇤⇤ 0.085⇤⇤⇤ 0.075⇤⇤⇤ 0.076⇤⇤⇤
(6.357) (6.439) (5.683) (5.730)
log GDP/capita 0.000 0.019 0.026⇤ 0.030⇤⇤
(0.010) ( 1.362) ( 1.907) ( 2.164)
(4.830) (1.488)
(0.976) (0.855)
( 7.994) ( 6.506)
( 2.409) ( 2.389)
N 5770 5770 5770 5770
Adjusted R2 (%) 0.7 1.0 1.8 1.8 168
Paper history
‣Why are no estimates for CPT parameters in the paper?
‣ Why is no loss aversion included?
Some anecdotes from a revision process…
169
2.5 INTRA: CPT parameters
and probability weighting

Rieger, Wang, Hens: Estimating cumulative prospect
theory parameters from an international survey, Theory
and Decision, 2016.
(You get a hard copy of this paper.) ← Sorry!
170
ght to be probability
n-linear larger than one) that leads
weighting to a steeper
function w. value function in losses than in
. Fourth, small probabilities
this article, we present =have
(1 −overly
C P T results for w+CPTp))v(A)
(large + wclassical
decision
with the + ( p)v(B),
weight, as expressed by
specification of
on-linear probability weighting function w.
ky and Kahneman (1992). The model is given for lotteries in gains as follows:
dthis article,
forINTRA: CPTwe
lotteries in present
parameters
lossesandresults forweighting
probability
as: CPT with the classical specification of
sky and Kahneman P T(1992).
= (1 − The
C specification:w+model is given
( p))v(A) + wfor lotteries in gains as follows:
+ ( p)v(B),
Model
C P T = (1 − w− ( p))v(B)
C P T = (1 − w+ ( p))v(A)
+ w− ( p)v(A),
+ w+ ( p)v(B), (in gains)
r lotteries in losses as:
here A andinBlosses
or lotteries are the
as: payoffs of the lottery ( A < B), p is the probability to o
C P T = (1 − w− ( p))v(B) + w− ( p)v(A), (in losses)
e higher outcome B, w± are the probability weighting functions in gains/losse
C P T = (1 − w− ( p))v(B) + w− ( p)v(A), 3
sAthe value
and BValuefunction.
are the w ± and v are given by:
payoffs of the lottery (A < B), p is the probability toM.obtain
function: O. Rieger et a
gher outcome !
e A and B areB, ± are the
thewpayoffs ofprobability
the lotteryx α(weighting
,A3 < B), pfunctions
isx the 0 in gains/losses,
≥ probability and
to obtain
igher outcome
e value B, w
function. w±±are
andthe are :=
v probability
v(x) given by: weighting functions in gains/losses, and
where
he > 0 is called
valueλ function. w and −λ(−x)
the “loss-aversion”
v are given by:
β , x and
3 coefficient, < 0,α, β > 0 (usually α, β ≤ 1
± ! α
describe the risk attitudes for! gains
x , and losses.x ≥0
The standard v(x) :=function
weighting x α,
is β , xx ≥ 00, (1)
Probability v(x)
weighting
:= −λ(−x)
function: < (1)not focus
We tried different specifications of w−λ(−x)
± and v βand
, also
x < alternative
0, PT models, but we do
he current article, see Rieger and Bui (2011) for details.
pγ
w ( p) :=
ied different specifications of w± and± v and also alternative
γ + (1 − PTp) γ )1/γbut we do not focus on this
models,
(2
ried different
( p
urrent article, specifications
see Rieger and ofBui and v and
w± (2011) foralso alternative PT models, but we do not focus on this
details.
current article, see Rieger and Bui (2011) for details.
with the parameter γ = γ± ∈ (0, 1] describing
123
171
the amount of over- and unde

INTRA: CPT parameters and probability weighting
For comparison, we also estimated a standard expected utility

theory model with wealth level and (constant) relative risk
aversion as free parameters for the fit.
‣Reasonable descriptive model only for few subjects.
Predictions of CPT that cannot be modelled with expected

utility theory:
‣reflection effect,
‣probability weighting.
Did our subjects show these effects across all countries?
172
Reflection effect
How to measure the reflection effect?
Compare the symmetric gain/loss lotteries 2 and 8. Subjects

who were risk averse in the gain lottery, but risk seeking in the
loss lottery were classified as “showing a reflection effect”:
‣In all, but one country (Tanzania*), at least 80% of subjects

showed a reflection effect (on average 94%).
*In Tanzania, only 57% showed a reflection effect. Sample size in Tanzania, however,
was small (N=47).
173
Probability weighting
To test for probability weighting, we applied the method

described later and measured the proportion of subjects in
each country that showed probability weighting.
‣On average, 75% of the subjects showed probability

weighting. In every country, the majority of subjects
showed probability weighting and in all, but in one country
(Tanzania), the majority showed a reflection effect and
probability weighting. 
(Compare Table 2.)
174
Factor analysis
Final test of the reliability of the CPT model:

principal component analysis on the country median data for
the certainty equivalences of the lotteries (or, alternatively, for
their relative risk premiums).
The first four extracted components nicely corresponded (in
decreasing order of importance) to:
‣ the lotteries in gains (roughly corresponding to α),
‣the mixed lotteries (λ),
‣the lotteries in losses (β), and
‣ lottery 5 (low probability for high gain, γ+).
175
Finding CPT parameters
‣ Using country BRIEF median data of lottery answers.

ARTICLE
‣Estimate first without BRIEF
mixed ARTICLE
lotteries (and therefore without
loss aversion).
THE AUTHOR
‣ Assume all parameters THEareAUTHOR BRIEF
in the interval [0,2]. ARTICLE
BRIEF ARTICLE
‣Estimate parameters of gain and loss lotteries separately.
‣ To find optimal parameters, minimize
BRIEF ARTICLE the error
THE AUTHOR THEterm  
AUTHOR
  X
ARTICLE
 
X |CE i
CE i
|/L i
i comp i elic i
THE AUTHOR
 
|CE comp
i
CE elic |/L
AUTHOR
X
i i
where i denotes the lotteries,|CEcomp denotes
CEelic thei certainty
|/L
X
equivalent as computed from the CPT parameters, 
i i i i
i
|CEcomp CEelic i i
denotes
|/L |CEcomp
the elicited certainty equivalent and 
CEelic |/L
i
mp CEelic |/Li is the largest payoff of the lottery i.
‣Compute loss aversion afterwards from mixed lotteries,
using the already estimated other parameters. 176
Further methodology
‣ To estimate standard errors, we used a bootstrapping

method, implemented with MATLAB, where for each
country, we selected 100 random subsamples of two-thirds
of the respective subjects and estimated CPT parameters
for each subsample to compute the standard deviation of
the estimates (Table 3).
‣ To test whether country differences are significant, we used
the same bootstrapping procedure and combined it with
independent-samples t tests. For most country-pairs,
indeed, all CPT parameters are significantly different and
for all countries, at least one parameter differs (Figure 1).
‣Since the proportion of male/female subjects differed
between countries, estimation have been repeated after
gender balancing country level data. 
Compare Table 4.
177
Robustness tests
‣ To reduce answers that might be errors, one can kick out

subjects that violate internality (see previous section) or
monotonicity of probabilities, i.e. assigning larger CE to
lotteries with higher winning probability (but otherwise
identical outcomes). 
If the deviation of the parameter estimate after taking out
these subjects is large, its value is not robust.
‣We can identify problematic cases also by looking at the
bootstrap standard errors. If they are large, the value is not
robust.
‣ Most (but not all) countries show good robustness.
Compare Table 5.
178
Key findings of parameter estimates
‣ CPT describes behavior reasonably well across all

countries.
‣The heterogeneity across countries is substantial.
‣ For more detailed findings consider Section 3.4 of the
paper.
179
Key findings of parameter estimates
‣ CPT describes behavior reasonably well across all

countries.
‣The heterogeneity across countries is substantial.
‣ For more detailed findings consider Section 3.4 of the
paper.
180
Culture?
Does culture determine the differences between countries?
‣We compute for every pair of countries the (Euclidean)

distance between the five CPT parameters and test
whether this is related to differences in economic situation
(logarithm of GDP/capita) and cultural differences
(Euclidean distance of Hofstede cultural dimensions).
181
Estimating cumulative prospect theory parameters…
Table 7 Regression results on pairs of countries for differences between countries in CPT value versus
Culture?
cultural and economic differences
Model 1 Model 2
Difference in Hofstede dimensions 0.065** 0.095***

(2.54) (3.74)
Difference in GDP/capita 0.330*** 0.280***
(12.98) (10.96)
Dummy variables for first country of pair no yes
Adjusted R 2 in % 11.3 30.2
N (country-pairs) 1378 1378
*** Significant on the 1% level, ** Significant on the 5% level, * significant on the 10% level
‣There
probability is a significant
weighting. relation
12 We obtain between
a correlation these
coefficient measures,
of 81.0% with p < 0.001.
i.e., that
This implies countries that are of
the measurement very different
λ, indeed, with the
captures respect toof
concept wealth
loss aversion,
and/or
and is not drivencultural factors,errors
by measurement tendsofto have
β and γ−also
. very different
CPT
By now, weparameters andthat
have established vicein versa.
most countries, our estimates are robust and
that country differences are significant. The question arises whether these differences
182
are related to economic or cultural differences between these countries. While this has
A closer look at probability weighting
Consider two binary lotteries A and B, both with outcomes 0 and X > 0. Lottery
A gives a payoff of X with probability pA and lottery B with probability pB . If a
decision maker can be described by CPT, but does not have any probability weighting,
his certainty equivalences for the two lotteries (C E A and C E B ) have to have a fixed
ratio, as the following computation shows, where v is the value function:
By definition of the certainty equivalence, we have
v(C E A ) = pA v(X ), v(C E B ) = pB v(X ).
Solving both equations for v(X ), we obtain one equation
u (C E A ) u (C E B )
= .
pA pB
Rewriting this, we find
u (C E A ) pA
= .
u (C E B ) pB 183
(CEEAA)) u u(C(CEE
uu(C B )B )
== . .
ppAA ppBB
Normative rule without probability weighting
Rewritingthis,
Rewriting this, we
we find
(CEEAA) )= pp
uu(C AA
= ..
uu(C
(CEEB ) ) ppB
B B
Weiscan
a normative rule that
apply this general everybody
result to three ofwho does not
our lotteries show2, 3, and 5) with
(lottery
We probability
can apply this general result to three of our lotteries (lottery 2, 3, and 5) with
X = 100 and p2 =weighting should
0.6, p3 = 0.9, and follow.
p5 = 0.1. This leaves us with three conditions
X = 100‣If and p2find= 0.6, p3 = 0.9, and = 0.1. This
p5 means leaves us with three conditions
that need towe > instead
be satisfied of =,
if a decision that
maker doesthat a person
not have probability weighting.
that need overweights
Moreover, toone
becan
satisfied if aoverweighting
showsmall
that decision maker
probabilities. does not
of smaller have probability
probabilities occurs if,weighting.
in our
Moreover,
case, one one
of thecan show that
following overweighting
conditions is of smaller probabilities occurs if, in our
satisfied:
‣ In the case of the INTRA lotteries we obtain three
case, one of the following conditions is satisfied:
inequalities:
u (C E 5 ) 1
u (C E 5 )> ,
1 (5)
u (C E 2 ) > 6 , (5)
uu(C
(CEE2 )2 ) 26
> , (6)
u (C E
u (C E 3 )2 ) 3 2
> , (6)
uu(C
(CEE5 )3 ) 13
> . (7)
uu(C
(CEE3 )5 ) 91 184
> . (7)
Empirical results on probability weighting:  M. O. Rieger et al.
percentage of subjects
185
90%
Fig. 2 Proportion of subjects showing probability overweighting in gain lotteries in the respective three
tested probability ranges or in at least one of them. We see that most probability overweighting took place
in small probabilities, as CPT would predict
Correlations between different measurements of probability
Table 8 Correlations between different probability weighting measurements
weighting
Probability weighting
γ+ γ− (10%/60%) (10%/90%) (60%/90%) (any)
γ+ Corr. 1 −0.07 −0.59*** −0.23* −0.28** −0.33**

p value 0.62 0.00 0.10 0.04 0.01
γ− Corr. −0.07 1 0.19 0.06 −0.02 0.09
p value 0.62 0.18 0.65 0.88 0.53
(10%/60%) Corr. −0.59*** 0.19 1 0.66*** 0.49*** 0.76***
p value 0.00 0.18 0.00 0.00 0.00
(10%/90%) Corr. −0.23* 0.06 0.66*** 1 0.64*** 0.82***
p value 0.10 0.65 0.00 0.00 0.00
(60%/90%) Corr. −0.28** −0.02 0.49*** 0.64*** 1 0.66***
p value 0.04 0.88 0.00 0.00 0.00
(any) Corr. −0.33** 0.09 0.76*** 0.82*** 0.66*** 1
p value 0.01 0.53 0.00 0.00 0.00
*** Significant on the 1% level, ** significant on the 5% level, * significant on the 10% level
186
Probability weighting, cultural and economic factors
‣ Higher IDV is associated with lower degree of probability

weighting (i.e., higher sensitivity to probabilities), but this is
only true for the country median, i.e., for the cultural values
of the society surrounding the decision maker.
‣ The same is true for UAI, where a higher degree of UAI in
the country is associated with higher levels of probability
weighting (i.e., lower sensitivity to probabilities).
‣A closer look suggests that IDV affects mostly probability
weighting in the range of 60–90%, whereas UAI affects it
more generally.
‣Subjects in wealthier countries are more sensitive to
probabilities, regardless of the probability range.
‣ Women seem to be more prone to probability weighting
than men. 
187
Probability weighting,
Table 9 Ranked cultural
regression of γand economic factors
+ with cultural and economic factors (country level)
Ranked γ+
PDI 0.178
(1.29)
IDV −0.423***
(−3.42)
MAS 0.044
(0.31)
UAI 0.339**
(2.68)
log(GDP/capita) −0.379*** −0.336*** −0.425*** −0.364***
(−2.74) (−2.76) (−2.97) (−2.88)
N 48 48 48 48
Adj. R 2 in % 18.9 33.5 16.1 27.3
*** Significant on the 1% level, ** significant on the 5% level, * significant on the 10% level 188
*** Significant on the 1% level, ** significant on the 5% level, * significant on the 10% level
Table 10 Ranked regression of the proportion of subjects that showed probability overweighting with
Probability weighting, cultural and economic factors
cultural and economic factors (country level)
Ranked percentage of subjects with probability overweighting

PDI −0.121
(−0.83)
IDV 0.244*
(1.77)
MAS −0.160
(−1.09)
UAI −0.312**
(−2.33)
log(GDP/capita) 0.307** 0.289** 0.288* 0.278**
(2.10) (2.09) (1.96) (2.07)
N 48 48 48 48
Adj. R 2 in % 9.7 14.2 10.7 18.0
*** Significant on the 1% level, ** significant on the 5% level, * significant on the 10% level 189
M. O. Rieger et al.
Table 11 Logit regression results on individual level for non-parametric probability weighting. (Wald
Probability
scoresweighting, cultural and economic factors
in parentheses.)
Probability weighting in at least one of the probability pairs

Model 1 Model 2 Model 3 Model 4 Model 5 Model 6
Constant 2.090*** 2.313*** 1.019*** 1.650*** 1.765*** 2.025***

Gender −0.196*** −0.166*** −0.159*** −0.134** −0.170*** −0.141**
(10.901) (7.76) (7.035) (4.940) (7.936) (5.362)
Age −0.003 −0.004 −0.006 −0.005 −0.003 −0.004
(0.136) (0.196) (0.552) (0.477) (0.178) (0.254)
IDV median −0.009*** −0.006*** −0.008*** −0.004*
(21.778) (7.70) (11.500) (3.239)
IDV ind. diff. 0.000 0.000 0.000 0.000
(0.006) (0.02) (0.068) (0.089)
UAI median 0.006*** 0.004** 0.003* 0.003
(11.520) (5.632) (3.235) (2.343)
UAI ind. diff. 0.000 0.000 0.000 0.000
(0.733) (0.509) (0.842) (0.658)
log(GDP/cap.) −0.19*** −0.197*** −0.187***
(45.508) (51.548) (44.037)
Nag. R 2 in % 0.8 1.9 0.5 1.9 0.9 2.0 190
Table 12 Logit regression results on individual level for non-parametric probability weighting for different
Probability weighting,
probability ranges.cultural andineconomic
(Wald scores parentheses.)factors
Probability weighting between…

10 and 60% prob. 10% and 90% prob. 60% and 90% prob.
Constant 0.945*** 1.108*** 0.224 0.438* −0.609** −0.397

Gender −0.206*** −0.186*** −0.150*** −0.126** −0.184*** −0.162***
(15.454) (12.462) (8.593) (5.966) (11.347) (8.632)
Age −0.029*** −0.030*** −0.003 −0.004 0.023*** 0.022***
(16.467) (17.514) (0.228) (0.373) (9.938) (9.043)
IDV median −0.003 0.000 −0.002 0.001 −0.009*** −0.005**
(1.642) (0.006) (1.406) (0.269) (18.983) (6.469)
IDV ind. diff. 0.000 0.000 0.000 0.000 0.000 0.000
(0.389) (0.344) (0.068) (0.036) (0.302) (0.406)
UAI median 0.005*** 0.005*** 0.001 0.001 0.005*** 0.005***
(10.178) (9.580) (0.879) (0.646) (7.287) (7.235)
UAI ind. diff. 0.001 0.000 0.000 −0.001 0.000 0.000
(1.376) (1.136) (1.297) (1.516) (0.000) (0.010)
log(GDP/cap.) −0.133*** −0.170*** −0.184***
(32.547) (55.905) (61.284)
191
Nag. R 2 in % 1.4 2.1 0.3 1.5 1.3 2.6
History of the paper
Some questions may arise:

‣Why is this paper so complicated?
‣Why so much more robustness checks than in other
papers?
‣Why did we use Matlab for some of the statistical analysis?
The history of the paper can explain this…
192
2.6 INTRA: loss aversion

Wang, Rieger, Hens: The Impact of Culture on Loss
Aversion, J. Beh. Dec. Making, 2016
193
1 4 Journal of Behavioral Decision Making
2
3Eliciting lossthe lottery) was therefore zero by definition. A similar formu-
aversion Survey
4 lation was used in Tversky and Kahneman (1992) (p. 312). As men
5 Question used:formulations were as follows:
The precise sion in
6 In the following lotteries you have a 50% chance of of Risk
7 winning or losing money. The potential loss is given. Please of Zuri
8 state the minimum amount $X for which you would be was tran
9 willing to accept the lottery. or trans
10 the amo
11 50% chance loss of $25 purchas
12 50% chance win of $X come a
13 X should be at least $____ to make the lottery acceptable. Hofs
14 mogeno
15 50% chance loss of $100 control
16 50% chance win of $Y chose u
17 ses at r
18 Y should be at least $____ to make the lottery acceptable. first yea
19 The loss aversion parameter θ has been defined by194 ground
34 1 wealth and
35 for the smaller stake is significantly smaller than the one the individ
36 for the larger stake (2.81 vs. 2.96, p<.001). The magnitude level GDP
37Eliciting of this difference, however, is relatively small. Moreover,
loss aversion
from the W
38 Cronbach’s α of the two measures is .73, demonstrating good use countr
39 reliability.
Since Therefore,ofour
the estimation loss aversion
lambda parameter
is numerically θ is (as
difficult de- we World Fac
40 have as theand
finedseen) average of the not
therefore tworobust
subindices
enough to be used for
41 individual level data, we use instead theta:
! "
42 1 X Y
43 θ :¼ þ :
2 25 100
44 Data prep
45 Survey dat
The In resulting
later values we
sections, show significant,
report results and nottojust
related the random,
aggre-
46 differences betweenparameter
cultural clusters: this can b
47 gated loss aversion θ. When we repeat the analy- bounded) a
When
ses withcombining
θ1 and θsimilar
2, the countries
results show intovery
cultural clusters
similar (e.g.,
patterns
48 of loss ave
Anglo-American
(not reported here). countries and Eastern European countries,
49 when analy
based To on Chhokar,
measure the Brodbeck, and House,
Hofstede cultural 2008),19
dimensions, between-
ques-
50 to deal wi
cluster
tions variations
based on the are large,VSM94
Hofstede as an ANOVA test at(Hofstede
questionnaire the level of
51 cultural clusters reveals (F(8, 6683) =survey.
16.44, Demographic
p <.001). highest and
52 & McCrae, 2004) were included in the ranked reg
53 information (gender and age) and information about personal the impact
195
54 background, nationality, and cultural origin of the partici- the ranked

6 Journal of Behavioral Decision Making
Cultural differences in median loss aversion
M
sio
tes
bo
As
ate
hy
an
* hy
M
of
wh
196
*There are large differences within some clusters, especially the Asian one! so
38 clusterTable
culture dummy variables on culture cluster dummy variables
2. Regression 103
)
39 104
Loss aversion (Ranked θ)
40
Regression analysis 105
Model412 Model 1on ranked theta
Regressions Model 3 Model 106
Model 12
42 107
!239.1***(3.81) !214.6***(3.55)
6***(3.55) Gender (1 = male) !212.5***(3.48) !239.1***(3.81)
43 Age !10.0 (1.00) 108
!4.6(.45)
(1.00)
!4.6(.45) !4.2 (.39) !10.0
44
2***(2.61) –.2***(2.69)
Risk avers. gain –.2***(2.59) 109
–.2***(2.61)
–.2***(2.69)
45 !33.1 (.44)
ln(GDP/cap) (.15) 25.0 !33.1110(.44)
31.346(.59) African !178.7 (.71) !131.3111(.59)
7**47(2.15) Anglo-American !298.1**(2.08) !311.7** (2.15)
!132.6
112(.53)
32.648(.53) Latin American !151.2 (.56)
92.2(.48) Latin European 110.8 (.57)
113
92.2(.48)
49
2***(2.83) Eastern European 447.0 ***(2.58) 114
460.2***(2.83)
72.550(1.47) Germanic/Nordic 186.1(1.58) 172.5
115(1.47)
07.051(.82) Middle Eastern !127.5 (.80) !107.0116(.82)
41.352(.23) Asian 21.7(.10) 41.3 (.23)
3828.0***(9.99) 117
3451.1***(12.10)
1***(12.10) Constant 3440.0*** (7.69) 3828.0***(9.99)
53 6177 118
6177
6177 N 6177 6177
1.9254 R2(%) .50 1.93 119
1.92
.50 197
55
2 67
3 Table 3. Regression analysis on cultural dimensions
68 and religions
4 Loss aversion (Ranked θ) 69
5 70
Regression
Model 3 analysis
6 Model 4 ModelModel
5 1 71 Model 2 Model
!182.5***(3.31)7 Gender (2.87)
!185.9*** !239.1*** (3.81) 72 !195.7***(3.03)
(1 = male) !170.4***(2.80) !182.5***(
!9.2(1.28)8 Age!3.4 (.35) !10.0(1.00) 73
!7.8(.96) !9.7(.92) !9.2(
–.2***(8.09)9 Risk avers. gain
–.2***(3.26) –.2***
–.1***(4.23) 74 –.1***(3.34) –.2***(
.8***(2.87)10 Risk avers. loss
.8***(2.91) .7***(2.69) 75
.8***(3.30) .8***(2.67) .8***(
39.7(.52) 11 log 43.5(.67)
GDP/cap 48.0(.74)
!33.1(.44) 32.6(.50) 39.7(
log 48.9(.35)
growth rate 76 3.8(.03) 37.9(
37.9(.24) 78.8(.58)
!15.4(.11)
10.8*(1.96)
12 IDV8.6*(1.75)
average 8.7*(1.79) 77 10.8*(
1.4**(2.32)13 IDV ind. di. 1.4**(2.26) 78 1.4**(
7.2(1.50)14 PDI average
6.6(1.26) 5.8(1.13) 79 7.2(
1.6**(2.41)15 PDI ind. di. 1.5**(2.34) 80 1.6**(
8.0***(3.43)16 MAS average
7.0***(2.00) 7.0***(3.01) 8.0***(
MAS ind. diff. 81 .2(
.2(.91) .2(.91)
1.5 (.30)
17 UAI7.0 average
(1.47) 7.9*(1.74) 82 1.5 (
.4(.99) 18 UAI ind. diff. .3(.95) 83 .4(
19 Protestant
476.6(1.24) 421.0*(1.80) 84 !194.7(.47)
20 Catholic
!80.5 (.31) !131.5 (.51) 85 !191.2 (.47)
21 Orthodox
533.7*(1.88) 490.9* (1.80) 738.1***(2.67)
Muslim 86 !618:0(1.63)
!372.6(1.06) !397.6(1.14)
22 Jewish (0.98)
!247.9 !273.4(1.16) 87 6.7(.02)
23 Buddhist
299.3(1.04) 255.9(0.94) 88 Religions65.3(0.17)
are country
1938.5**(2.66)24 Constant
1635.8**(2.42) 3827.9***(9.99) 89 average
1691.8**(2.57) 3640.5***(9.62)
data! 1938.5**(
5801 25 N 6146 58016177 90 6177 5801
2
2.60 26 R (%)
3.01 3.25 .50 1.80 198
2.60
91
Impact of religion: recent evidence
‣ A recent study (described in details in Chapter 4) found

some evidence for a relation between religion and loss
aversion also on an individual level:
‣ Buddhists and muslims* tend to have lower loss
aversion.
‣ Confucianists, daoists and communists tend to have
higher loss aversion.
‣ The study did not distinguish between protestants,
catholics and orthodox.
‣ Most effects, however, disappear when controlling for
country!
*low number of subjects (no 199

muslim country included in study!)
Summary
‣ Key results:
• Individualism, power distance, and masculinity
increase loss aversion.
• Religion also might have an influence.
• In comparison, the connection of loss aversion to
macroeconomic variables seems to be much smaller.
200
2.7 Framing and culture
We have already seen: framing effects differ between

countries and in particular between East Asian and
Western countries (Weber & Hsee 1999, Wang &
Fischbeck 2004, Levinson & Peng 2007).
201
Holistic vs. Analytic
Thinking Style
A potential explanation has been given by Nisbett (2004):

‣ East Asians tend to have a holistic thinking style.
‣ Westerners tend to have an analytic thinking style.
Therefore, the focus of attention for a task is different,
thus leading to different framing effects.
‣ In some tasks, a holistic thinker might integrate all
relevant information, whereas an analytic thinker
might focus on the essential looking information and
thus might be fooled easier into a framing effect.
‣ In others, a holistic thinker might consider irrelevant
information, and thus get fooled easier.
Marc Oliver Rieger, Professor of Banking and Finance, University of Trier 202
Example
Imagine that you have been given 1,000 EUR at the beginning
of a game. However, its rule is that you may or may not keep
this initial amount of money, depending on your subsequent
choices between a sure payoff and a gambling option:
• If Plan A is adopted, 600 EUR will be lost.
• If plan B is adopted, there is a 2/5 probability that nothing
will be lost and a 3/5 probability that 1,000 EUR will be lost.
Which of the two plans would you choose?
‣ A holistic thinker might integrate the 1,000 Euro into his

considerations.
‣ An analytic thinker might only focus on the difference between
the two choices which might lead him into risk-seeking
behavior, because
Marc Oliver Rieger, Professor the
of Banking and situation
Finance, University of Trier is about losses. 203
Example
Imagine that you have been given 1,000 EUR at the beginning
of a game. However, its rule is that you may or may not keep
this initial amount of money, depending on your subsequent
choices between a sure payoff and a gambling option:
• If Plan C is adopted, 400 EUR will be kept.
• If plan D is adopted, there is a 2/5 probability that 1,000 EUR
will be kept and a 3/5 probability that none of the initial
money will be kept.
Which of the two plans would you choose?
‣ A holistic thinker might integrate the 1,000 Euro into his
considerations.
behavior, because
erage in this task.
Illustration
Example
Imagine that you are about to purchase a jacket for 125 Euro,
and a calculator for 15 Euro. The calculator salesman informs
you that the calculator you wish to buy is on sale for 10 Euro at
another branch of the store, located 20 minutes-drive-away.
Would you make the trip to the other store?
‣ A holistic thinker might integrate all information and notice that

.
behavior, because
Example
Imagine that you are about to purchase a jacket for 15 Euro, and
a calculator for 125 Euro. The calculator salesman informs you
that the calculator you wish to buy is on sale for 120 Euro at
another branch of the store, located 20 minutes drive away.
Would you make the trip to the other store?
‣ An analytic thinker might only focus on the most crucial
information and notice that it’s only about 5 EUR difference.
‣ A holistic thinker might integrate all information and notice that
it’s about spending 135 EUR or 130 EUR.
‣ Framing effect only occurs “in the middle” between these
extremes. That’s why thinking style does not influence the
framing effect much.
Illustration
Example
Recall the lost vs. found scenario of Levinson and Peng (2006).
‣ An analytic thinker will only focus on the most crucial

information and thus the story (lost vs. found scenario) wll not
impact his value estimation.
‣ A holistic thinker will integrate all information – and thus might
fall into the “trap”.
‣ This is why Levinson and Peng (2006) measured framing
effect in this task mostly in East Asian subjects.
o big di↵erence, on average
Illustration
Survey
‣ We conducted an online survey with N=296 undergraduates
(146 in Germany, 150 in Vietnam).
‣ The students were randomly assigned to groups A or B.
(Pretests had shown that within-person measures of framing
effect fail.)
‣ We asked four framing questions in different frames.
‣ Three gain/loss questions (A: gain/loss/gain frame, B: loss/
gain/loss frame) and one purchasing framing question (the
above mentioned calculator & jacket question by Tversky and
Kahneman, 1981).
Measuring  
Holistic Thinking Style
‣ We also measured the AHS scale by Choi et al.(2007)

and three categorization tasks as two independent
measures of holistic thinking style:
‣ AHS tests agreement with items like “Everything in the
World is somehow connected.”
‣ The categorization task asks to what an item belongs,
e.g. whether “cow” belongs together with “grass” or
“chicken”. (The former answer is considered to be
holistic, the latter analytic.)
‣ In both scales, Vietnamese had higher holistic values
than Germans (as expected).
Country Results
The results showed that Vietnamese did indeed better  

in the three gain/loss questions (although not in the
purchasing problem).
30%
Gain/loss 1 Gain/loss 2 Gain/loss 3 Purchasing
German sample (n=145)
22.5%
Gain frame 91.5% 66.2% 59.2% 31.0%
Loss frame 68.9% 45.1% 31.5% 23.0%
15% effect
Framing 22.6% 21.1% 27.6% 8.0%
Vietnamese sample (n=151)
Gain frame 58.7% 44.7% 50.7% 48.0%
7.5%
Loss frame 53.9% 37.3% 30.3% 34.2%
Framing effect 4.7% 7.4% 20.4% 13.8%
0%
Difference between Germans
17.9% 13.7% 7.2% -5.8%
andOliver
Marc Vietnamese
Rieger, Professor of Banking and Finance, University of Trier 213
Gain/loss 1 Gain/loss 2 Gain/loss 3 Purchasing
A Note on Significance
‣ In previous comparisons of similar results, usually no

statistical significance has been reported.
‣ We estimated p-values with a bootstrap method that
we developed for this particular task.
‣ Results:
• The difference for the single question 1, as well as
the average over all questions or the questions 1-3
is statistically significantly different between the two
countries.
• There is no significant difference in purchasing
question.
Holistic vs. Analytic
When sorting by high/low AHS or categorization, the
holistic thinking style groups showed less average
framing effect:
Categorization AHS
German sample (n=145)
analytic 20.7% 22.4%
holistic 17.5% 12.6%
Vietnamese sample (n=151)
holistic 9.6% 9.3%
Total sample (n=296)
holistic 13.5% 10.9%
Statistical Significance
‣ For the AHS scale, the difference of the average

framing (for all questions, as well as for questions 1-3)
was significant.
‣ For the categorization task, it was only marginally
significant for questions 1-3.
Summary so far
‣ Holistic thinking style helps to avoid the framing effect

in most tasks.
‣ Even controlling for two different measurements of
holistic thinking style, the Vietnamese subjects,
however, still tend to show less framing effect than the
Germans.
Now, what about other factors that may potentially

influence framing, e.g. demographic variables?
Demographic Effects  
on Framing
In both countries, males and business administration students
showed less framing than others. How long they were studying
did not matter; the effect of age differed between Vietnam and
Germany (small sample size of young students in Germany!).
gender age years studying major
female male < 21 ≥ 21 ≤2 >2 BWL Others
Vietnamese 18.4% 6.9% 12.8% 15.6% 13.3% 13.1% 9.8% 19.1%
N 93 55 80 71 87 64 112 39
Germans 24.1% 16.0% 39.2% 20.0% 19.1% 19.7% 17.3% 27.2%
N 70 75 11 134 91 54 109 36
Chapter 3
How Culture Affects  
Game Theory
Behavioral game theory
‣ What happens to game theory, if people are not

always perfectly rational?
Three examples for a start:

‣ centipede game
‣ ultimatum game
‣ beauty contest
220
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(6:$()>677 two-players 
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game, starting top left:
1 C 2 C 1 C 2 C 1 C 2 C
100
S S S S S S 100
1 0 98 97 99 98
1 3 98 100 99 101
The game is played only once.

-56 %01234, $,"/,-' ,50&6&1"&04 /8 -5.7 :$;6U
221
Ultimatum game
Player A suggests a sharing rule for 10 Euro.
Player B accepts or rejects:

‣ If he accepts, he and player A share according to
the rule player A had suggested.
‣ If he rejects, nobody gets anything.
The game is played only once.
222
Play a beauty contest game
Let us play the following game:
‣ N players each choose a number x in [0,100]

2
‣ Compute target: 3 xi /N
i
‣ Closest to target wins 1 Euro.
Let us play this game (if time permits)!
223
Beauty contest result
Beauty Conest Game -Fall Semester 2008
5
Frequency
0
0 6 10 16 20 26 30 36 40 46 50 More
Average=19.82
Target number=13.21
Winning number =12
224
What do we learn?
In all cases, classical game theory does not predict

the outcome that is commonly played.
‣ Need to consider behavioral effects.
‣ Need to do experiments.
‣ Possibility that cultural factors play a role!
225
Games as social allocations (1)
Ultimatum game
Proposer has 10 Euro.
Proposer can decide to offer x Euro to Responder.
Responder can accept or reject it:

‣ If Responder accepts it, then he get x Euro and
Proposer keep 10-x Euro.
‣ If Responder rejects it, then both get nothing.
226
Games as social allocations (2)
What should the Responder do?
Pure self-interest: take any x>0.
Empirical evidence: Reject x≤ 2 half of the time.
Reason: The responders care about the fairness.
227
Experiments on ultimatum
games
228
Ultimatum bargaining
across cultures (1)
Machiguenga farmers in Peru (Henrich 2000)

Offered 26% on average, accepted all but 1 offer.
Very socially disconnected, family-level society
229
Ultimatum bargaining
across cultures (2)
Aché in Paraguay, Lamelara in Indonesia

Hyperfair (more than 50%) offers.
Hunter-gatherer (potlatch culture), whalers
230
Impacts of market integration
and payoff cooperation
Market integration:
How much do people rely on market exchange in their daily lives?
Payoff to cooperation: How important and how large is a group’s payoff from cooperation in
economic production?
231
Chapter 4
A Closer Look at  
East Asian Culture
4.1 East Asia: Background
If you want to understand cultural differences, you need

to understand the roots of culture first.
Therefore, we give a short intro into：
‣ Geography of East Asia

‣ History of East Asia
‣ Economic development
233
East Asia: Geography
234
East Asia: History*
*Sorry for gross simplifications and omissions and for still being a bit lengthy. To put a few thousand years in a few slides is hard!
China:
‣ Area with many ancient cultures, ancient writing system
‣ First unification of the core area in 221 BC by Qin (“China”)
‣ Expansion, mostly to West and South until ca. 760
‣ Strong influence on neighboring countries and Japan
around that time, while itself being influenced by buddhism
‣ More focus on the Eastern and Southern part of nowadays
China from ca. 760 to the Mongol invasion
‣ 1276 the Mongols conquered all of China (until 1370)
‣ During their rule, Marco Polo visited China
‣ After the Mongols, the Great Wall was built
‣ Later, China was ruled again by a Northern tribe (the
Manchu) until 1911 235
East Asia: History
‣ From the 19th century on, the Chinese empire was

defeated several times by European countries, in particular
Great Britain (e.g. the “opium war”: Hong Kong) and finally
also by Japan.
‣ In 1911, a republic uprising ended the empire, soon civil
wars started.
‣ In the 1920s Chiang Kai-shek became de facto dictator.
‣ Communists under Mao Zedong and the Japanese both
undermined his rule.
‣ War with Japan started in 1938. The Japanese occupied
most areas of China. After their defeat against the US, civil
war in China broke out, Mao Zedong finally defeated
Chiang Kai-Shek who fled to Taiwan and founded the
People’s Republic of China in 1949. 236
East Asia: History
‣ Mao Zedong became dictator, let China participate in the

Korean War and was responsible for the death of millions
of Chinese in particular during the “big leap” and the
cultural revolution.
‣ After his death, Deng Xiaoping started a huge economic
liberalization.
‣ Economic freedom didn’t bring full political freedom, as the
Tiananmen Massacre 1989 demonstrated.
‣ In recent years, under president Xi Jinping, the country
becomes even more illiberal again, and has a more
aggressive foreign policy (e.g., in the China South Sea).
237
East Asia: History
Japan:
‣ Strong cultural influence from China, esp. around 400-700
‣ Writing, arts, science, religion imported from China
‣ Basically completely closed from around 1500-1850
‣ US forced an opening that led to political reforms in Japan
‣ Rapid adaption of Western technology and governmental
system from 1868 onwards.
‣ Conquest of various islands (including Taiwan) and Korea
and Mandchuria.
‣ Large scale nationalism, collaboration with Nazi Germany
and start of the war with China (1938) and the US (1941).
‣ After the nuclear bombing of Hiroshima and Nagasaki defeat
against the US, loss of all conquered territories.
‣ Since 1945 democracy with a solely representative emperor.
238
East Asia: History
Korea:
‣ On the intersection between China and Japan, often
depending on China or even conquered.
‣ Invention of a unique alphabet with 24 letters, replacing the
Chinese characters in the 15th century.
‣ Occupied by Japan in 1910, after the war, the North was
occupied by the Sowjet Union and became communist.
‣ In 1950, the North attacked the South. UN troops were
fighting back and conquering the North. China intervened
unofficially with “volunteer troops”. The war ended 1953 with
a draw.
‣ North Korea is one of the least free countries in the world.
‣ South Korea is a flourishing, wealthy democracy.
239
East Asia: History
Taiwan:
‣ Inhabited by pacific tribes (similar to the South sea)
‣ Colony of the Netherlands (1622-1662)
‣ Conquered by the fleeing Ming armies of China (1662),
afterwards Chinese settlers
‣ Conquered by the Japanese in 1895, part of Japanese
empire
‣ After World War II, Japan had to return Taiwan to China
‣ In 1949, Chinese fleeing from the communists flood Taiwan,
Taiwan becomes the sole land of the “Republic of China”.
‣ Until 1970s, representing China internationally, afterwards
international isolation.
‣ Democratisation in the 1990s, now fully working democracy
and relatively wealthy country, but still under threat of China.
East Asia: History
Vietnam:
‣ Strictly spoken not East Asia, but South East Asia.
‣ In its long history often partially under Chinese rule or influence.
‣ Other influences from the South (Thailand, Cambodia, India).
‣ French colony 1858-1954, 1945 briefly occupied by Japan.
‣ After independence war, separated into Northern (communist)
and Southern Vietnam.
‣ After invasions of Northern troops into the South, the USA got
more and more involved into the war (Vietnam war) with
atrocities on both sides.
‣ When the war was no longer acceptable for US citizens, the US
withdrew. Not long afterwards, Northern Vietnam occupied the
South and unified the country under communist rule.
‣ Wars with Laos, Cambodia and China, later economic reforms.
Economic development of
East Asian countries
242
4.2 Why do we Study East Asia?
Rich* East Asian culture
Switzerland (9th) Hong Kong (9th)
Germany(17th) Taiwan (19th)

Japan (28th)
Beijing (39th)
Democratic
China (79th)
Vietnam (125th)
Poor *World ranking in GDP PPP per capita (IMF 2017)
Some special points about
East Asian Cultures
Important cultural sources:

‣ Daoism/Shintoism
‣ Confucius
‣ Buddhism
‣ Interactions with West (communism/liberal values)
 
Typical characteristics:
‣ Low IDV
‣ High PDI
‣ Strong holistic thinking style
‣ Relatively little time discounting (high “patience”)
244
Conclusion
‣ East Asian countries are very important –

economically and politically, so studying them is
pivotal to understand the world!
‣ But they are also an ideal “lab” to test influences of
culture and politics on economic decision making, in
particular in finance!
245
4.3 The PANDA study
General motivation: 
After the completion of our global INTRA
study (International Test on Risk Attitudes)
with nearly 7000 subjects in 53 countries, we
broaden the view to more diverse economic
decisions, but focus on a particularly
interesting region of the world: East Asia.
The surveys in this study are being
conducted in Taiwan, China, Hong Kong,
Japan and Vietnam, but also in Germany,
Estonia and India (for comparison).
246
PANDA study
‣ Partially classroom (non-incentivized), partially online
(semi-incentivized), partially lab (incentivized)
‣ Countries in East Asia (China, Hong Kong, Japan,
Taiwan, Vietnam), Europe (Estonia, Germany) etc.
‣ Topics include…
247
Innovation
Learning Creativity
Probabilities Trust
Economics
Framing Politics Honesty
Culture
Updating beliefs Market economy
Social redistribution
Main research questions of
PANDA (1)
‣ How do culture and political system affect trust and

honesty (in-group and out-group)? (controlled and
incentivized experiment)
• Matrix test as developed by Dan Ariely, with
modifications
• Paper and pencil questions on trust (and other items)
‣ Are East Asians (still) more miscalibrated than
Westerners in probability judgements? Might this be an
artefact of differences in statistical knowledge? What about
their general overconfidence?
PANDA (2)
‣ How can differences in the perception of technologies

(chances and risks) between East Asians and Europeans
be explained? Are there differences in information (e.g.,
due to censorship), different values (individualism versus
collectivism) or different needs behind the different
evaluation? How are the differences between East Asia?
‣ How can the larger propensity to stock market
investments in East Asia be explained? Is it higher
financial literacy, different estimation of probabilities and
risks, different attitudes towards market economy and
capitalism?
PANDA (3)
‣ Are there differences in belief formation and updating?

How are they related to the ability for critical thinking?
‣ How do attitudes towards market economy und fairness
differ between the countries?
‣ Connections between learning attitudes, creativity,
critical thinking and innovation potential: in Europe, it is
often assumed that better learning attitudes in East Asia
lead to less freedom for children and subsequently lower
creativity and critical thinking. This supposedly hampers
innovation potential. We study whether this conjectured
relation can be found and if so whether it differs across
East Asian countries. (Joint project with Prof. Mühlfeld and
Prof. Block, both University of Trier.)
Time frame and support
‣ Data collection 2018-2019

‣ Data evaluation 2018-2020
252
4.4 Social Difference
Acceptance
‣ Online survey (N=1621)
‣ Several items on fairness and social differences:
1. Only if differences in income and social standing  
are large enough is there an incentive for individual
effort.
2. Differences in social standing between people are
acceptable because they basically reflect what
people made out of their opportunities they had.
3. All in all, I think social differences in my country are
justified.
4. Generally speaking, business profits are distributed
fairly in this country.
SDA index computed based on agreement to these items
(Cronbach’s Alpha 0.73). 253
Social Difference Acceptance
‣ Strong country differences:
Estonia Taiwan China Vietnam Germany Japan

254
Social Difference Acceptance
‣ These country differences in SDA have strong impacts on

judgements of fairness.
‣Besides that there are other striking cultural differences, as
can be seen from the following questions. (We only show
descriptive data, a detailed analysis is in preparation.)
255
Two qestions
1. Suppose the government wants to undertake a reform to

improve the productivity of the economy. As a result, everyone
will be better off, but the improvement in life will not affect
people equally. A million people (people who respond
energetically to the incentives in the plan and people with
certain skills) will see their incomes triple while everyone else
will see only a tiny income increase, about 1 %. Would you
support the plan?
2. On a holiday, when there is a great demand for flowers,

their prices usually go up.  
Is it fair for flower sellers to raise their prices like this?
256
Discussion
‣Please answer these questions for yourself!

‣ We will split the class then into groups. (In each group one
person takes notes of the discussion!)
‣ In each group please discuss:
• How did each of you answer the two questions?
• Why did you chose your answers?
• What do you think in which countries the majority would
answer what?
‣We collect the summarize the discussion results afterwards
together.
257
Government productivity reform
Suppose the government wants to undertake a reform to improve the
productivity of the economy. As a result, everyone will be better off, but the
improvement in life will not affect people equally. A million people (people
who respond energetically to the incentives in the plan and people with
certain skills) will see their incomes triple while everyone else will see only a
tiny income increase, about 1 %. Would you support the plan?
Government reform / unequal distribution
90%
68%
45%
23%
0%
No Yes
258
Flower Price Increase by Country
On a holiday, when there is a great demand for flowers, their prices
usually go up. Is it fair for flower sellers to raise their prices like this?
Higher Flower Prices Due to Higher Demand

100%
75%
50%
25%
0%
No Yes
259
Fairness and the state
‣In both questions, there is a striking difference between

Germany and the rest of the countries.
‣ While many Germans think that higher prices in the last

scenario would be unfair, they do, however, are less
supportive of government interventions. Ex-communist
countries are much more positive about that.
260
Flower Price Limits by Country
Should the government introduce limits on the increase in
prices of flowers, even if it might produce shortage of flowers?
Acceptance for Flower Price Limits
90%
68%
45%
23%
0%
No Yes
261
4.5 Perception of stocks
‣ Stock market participation differs tremendously

between countries.
‣ Germany has a much lower rate than, e.g., China.
‣ This has large effects on the accumulation of wealth.
‣ What can explain these differences?

‣ Can we learn from that what measures might be
promising to increase stock market participation in
countries like Germany?
262
Online survey
In the PANDA survey, a couple of stock related questions

were included:
‣Do you invest into stocks or funds?
‣ How likely is it that you would later, if you had enough
money?
‣Agreement to statements about the stock market regarding
moral value, profitability and herding.
‣ Incentivized hypothetical investment decision.
(Ashtiani, Rieger, Yousefi, working paper, 2020 –  

see Dropbox)
263
Stock market investments - real
Have you ever invested in stocks or funds?
100%
75%
50%
25%
0%
No Yes
264
Stock market investments - potential
How likely is it that you would invest money in stocks or funds in

the future, provided you had a reasonable amount of savings?
80%
60%
40%
20%
0%
Estonia Taiwan China Vietnam Germany Japan 265
Very unlikely Not likely Likely Very likely

The case of Germany
‣ Germans have in both questions the least agreement to

buying stocks.
‣What are the reasons?
• Risk attitudes?
• Lack of knowledge on the benefits of stocks?
• Concerns about capitalism?
• Cultural differences?
• Or other factors…?
266
Differences in attitudes towards stocks
Agreement with statements on stocks

3.5 “normal”
“long run
3 returns”
2.5
2 “gambling” “morally
questionable”
1.5
1
0.5
0 Investing in stocks is only for gamblers It is morally questionable to earn money with On the long run, stocks give a good return. Investingonthestockmarketisaperfectlynormal
stocks, because whatever I gain, somebody way to earn money.
else must lose.
Germany Estonia China Taiwan Vietnam Japan
267
Social Inequality Aversion (SIA)
Elicited by the following question:
Would you support the following plan:

Suppose the government wants to undertake a reform to
improve the productivity of the economy. As a result, everyone
will be better off, but the improvement in life will not affect
people equally. A million people (people who respond
energetically to the incentives in the plan and people with
certain skills) will see their incomes triple while everyone else
will see only a tiny income increase, about 1%.
268
Skepticism About Fairness (SAF)
Four different dimensions for SAF:
1. skepticism about fairness in the world (SAF in the world);

2. skepticism about fairness in markets (SAF in markets);
3. ex-ante skepticism about fairness in stocks (ex-ante SAF
in stocks);
4. ex-post skepticism about fairness in stocks (ex-post SAF in
stocks).
269
Regressions for potential investment
‣ Regression analysis shows that social inequality aversion

(SIA) and skepticism about fairness (SAF) play a significant
role and can explain some of the country differences in
potential (and real) stock holdings. – But not all!
‣ The results for the Hofstede dimensions are not robust.
270
Regression results
(1) (2) (3) (4) (5) (6) (7)

wstock wstock wstock wstock wstock wstock wstock
SIA -0.190*** -0.116***
(0.035) (0.034)
SAF in the world -0.069*** -0.076***
(0.016) (0.015)
SAF in markets -0.196*** -0.103***
(0.041) (0.040)
ex-ante SAF in -0.240*** -0.226***
stocks
(0.018) (0.019)
ex-post SAF in -0.089*** -0.020
stocks
(0.017) (0.017)
Additional controls yes yes yes yes yes yes yes
Observations 1,929 1,929 1,929 1,929 1,929 1,929 1,929
R-squared 0.314 0.324 0.321 0.322 0.372 0.324 0.389
271
Discussion
‣ Take a look at the working paper and the tables therein.

‣Discuss in three groups and try to answer the following
questions:
Group 1: How much of the country differences in stock
market investment (willingness) can (roughly) be explained
by differences in SIA and SAF?
Group 2: Take a look at all factors measured in this study.
Could you think about other factors that could explain
country differences in stock market investment?
Group 3: What does it mean that the interaction term with
SIA in Table 6 is significant and that the Germany dummy
switches sign?
272
Some preliminary results on cultural differences in fairness
perception…
When asking Chinese in Germany the SIA (and some SAF)

questions, their answer depended on the language of the
survey:
‣In Chinese, they responded similarly to the subjects from
the PANDA survey in China;
‣In German, they responded similarly to the subjects from
the PANDA survey in Germany.
This gives strong support for a cultural explanation of the

differences!
(Liao, Rieger, Soffel, work in progress)
273
4.6 Information processing,
critical thinking and fake news
‣ Online survey (Germany, Taiwan, Vietnam, N=641),

including questions on critical thinking and fake news
‣ Self-assessed critical thinking:
(1) It is not so important to keep trying to solve a
difficult problem,  
(2) I am only looking for facts that support my beliefs,
not facts that contradict them,  
(3) Thinking about other people’s point of view is a
waste of time,  
(4) I know what I think, so why should I pretend to
think about alternatives,  
(5) Thinking about what others believe means you
can’t think for yourself. 274
Information processing, critical thinking and fake news
‣ Four “critical thinking” stories.

• Two with four sub questions, both false.
• Two with 12 sub questions (one false, one true)
with counterarguments to see whether respondents
update their beliefs to good (or bad) arguments.
• Eliciting of credibility of stories and arguments.
275
Example
Imagine you read the following news on Facebook:
The hidden dangers of bar codes and QR codes

Bar codes are not only a pattern of black and white lines, they are a
barely known threat: researchers in bioenergetics have coined the term
"information radiation" to describe the potential negative effects when
we are exposed to a steady stream of encoded information, as, e.g., in
bar codes. Indeed, this information radiation is as harmful as the well-
known electromagnetic radiation that is emitted from radioactive
pollution, X-ray machines and microwaves. Long-run exposure leads to
sleeping problems, headache and might even cause cancer. And their
indirect effects by altering food that we consume is not even
researched yet!
Even worse, information radiation increases rapidly in the past years,
as, e.g., QR codes become more and more widespread.
Therefore avoid the contact with such codes as much as possible and
use specially developed tools to neutralize their negative effects! 276
Example
‣ Computation of “critical thinking” from the judgement

of these stories/arguments (fake minus real).
‣ Additionally, we asked respondents whether and to
how many of their friends they would forward news
items about gossip or health threats.
‣ We also asked whom they would believe if the story is
denied by authorities.
277
Results
‣East Asians are in general more “naive” or “open”

regarding news, i.e. they tend to believe fake news, but
also real news, more easily.
‣Self-reported critical thinking is much higher for
Germans.
‣East Asians are, however, more or less similar to
Germans in critical thinking, i.e. in discerning real news
from fake news.
‣Only in politically “unfree” countries (China and
Vietnam), we find lower levels of critical thinking ability.
‣ We observe less forwarding of fake news in China and
Taiwan.
278
Discussion
Discuss in groups and try to answer the following questions:

1. What could be potential reasons that Germans have
on average much higher self-assessed critical
thinking, but not higher actual critical thinking?
2. Why could we expect to see higher levels of critical
thinking ability in democratic countries?
3. Why do you think that Chinese and Taiwanese on
average forward fake news less than others?
4. Can you think about examples where critical thinking
ability is important in finance?
(For one of these questions, I also don’t know the answer…)
We will discuss the results afterward together.

279
Additional discussion
How about the recent importance of conspiracy theories?
Here are some results from a survey among students at a top

university in China:
Do you think COVID-19 originated in...

0% 20% 40% 60% 80% 100%
China
USA
Elsewhere
No Rather unlikely Rathr likely Yes
Figure 5: Belief in the origin of COVID-19 in China, an indirect way of measuring

280
the extent of conspiracy theories: subjects think that it is most likely that the virus
20%
10%
20% 20%
10%
5%
10% 10%
Additional discussion 0%
0%
0% 0% 2 3 4 5 6 7 8 9
And 24 a3 comparison
here 5 4 65 67 78 8 9 9 ≥10
between10 Germans4 5 and
6 Chinese
7 8 9 in≥10
Germans Chinese
Germany, demonstrating
Germans
Germans Chinese how politics influences
Germans these
Chinesebeliefs:
Anti-China conspiracies Anti-US conspiracies

Anti-China conspiracies
"Neutral" conspiracies 70%
60% 60%
60%
60%
50% 50%
50% 50%
40% 40%
40% 40%
30% 30%
30% 30%
20% 20%
20%
20%
10% 10%
10%
0% 0%
0% 2 3 4 5 6 7 8 9 2 33 44 5 5 6 6 7 7 8 89 10
9
4 5 6 7 8 9 ≥10
Germans Chinese Germans Chinese
Chinese 281
Germans Chinese
East Europe: another example of the
interaction between culture and politics
‣ Eastern Europe is – similarly to East Asia – a standard

example for effects of communism.
‣ There are, however, also other historic differences
between Eastern and Western Europe.
‣ It is difficult to disentangle them, since they overlap to a
large degree.
‣ We summarize results from a recent research paper on

this topic (Schaewitz, Rieger and Wang, 2020).
282
Overview: Communist and
Western Europe in 1989
▪ Communist/Eastern Europe: Socialist regimes with centrally planned economies

▪ Western Europe: Democracies and market-based economies
283
Culture and Institutions
Culture: “those customary beliefs and values that ethnic, religious,
and social groups transmit fairly unchanged from generation to
generation.” (Guiso et al.,2006, p.23)
“Institutions are the humanly devised constraints that structure

political, economic and social interaction. They consist of both
informal constraints (sanctions, taboos, customs, traditions, and
codes of conduct), and formal rules (constitutions, laws, property
rights).” (North, 1991, p. 97)
Ideological and territorial division of Europe and Germany

‣ two political and economical contrarian systems
‣ over four decades until the beginning of the 1990s
Do the political, economic, and societal institutions have shaped the
preferences of individuals living in either one of the two systems?
Do communistic institutions have long-lasting effects on the risk and 284

time preferences of individuals?
Risk and Time Preferences
Challenge with investigating long-lasting effects

‣ Temporal distance to the actual exposure of socialist
institutions
‣ Post-communistic effects
1) Did communist systems effectively shape the risk and time

preferences of individuals?
2) Did post-communist experiences, especially the
turbulence of the transition process toward democracy
and market economies, influence these preferences?
3) Is there a convergence of preferences between post-
communist and Western European countries?
285
Communist Institutions and
Preferences
Economic institutions, such as markets, shape the preferences of

individuals (Bowles, 1998)
Lack of free financial markets in socialist countries ! reduced
experience in financial decision-making
Experiences in markets attenuate behavioral biases regarding risk
preferences (Feng and Seasholes, 2005; List 2003, 2004, 2011)
Investment and saving decisions were not necessary in socialism
! less experience in intertemporal economic decision-making
Expectations
‣ Communist institutions lead to stronger behavioral biases in
preferences:
• Higher risk aversion in gains, stronger risk-seeking in losses,
higher loss aversion
• Stronger impulsiveness and impatience
286
Previous Literature
Several studies utilizing the natural experiment in Germany:
‣ Heineck and Süssmuth (2013)

‣ East Germans have lower general risk aversion than West
Germans
‣ Neugart (2016)
‣ East Germans show more risky investment behavior than West
Germans
‣ Tigges et al. (2000)
‣ East Germans are less risk orientated regarding financial decisions
‣ Friehe and Pannenberg (2019)
‣ East Germans show higher short-term patience but similar long-
term patience
Convergence of risk and time preferences between East and West
Germans in 2008
‣ Germany not representative for other post-communist states (reunited,
integrated, adjusted)
287
‣Europe as been widely neglected
Methodology and Data: Overview
288
Descriptive Overview of Risk and
Time Preferences
*p < 0.1; **p < 0.05; ***p < 0.01
‣ Differences in loss aversion and β in Germany

‣ More distinct prospect theory and quasi-hyperbolic
discounting preference patterns and lower impulsiveness
in post-communist Europe
‣ OLS-regression analysis: Communism or pre-/post- 289
communistic effects?
OLS-Regression –  
Post-Communist Dummy
▪ 1: Post-Communist/Eastern European country

▪ 0: Western European country
290
OLS-Regression –  
Russian Empire in 1914
Pre-communist cultural and institutional influences (the czarist Russian Empire,
the Russian Orthodox Church, and Slavic/Baltic culture): Russian Empire 1914
Area proportions in 1914 within the

territory of the Russian Empire
Country in 2007 Proportion
Azerbaijan 100.0%
Bosnia-Herzegovina 0.0%
Croatia 0.0%
Czech Republic 0.0%
Estonia 100.0%
Georgia 100.0%
Hungary 0.0%
Lithuania 95.6%
Moldova 100.0%
Poland 42.2%
Romania 57.9%
Russia 99.9%
Slovenia 0.0%
291
OLS-Regression – Covariates
Transition process: Highest rate of unemployment between

1990 and 1999
Quality of formal institutions (especially the quality of
governance): Worldwide Governance Indicators 2007
‣ six dimensions
‣ high correlation ! principal component analysis ! one
composite score for insitutional quality
Current economic situation: GDP per capita (2007);
unemployment rate (2007)
Cultural clusters: Anglo Europe; Latin Europe; Eastern
Europe; Germanic/Nordic Europe
Sociocultural control variables: age; gender; economic
students; non-natives
292
Results: Risk Preferences and  
Loss Aversion (OLS-Regression)
RRP Gains RRP Losses (ln) Loss Aversion
Post-Communist 0.176*** 0.146*** -0.157** -0.170** 0.200 0.0575

(3.85) (3.41) (-2.27) (-2.32) (1.28) (0.37)
Russian Empire 1914 0.0593 0.0270 0.320**

(1.27) (0.42) (2.75)
Institution Score 2007 0.0102 0.0119 0.0226 0.0236 0.0300 0.0408

(0.77) (0.85) (1.02) (1.05) (0.87) (1.05)
Post-Communist x -0.0132 -0.00823 -0.00676 -0.00477 -0.0449 -0.0192

Institution Score 2007 (-0.88) (-0.55) (-0.27) (-0.18) (-1.05) (-0.42)
(ln) Highest rate of unemployment 0.0152 0.00648 0.00764 0.00367 0.118 0.0759
between 1990 and 1999 (0.56) (0.23) (0.26) (0.11) (1.57) (0.94)
Post-Communist x 0.172*** 0.158*** -0.247*** -0.255*** -0.143 -0.226

(ln) Highest rate of unemployment (3.70) (2.85) (-3.45) (-4.08) (-0.92) (-1.62)
between 1990 and 1999
Controls + + + + + +
Observations 3291 3291 3325 3325 3312 3312

Adjusted R2 0.073 0.074 0.042 0.042 0.034 0.037
*p < 0.1; **p < 0.05; ***p < 0.01
293
Results: Time Preferences  
(OLS-Regression)
Beta (β) Delta (δ) Waiting Tendency
Post-Communist -0.261** -0.0687 -0.0354 -0.00713 0.135* 0.176**

(-2.57) (-0.84) (-1.68) (-0.32) (1.86) (2.50)
Russian Empire 1914 -0.407*** -0.0601** -0.0903

(-3.98) (-2.75) (-1.38)
Institution Score 2007 0.0133 -0.00228 0.00179 -0.000502 0.0794*** 0.0760***

(0.67) (-0.09) (0.24) (-0.06) (3.08) (2.81)
Post-Communist x 0.00785 -0.0213 0.00481 0.000506 0.000164 -0.00626

Institution Score 2007 (0.26) (-0.73) (0.61) (0.06) (0.01) (-0.22)
(ln) Highest rate of unemployment 0.106** 0.164*** 0.00433 0.0129 -0.0396 -0.0266
between 1990 and 1999 (2.61) (3.58) (0.34) (0.96) (-1.32) (-0.80)
Post-Communist x -0.0244 0.0791 0.0246 0.0398 0.00436 0.0268

(ln) Highest rate of unemployment (-0.14) (0.62) (0.70) (1.56) (0.06) (0.42)
between 1990 and 1999
Controls + + + + + +
Observations 3525 3525 3538 3538 3759 3759

Adjusted R2 0.172 0.207 0.046 0.053 0.095 0.096
*p < 0.1; **p < 0.05; ***p < 0.01
294
Possible Causes for Differences  
in Preferences
1) Did communist systems effectively shape the risk and time preferences of
individuals?
2) Did post-communist experiences, especially the turbulence of the transition

process toward democracy and market economies, influence these
preferences?
Pre-communist formal Post-communist
Legacy of communist
and informal challenges (in the
institutions
institutions transition processes)
RRP in Gains + +
RRP in Losses - -
Loss Aversion +
Beta (β) -
Delta (δ) -
Waiting Tendency +
Note. The sign + (-) indicates a positive (negative) correlation between the preference measure and the possible influence. Bold
signs indicate the presumable, more important causes for the difference observed between Eastern and Western Europe.
295
Convergence in Germany
3) Is there a convergence of preferences between East and
West Germany?
296
Convergence in Europe
4) Is there a convergence of preferences between post-

communist and Western European countries?
297
Chapter 5
Cultural Finance  
on the Market Level
5.1 Is culture relevant to
finance?
Classical rational finance:

Cultural differences should not matter for financial
decisions.
‣Therefore no influence on financial markets.
However:
‣There is counter-evidence to this claim.
‣Various results in finance, economics, sociology and
psychology.
‣In fact, culture is relevant to finance!
299
Overview
Differences in market behavior

Three examples:
‣Momentum
‣Equity premium
‣Stock market participation
300
Example 1: Momentum (Griffi, Ji and Martin (2003))
Data: Stock returns from 40 countries.

Momentum portfolio profits are large and positive in gerenal,
and only weakly comove among 40 countries, whether within
regions or across continents.
The momentum profits for Asia are decidedly weaker than
those around the world, particularly for Europe.
Momentum cannot be explained by standard macroecnomic
state variables.
(Griffi, 301
Ji and Martin, 2003)
Trend chasing around the world
1.8
1.4
0.9
Europe
Profit of
momentum 0.5
Asia
0.0
-0.5
0 50 100 IDV
Profitability of momentum strategies (trend chasing) depends on Hofstede index of individualism (Chui, Titman & Wei, 2005).
Control for institutional differences (La Porta et al.).
302
Example 2: Equity premium and ambiguity aversion
(Rieger & Wang, Finance Research Letters, 2012)
303
B. a payment of X $ in 10 years from now
X has to be at least _____ $, such that B is as attractive as A.
__________________________________________________________________________
Measure of Ambiguity Aversion
Please imagine the following offers and mark your choice:
Question 4. In an urn, there are 100 balls with three colors (red, yellow, and blue).
30 balls are red, whereas the remaining 70 consist of yellow and blue balls.
30 balls 70 balls
red yellow blue
Imagine a ball is randomly drawn from the urn. You are offered the following two
Lotteries. Which lottery would you prefer?
A. If the color of this ball is red, you win 100 $; otherwise you win nothing.
B. If the color of this ball is yellow, you win 100 $; otherwise you win nothing.
I prefer _ A _B 304
Example 3: Stock market participation and trust
305
Discussion
We can try to verify these results on individual level using the

PANDA data.
To do so, we will split into groups. Each group:
‣Please take a look at the regression results in the Dropbox
(Papers/Trust and stock market participation -
regressions.pdf)
‣Check whether trust has the predicted effect.
‣Check the other control variables and discuss whether they
have expected effects.
‣Discuss why several models have been used.
306
5.2 Dividend payout policy
Key result:
Strong dependence of average dividend payout ratios of
companies in 46 countries with the INTRA survey values
of patience, loss aversion and ambiguity aversion.
(Breuer, Rieger, Soypak, Journal of Banking and
Finance, 2014)
307
Behavioral Decision Theory
‣If behavioral theory predicts a certain behavior for

individual financial decisions, this can be verified by
observing a sufficiently large number of investors.
‣If it predicts certain reactions to market outcomes, then
this can be verified by checking these market outcomes.
‣If a behavioral theory, however, predicts a certain
general behavior of financial markets, then this can be
difficult to verify!
- Possible to run financial market experiments, but
always difficult to justify their validity.
- What else to do?
308
Behavioral Decision Theory
‣Here, cultural finance can help: what if we had several

financial markets to test the validity of the theory?
‣That is indeed the case when we look on the
international level! (Thanks especially to home bias,
international markets are even nowadays quite different
from each other.)
‣However, to use these different markets, we need to
know how behavioral parameters (the ones crucial in our
theory) vary between them. Studies like INTRA can help
us here.
309
Example: dividend payout policy
Behavioral model:
‣Investors like dividends, because they can spend them
without psychological disutility.
‣Firms pay dividends because investors demand them.
‣Myopic, loss averse and ambiguity averse investors
prefer more dividends, as can be shown with a
mathematical model.
310
ginal work, which focuses on the possible influence of wealth
transfer among accounts on household savings, we take a closer
look at the subjective perception of these simple wealth transfers
Example: dividend depending
by investors payout policy on their preferences.
Fundamental idea of the model (extension of Shefrin and

Thaler, 1988):
:
Current Future
asset S2 income
S1
account account
x1
Current
d1 income
account
t=1 t=2 311

‣Investors prefer current income account money, since

they can spend this money (psychologically) easier.
‣On the other hand, reinvested money might bear larger

fruits in the future.
‣The trade-off between these two factors is determined

by behavioral preferences.
312
e idend policy d1 that maximizes the (representative) investor’s
l overall utility U which is computed as the sum of utility
d uðd1 !
ðRÞ
and uðS
d1 Þ payout 1 !
ðRÞ
in the first period and the subjectively
S1 Þ
Example: dividend policy
e R1 ðRÞ
discounted expected utility ð2 ! dÞ " 0 uðS2 ! S2 Þf ðr1 Þdr 1 þ
- The
R 0 expectedðRÞ
utility of an investor receiving a dividend d1
y d " can uðScomputed
!1 be 2
Þdr 1 of the second period:
! S2 Þf ðr1as:
e ðRÞ
Uðd1 Þ : ¼ uðd1 ! d1 Þ þ uðS1 ! S1 Þ
ðRÞ
- Z 1 Z 0
ðRÞ ðRÞ
- þ b " ð2 ! dÞ " uðS2 ! S2 Þf ðr 1 Þdr 1 þ b " d " uðS2 ! S2 Þf ðr 1 Þdr 1 : ð1Þ
0 !1
e
e In (1), the index ‘‘(R)’’ denotes reference values to distinguish
- Here the
between index
gains ‘‘(R)’’
and denotes
losses, reference
i.e. for x e {d, S}values to
we assume
- distinguish between
8 gains and losses.
ðRÞ a
þ
<
𝜆,
ðRÞ
g u is a ðRÞ ðx ! x
CPT-valuet function
t Þ x P x
with losst aversion
t ;
uðxt ! xt Þ ¼ ð2Þ
- : !k " ðxðRÞ ! x Þa! x < xðRÞ ;
𝛽 is the quasi-hyperbolic
t time
t discounting
t t parameter.
- 𝛿 (between
with k being a1loss
andaversion
2) is an ambiguity
parameteraversion
typicallyparameter.
greater than 1 and
e a+ as well as a! being variables that determine the curvature
313
of u
the future incom
e idend corporate
policy dividend
d1 that policymaximizes
in a more formalthe (representative)
manner. However, they investor’s
assume a value function that is not completely in line with pros-
l overallpectutility U which is computed as the sum of 2 utility
ðRÞ
S 2 ! S ¼ ðx1 ! d
theory, they refrain from taking ambiguity aversion into ac-
d uðd ! count
d
ðRÞ and they do not ðRÞ
1 dividendÞ and uðS 1 ! S distinguish between different mental
Þ in the first period and the The future inc
subjectively
Example: 1
accountspayout policy
for dividends 1 asset holdings which are at the core
and (1)). In addition, w
e R1 ðRÞ
discounted
of the generalexpected
ideas of Shefrin utility
and Thaler ð2 (1988).
! dÞIn"what0
uðS
follows,
2 ! S 2
ever,
Þf as
ðr 1 a genera
Þdr 1þ
- The
R 0 we expected
mainly attempt
ðRÞ
utility
to of an the
depict investor
approachreceiving
of Shefrin anda dividend
Thaler d
mally1 model am
y d " can uðScomputed
(1988)
!1 be 2
! aSmore
in 2 Þf ðr Þdr 1 offramework.
quantitative
as:
1 the second period:
As opposed to their ori- mainly interested
ginal work, which focuses on the possible influence of wealth one main conseq
e transfer
Uðd1 Þ : ¼ uðd1 ! among
d1 Þ accounts
ðRÞ
þ uðS1 !on S1household
ðRÞ
Þ savings, we take a closer evaluating a futu
- look at the subjective
Z 1 perception of these simple wealth Z 0 transfers ambiguity averse
by investors depending on their ðRÞ preferences. ðRÞ reducing the ove
- þ b " ð2 ! dÞ " uðS2 ! S2 Þf ðr 1 Þdr 1 þ b " d " uðS2 ! S2 Þfisðrdisturbing
1 Þdr 1 : ð1Þfor a
0 !1
e guity aversion by
and 2 where for d
e In (1), the index ‘‘(R)’’ denotes reference values to distinguish ity aversion is in
- Here the
between index
gains and ‘‘(R)’’ denotes
losses, i.e. for
Current
reference
x {d, S}values
e we assume to
Future subjectively disco
- distinguish between8 gains

S1
and
asset losses. S2 income count is decreasi
< ðRÞ a account
þ account ambiguity aversi
xt ; 𝜆,
ðRÞ
g u is a ðRÞ
CPT-value ðxt ! xt Þ with loss
function xt P aversion the approach by
uðxt ! xt Þ ¼ x1
a ! Certainly,
ð2Þan
- : !k " ðxðRÞ ! x Þ
𝛽 is the quasi-hyperbolic time x
discountingx
ðRÞ
t t t < t ; parameter. boundedly ration
Current ence values equa
- with𝛿 (between
k being a1loss andaversion
2) dis
1 an ambiguity
income
parameter aversion
typically parameter.
greater equal
than to11,and
to neg
account future stock price
+
e a as well as !
a being variables that determine
t=1 t=2
the curvature 314
of u
It is well-known
(1988), we interpret
(uncertain)
prefer utility
to liquidate the component
term
his or uðdher1 !d of1 the
stock Þ as holdings
the
future utility atcontribution
income timeaccount
t = 1. T
set ðRÞ
of the
uðS current
means ! S that
ðRÞ
Þ income
for investors
the account
who
investor’s while
are willing
current uðSasset! S
2 to hold Þ stands
account.
2 their for the
stocks will
nce 1 1
(uncertain)We utility
characterized
assume component
byS quite
ðRÞ
– the of
positive the subjective
reference future pointincome account
expectations
for the future and
regard
inco
hes Example: dividend 2
uðS !future
S
ðRÞ
1 account Þ rates
– to of
payout policy
for the be return
investor’s
identical . Therefore,
r1currentwith asset
S we should
account.
which means typically
that observ
change
ang 1 1
We
Wenegative
the assume
assume
value relation
ofS
ðRÞ
an – –thethe between
reference
reference
investor’s stockb
pointand
point for
holdings 1 for
dthe
for the
future
from ourfuture
t =simple
1 income
to t decis
= 2 e
ral 2
accountproblem.
income – to be
account identical be with
– toaccount. identical SWe1 which
with means
Thus that changes in
S1.have
hey the future income thus
the value Allofofan our arguments
investor’s so far
stock can alsofrom
holdings be verified
t = 1 toby t =a 2moreenterform
os- analysis ðRÞ
S
the future
2 ! S ¼ofðxthe
2income !decision
d1 Þ " ð1We
1 account. þproblem
r 1thus
Þ ! ðx under
1 ! d1 consideration.
have Þ ¼ ðx1 ! d1 Þ " rThe 1 : maxim
ac- zation of (1) with respect to d1 thus gives us the following nec
tal S2 !Maximizing
ðRÞ
SsaryTheðxfuture
2 ¼condition d1 Þincome
1 !leads to þan
"for
ð1 ther 1account
first
Þ ! ðx
inner order
1 ! isdcondition
solution:discounted
1 Þ ¼ ðx1 ! dby 1 Þ " the
r 1 : factor bð3Þ (see
ore (1)). In addition, 0
we 0 want toðRÞaccount for ambiguity ðRÞ
aversion. H
ws, Thegðd
ever,future
1 Þas Ugeneral
: ¼aincome u ðd1 $isd1discounted
ðd1 Þ ¼account
problem, upÞ $to u ðx
0
1 $by
now, dit1the
$is Snot
factor
1 Þ clear b (seehow Eq.to
(1)). In addition, we want toZaccount 1 for ambiguity aversion. How-
ler mally model $ b ambiguity
% ð2 $ dÞ % aversion
u 0
ððx $ in
d a% rconsistent
Þ Þ % r % f ðr way.
Þdr As we
ever, as a general problem, up to now, it is not clear how to for-1 1 1 1 1 1
ori- mainly interested in comparative 0 static results, we refer to
mally model ambiguity Z 0aversion in a consistent way. As we are
lth one main consequence0 of ambiguity aversion: Instead of sim
mainly interested $ b % in d % comparative
u ððx1 $ dstatic 1 Þ % r 1 Þresults,
% r 1 % f ðr 1weÞdr 1refer¼ 0: to just
ser evaluating a future uncertain alternative by its expected uti
one main consequence of ambiguity aversion: Instead of simply
$1
ers ambiguity
First, weaverse observeindividuals
that as will
long levy as agdiscount
is a on this value
decreasing funct t
evaluating a future uncertain alternative by its expected utility,
reducing
around theoptimal
the overall value utility,ofsince d1, i.e. anthe uncertain
sufficient return distribu
ambiguity averse individuals will levy a discount on thiscondition
value thusfor
315
study how g changes, when b, d, and k change, thus we determi
og/ob, og/od, and og/ok:
Dependence on b: Only the last two terms of g depen
Example: dividend payout policy R 1
on b. Rewriting 0 u0 ððx1 $ d1 Þ % r 1 Þ % r1 % f ðr1 Þdr 1 ¼ Probðr 1 > 0
We0 ððx
E½u now can prove that the following term is positive
1 $d1 Þ % r 1 Þ % r 1 jr 1 > 0( and the analogous integral for r1 <
(provided
we have that Prob(r1>0) is sufficiently large:
@g
¼ $ð2 $ dÞ % Probðr 1 > 0Þ % E½u0 ððx1 $ d1 Þ % r 1 Þ % r 1 jr 1 > 0(
@b
$ d % Probðr 1 < 0Þ % E½u0 ððx1 $ d1 Þ % r 1 Þ % r 1 jr 1 < 0(: ð
As long as positive rates of return being sufficiently probab
ThisProb(r
i.e. implies that more impatience leads to an increase in
1 > 0) being sufficiently large, we get og/ob < 0 and ther
dividend
fore payouts.
a negative correlation between optimal dividend level d1 an
316
to per- b. As the investor should be willing to hold the asset until t =
endent for high enough probabilities of positive rates of returns, o
me t = 1 dividends d1 should be decreasing in the investor’s patience
theless, We canDependence
also prove that on d:this term just
Again, is positive:
the last two summands of g d
ned by on d,
Z 1
values @g
d levels ¼ b % u 0
ððx1 $ d1 Þ % r 1 Þ % r1 % f ðr 1 Þdr 1
@d 0
otential Z 0
as long $b% u0 ððx1 $ d1 Þ % r1 Þ % r1 % f ðr1 Þdr1 :
at time $1
This term is clearly positive, as the left integral with p

uncer- Thereforereturns is positive
a larger ambiguityand aversion
the rightincreases
integral with negative ret
dividend
negative. This means that the optimal dividend payout l
tility in payouts.
biguity should be increasing in ambiguity aversion.
to real- Dependence on k: First, consider a situation without a ref
tcomes point violation at time t = 1. Then, regarding t = 2, the loss av
coefficient increases the marginal utility u0 in losses, i.e. for
317
The effect of loss aversion is a bit tricky, but in “generic”

situations an increase of loss aversion will increase
dividend payouts.
For details we refer to the original paper (page 251).
All in all, we have derived that dividend payouts increase

when:
‣Patience decreases,
‣Ambiguity aversion increases,
‣Loss aversion increases.
318
Idea of empirical test
But how to test this theory empirically?

Idea:
‣Thank to the home bias, most investors invest in their
home country’s stocks.
‣Firms therefore have to cater the test of local investors.
‣Levels of patience, loss aversion and ambiguity
aversion vary across countries. These values are
available from the INTRA study (which we will discuss
later).
‣We can empirically test whether in countries with higher
patience and lower loss and ambiguity aversion dividend
payouts are lower.
319
Table 3
Results of various regressions using different methodologies.
Industry Dummies OLS Regression Lo

Empirical results (1)
Re
Div/Cash Div/EBIT Div/Sales Div/Cash Div/EBIT Div/ Di
Sales Du
(1) (2) (3) (4) (5) (6) (7
Patience !0.267*** !0.218** !0.065*** !0.234*** !0.173** !0.054** !2
(!3.84) (!3.22) (!3.59) (!4.31) (!2.91) (!2.79) (!
Loss 0.024*** 0.023*** 0.005*** 0.017*** 0.016*** 0.003*** 0.2
Aversion (7.19) (7.20) (7.30) (7.86) (7.40) (3.88) (3
Ambiguity 0.572*** 0.538*** 0.120*** 0.373*** 0.304*** 0.062+ 6.2
Aversion (8.30) (6.16) (4.03) (7.12) (4.61) (2.01) (8
Other Yes Yes Yes Yes Yes Yes Ye
Controls/
Year
Dummies
Industry Yes Yes Yes No No No No
Dummies
Observations 43,340 43,818 43,818 43,340 43,818 43,818 43
This table presents the results of various robustness tests, including results with320industry dum
four large countries and excluding mandatory dividend countries. Sample period is 1992–201
Empirical results (2)
Robustness checks:
‣Various standard checks, controls, high versus low etc.
‣Different proxies (e.g. future orientation instead of
patience)
‣More globalized firms have fewer local investors, thus
their relation to the local behavioral parameters is
weaker. 
Reference:
Breuer, Rieger, Soypak: The behavioral foundations of
corporate dividend policy a cross-country analysis,
Journal of Banking & Finance, 42 (2014), pp. 247–265.
321
Conclusions from this part
‣International data on behavioral preferences allows to

test behavioral theories.
‣We have seen this on the example of dividend payout
policies.
‣Thus, such data is of high usefulness not only to
understand cultural differences in finance, but also for
more general questions in behavioral finance.
The connection behind this:

1.Culture influences behavioral decisions.
2.Behavioral decisions influence market outcomes.
3.Therefore we can test behavioral models for market
outcomes by using international markets. 322
5.3 Cash holdings
Strong dependence of average cash holdings of

companies in 29 countries with the INTRA survey values
of ambiguity aversion.
(Breuer, Rieger, Soypak, Review of Finance, 2016)
323
Cash holdings
Using a mathematical model, the paper arrives at the

following hypotheses:
1. With increasing ambiguity aversion of investors, the
market value contribution of cash holdings decreases
for financially constrained firms.
2. For financially unconstrained firms, the market value
contribution of cash holdings is not related to the
magnitude of investor’s ambiguity aversion.
They lead to these two hypotheses:
1. The optimal amount of cash holding decreases for
financially constrained firms in ambiguity aversion of
investors.
2. For financially unconstrained firms, the optimal
amount of cash holdings is independent of the
magnitude of investor’s ambiguity aversion. 324
Cash holdings
‣ To test this empirically, we use an international data set

and ambiguity aversion data from INTRA.
‣Moreover, we need proxies for financial constraints. Here
we use three very different methods:
• dividend payouts to assets,
• value of total assets,
• company age.
‣In the following, we show parts of the regression table (with
many controls omitted).
325
Dividend Dummy Size Dummy Age Dummy
2.216*** 1.120 4.133*** -0.369 2.329** -0.509
t Constrained Unconstrained Constrained Unconstrained Constrained Unconstrained
3.288 1.603 5.390 -0.646 2.013 -0.926
Table III. Financial constraints -1.173** and the valuation
0.878 of cash
-1.560** as a function
0.306 of ambiguity
-1.715** aversion 0.639
Ct×Ambiguity Aversion -0.351 -1.194*** -0.331 -0.962** -1.644*** -0.258
t -2.395 1.350 -2.448 0.614 -2.111 1.012
-0.997 -3.065 -0.933 -2.488 -3.214 -0.573
This
Cash table presents the
holdings results of 0.350***
0.357***
regressions on the excess 0.295***
0.427***
stock returns0.385***
distinguishing between two
0.268***
subsamples:
Et the -1.071**constrained
financially 1.145***
and 0.907*** unconstrained
financially 0.159 firms.1.052**
The main 0.109 of inter-
variable
D t 9.714 6.986 9.119 7.616 5.836 6.473
est is the interaction term, -2.050 4.978 . We use dividend
3.281 0.485 payouts to assets, the
2.551 value of to-
0.284
‣ Regression on stock returns: negative impact of ambiguity
tal assets t and company 0.074***
-0.010 0.098***
age as defining 0.117***
criteria for
-0.078** the level of
-0.048 0.064*** 0.099***
financial constraints
-0.056* -0.020 0.082*** (1) and
in Columns
-0.192***
NFt
(2), (3) andaversion × Cash holdings for constraint firms.
5.138
(4) and (5)-0.341 5.693
and (6), respectively.
-2.361 6.291
In Columns
-1.416 (1), (3)4.529 3.868
and (5), we-0.428
-1.873 4.341 for finan-
report the results
-5.557
cially constrained firms and in Columns
2.216***
0.696*** 1.120 (2), (4) 4.133***
0.652*** and (6) for unconstrained
0.768*** -0.369
0.539*** firms.
2.329**Robust0.454***
0.941*** standard
-0.509 errors
Ct t
are clustered at the firm level and we11.132use year and12.486
industry dummies.
3.288
12.401 1.603 5.390 9.573 All t-values
-0.646 2.013 are reported
10.380 7.320 under the
-0.926
coefficient estimates.-0.002*** Statistical
-0.351 significance
-1.194***
-0.001***
at -0.002***
the 1 %, 5 %-0.962**
-0.331 and 10 % level
-0.000*
are indicated
-1.644***
-0.001***
by ***, **
-0.258
-0.000
and *, respectively.
Ltt
-0.997 -3.065 -0.933 -2.488 -3.214 -0.573
-6.545 -4.674 -7.349 -1.720 -4.702 -0.945
Dividend Dummy
-1.071**
0.233*** 1.145***
0.182*** 0.907***
0.316*** Size Dummy 0.159
0.183*** 1.052**
0.286***Age Dummy 0.109
0.155***
CDt-1 t
-2.050
Constrained
9.751 4.978
Unconstrained
5.422 3.281
Constrained
9.480 0.485
Unconstrained
8.358 2.551
Constrained
6.739 0.284
Unconstrained
6.480
-0.010
-1.173**
-0.176** -0.078**
0.878
-0.301*** -0.048
-1.560**
-0.365*** -0.056*
0.306
-0.082 -0.020
-1.715**
-0.076 -0.192***
0.639
-0.117*
CNF
Ct×Ambiguity
t ×C t Aversion
t-1
-0.341
-2.395
-3.201 -2.361
1.350
-3.725 -1.416
-2.448
-4.291 -1.873
0.614
-1.554 -0.428
-2.111
-0.736 -5.557
1.012
-1.894
0.696***
-0.005**
0.357*** 0.652***
-0.004
0.350*** 0.768***
-0.005**
0.427*** 0.539***
-0.003
0.295*** 0.941***
-0.009**
0.385*** 0.454***
-0.001
0.268***
CtC
E×L
t t
12.401
-2.282
9.714 11.132
-1.285
6.986 12.486
-2.068
9.119 9.573
-1.389
7.616 10.380
-2.573
5.836 7.320
-0.405
6.473
-0.002***
-0.223***
0.074*** -0.001***
-0.059
0.098*** -0.002***
-0.259***
0.117*** -0.000*
-0.174***
0.064*** -0.001***
-0.250***
0.099*** -0.000
-0.107*
0.082***
Ambiguity
Lt Aversion
t
-3.085
-6.545
5.138 -1.534
-4.674
5.693 -5.082
-7.349
6.291 -3.039
-1.720
4.529 -3.521
-4.702
3.868 -1.954
-0.945
4.341
0.068***
0.233***
2.216*** 0.015*
0.182***
1.120 0.068***
0.316***
4.133*** 0.011
0.183***
-0.369 0.042***
0.286***
2.329** 0.004
0.155***
-0.509
Common C
Law
t-1 t Dummy
3.900
9.751
3.288 1.688
5.422
1.603 6.086
9.480
5.390 0.874
8.358
-0.646 3.002
6.739
2.013 0.307
6.480
-0.926
0.204
-0.176**
-0.351 1.038***
-0.301***
-1.194*** 1.618***
-0.365***
-0.331 -1.255***
-0.082
-0.962** 0.866**
-0.076
-1.644*** 0.453
-0.117*
-0.258
Inflation
Ct×C t t-1
0.486
-3.201
-0.997 3.715
-3.725
-3.065 4.343
-4.291
-0.933 -2.894
-1.554
-2.488 2.155
-0.736
-3.214 326 1.039
-1.894
-0.573
-0.008 -0.015*** 0.003 -0.022*** -0.012** -0.022***
This table presents the results of regressions of cash holdings divided by net assets (Cash/NetAssets) on
various
This tablefirm characteristics.
presents the resultsTheofmain variableonofthe
regressions interest
excessis our
stockpreference parameter, Ambiguity
returns distinguishing between Aver
two
sion. We usethe
subsamples: dividend payouts
financially to assets,
constrained andthe value of unconstrained
financially total assets andfirms.
company age as
The main defining
variable criteria
of inter-
for is
est thethelevel of financial
interaction term,constraints in Columns (1). and (2), dividend
We use (3) and (4) and (5)
payouts and (6),the
to assets, respectively.
value of to-In
Columns
tal
Cash assets
holdings(1), company
and (3) and (5),ageweasreport thecriteria
defining results for
for the
financially
level of constrained firms andininColumns
financial constraints Columns (1)(2),
and(4
and (3)
(2), (6) and
for (4)
unconstrained
and (5) and firms. Robust standard
(6), respectively. errors (1),
In Columns are (3)
clustered
and (5),atwe
thereport
firm level and we
the results for use yea
finan-
cially ‣ Regression
and industry dummies.
constrained firms Allont-values
and incash
Columns holdings:
are reported
(2), (4) and negative
under impactestimates.
the unconstrained
(6) for coefficient of ambiguity
firms. Statistical
Robust significance
standard errors
at the 1 %, 5% at and 10 %level
are clustered
aversionthe firm
for level arewe
and
constraint indicated
use yearbyand
firms.***, **, and
industry
(Again, *, respectively.
dummies.
many All t-values are reported under the
controls.)
coefficient estimates. Statistical " significance at the 1 %, 5 % and 10 % level are indicated by ***, **,
and *, respectively.
Dividend
Dividend Dummy
Dummy Size
SizeDummy
Dummy Age
Age Dummy
Dummy
Constrai-
Constrained Unconstrained
Unconstrained Constrained
Unconstrained Constrained
Unconstrained
ned
-0.309***
-1.173** 0.031
0.878 -0.500***
-1.560** 0.253***
0.306 -0.416***
-1.715** 0.081
0.639
Ambiguity Aversion
Ct×Ambiguity Aversion
-2.395
-3.902 1.350
0.640 -2.448
-6.790 0.614
4.703 -2.111
-3.592 1.012
1.587
0.357***
-0.003* 0.350***
0.001 0.427***
-0.006*** 0.295***
-0.008** 0.385***
0.004* 0.268***
-0.001
Et Size
Real
9.714
-1.807 6.986
0.758 9.119
-2.936 7.616
-2.304 5.836
1.646 6.473
-0.669
0.074***
0.109*** 0.098***
0.068*** 0.117***
0.089*** 0.064***
0.087*** 0.099***
0.102*** 0.082***
0.058***
‣ The
t
MB-Ratio effect5.138
disappears
13.134
5.693when only
8.540
6.291 considering
11.498
4.529
9.560
companies
3.868
10.177
4.341
6.214
with a large
2.216***
-0.632***
proportion 1.120 of foreign
-0.576***
4.133***ownership
-0.647***
-0.369 (>30%).
-0.526***
2.329**
-0.844***
-0.509
-0.377***
t
NWC/Assets
‣Controlling 3.288 1.603
for risk -14.676
-14.452 aversion 5.390
does -0.646
-15.075 not change
-12.236
2.013
the-13.485 -0.926
picture. -8.910
-0.351 -1.194*** -0.331 -0.962** -1.644*** -0.258
t -0.005*** -0.005*** -0.005*** -0.005*** -0.006*** -0.004***
Lt -0.997 -3.065 -0.933 -2.488 -3.214 -0.573
-15.324 -17.310 -14.767 -14.996 -14.077 -12.643
-1.071** 1.145*** 0.907*** 0.159 1.052** 0.109
Dt 0.054*** 0.009 0.061*** 0.008 0.042*** -0.026***
SG -2.050 4.978 3.281 0.485 2.551 3270.284
4.810
-0.010 1.034
-0.078** 5.401
-0.048 1.067
-0.056* 2.832
-0.020 -3.234
-0.192***
5.4 Value investment
Example Fama/French 1998:

‣Stocks with a high book to market value tend to have
a better performance.
‣The extra performance is different between countries.
Behavioral explanation:
Value stocks are only attractive if risk aversion is not too
high and patience is not too low.
Hens and Schindler (JEBO, 2020) derive this predictions
from a mathematical model and show that it is highest
where patience is low and risk aversion is high…
328
T-statistics, calculated with Newey and West (1994) heteroscedasticity and autocorrelation con-
sistent standard errors, are reported in brackets. Min and max sample size for each time period’s
cross-sectional regression are provided in the bottom section along with the start time period for
the datapremia:
Value sample through December 2011, with the exception of Panel C because our private credit
data are limited
Patience to aversion
and risk December as2010.
factors
Panel A: Panel B: Panel C: Panel D
Behavioral Macro. Dev. Financial Dev. Fin. Characteristics
Intercept 2.04 (3.37) 2.05 (1.88) 2.23 (1.65) 1.83 (2.74)

Patience -1.2 (-2.05) -1.25 (-2.01) -1.4 (-2.02) -1.66 (-2.17)
Risk Aversion 0.18 (2.2) 0.19 (2.25) 0.23 (2.6) 0.2 (2.74)
Individualism -6.86 (-1.76)
Uncertainty avoidance -0.05 (-0.13)
IndProd Gr 0.32 (1.33)
GDP gr -0.03 (-2.09)
IndProd/GDP -0.4 (-1.21)
GDP pc -6.67 (-0.61)
Credit 0.01 (0.03)
MCap -0.06 (-0.28)
Accounting 0 (-0.27)
Inflation -6.09 (-1.51)
Rflow -0.02 (-0.36)
BtoM 14.18 (0.3)
PE 3.77 (2.17)
CF Vol 2.74 (0.02)
Firm Size -16.26 (-2.24)
Min Sample Size 32 31 21 329 35

Max Sample Size 36 36 31 35
5.5 Foreign investment
and culture: discussion
When investing in a foreign market, cultural factors can play a

decisive role.
After the fall of the iron curtain (1989), foreign companies
started investing in Eastern Europe. The largest investors
were Germany and Austria, but there investments differed in
many ways.
‣ Austrians invested more in service industries, banks,
insurances etc.
‣ Their branches were run by locals.
‣ Germans invested more in manufacturing (cars etc.).
‣ Their branches were run by German managers.
330
5.5 Foreign investment
and culture: discussion
When investing in a foreign market, cultural factors can play a

decisive role.
After the fall of the iron curtain (1989), foreign companies
started investing in Eastern Europe. The largest investors
were Germany and Austria, but there investments differed in
many ways.
‣ Read the newspaper article provided in the Dropbox. (Use
deepl.com to translate it into English!)
‣ Discuss in groups what are the main hypotheses!
‣ Check on https://www.hofstede-insights.com/country-
comparison/ for the cultural dimensions of Austria,
Germany, and some Eastern European countries and see
whether you find evidence for the hypotheses in the article!
‣ We discuss the results afterwards together. 331
5.6 What can we learn from
all of this?
Cultural factors play a large role in financial decision

making and in financial markets.
‣Some examples are: risk-attitudes, framing, equity
premium, momentum strategies, value investments,
asymmetric volatility etc.
Such differences play therefore a crucial role for:
‣ Offering financial services in other cultures
‣ Investing on foreign markets
‣ Predicting developments in countries where cultural
factors are changing
‣ Foreseeing successful strategies for new markets 
332
Offering financial services in other cultures
Risk attitudes and framing differ across cultures.

Demand for financial products differs, e.g.:
‣Capital protection might be interesting in countries where
loss-aversion is high.
‣ Insurances may be less attractive due to framing.
333
Investing on foreign markets
Investment strategies will have different success in different

cultures, e.g.:
Momentum strategies work better in countries with high
individualism, thus, e.g., in Germany or the USA momentum
strategies will be more successful than in China.
Value investment does not seem to work in Italy.
334
Predicting developments
Knowing the precise cause of differences between financial

markets is interesting for various reasons:
It allows to predict developments in countries where cultural
factors are changing. 
(Example: if we know that framing is different for young
people in China, then insurances will probably become more
important.)
It can help to foresee successful strategies for markets which
are just emerging and where it is therefore difficult to rely on
past experience. 
(Example: although there is no data yet, it is likely that
momentum strategies will not be successful in other new
emerging markets in East Asia, since individualism is low.)
335
Conclusions and future research
State of the art:

‣Interesting insights into the cultural reasons for some of the
differences between financial markets.
‣ Many puzzles still need to be solved.
Methods of future research:
‣Further development of behavioral theories of individual
and collective financial decisions.
‣ Collection and systematic analysis of experimental and
market data from a large variety of countries.
336
Discussions on group projects
A: Patriotism in East Asia and home bias (data from stock

market game)
D: Loss aversion and stock market participation – less
important for East Asians?
E: Do East Asians have a larger financial cushion? Does this
lead to more risk taking?
H: Cultural differences between Chinese provinces regarding
risk and time preferences
337
Chapter 6
Group Projects
Master/PhD thesis
Remark:
‣ If you are interested, you can also do your master thesis or

a project as part of your PhD thesis under my supervision.
‣ One of my students from the previous Cultural Finance
class wrote his master thesis under my supervision. The
paper that resulted from his thesis is now under revision at
a finance journal.
‣ Please contact me for further information about this
possibility.
339

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Cultural Economics and

Zürich, August/September 2021

Prof. Marc Oliver Rieger, mrieger@uni-trier.de, banking-finance.uni-trier.de

Born 1974 in Berlin, Germany

Prof. Marc Oliver Rieger, mrieger@uni-trier.de

Prof. Marc Oliver Rieger, mrieger@uni-trier.de

Prof. Marc Oliver Rieger, mrieger@uni-trier.de

Culture, in particular Economcis and Finance, i.e.

‣ To understand differences between financial markets

‣ To understand differences between investors and

‣ To understand the world. (At least a little bit.)

‣ Empirical analysis of financial market data

1. Foundations: Classical and Behavioral Preferences

‣ Please register for a topic on Wednesday during

‣ Each group project has 30 minutes to present (plus

‣ You can decide who is presenting. (Not everybody

‣ Please submit your slides as PDF at least two days

‣ Do not make slides with fluff (blinking stuff,

A good structure is:

The classical theory here has two historical roots:

Imagine the following lottery:

Computing the expected value gives infinity (exercise!), so

The reason is obviously the risk involved in this.

Daniel Bernoulli (1738) states:

Decision criterion: expected utility, i.e. expected value of u

U (p) = Ep (u) = u(x1 )p1 + u(x1 )p2 + . . .

In the case of a continuous lottery we obtain:

u(x1 ) + (1 )u(x2 ) ⇥ u( x1 + (1 )x2 ). (2.1)

Rational preferences between lotteries should satisfy

(3) Independence: If I prefer A over B and if A’ and B’ correspond

(4) Continuity: If B is better than A and C is better than B, then

These axioms are intersting because of the following theorem:

When describing actual behavior, we find many violations

We start with the classical example, the “Asian disease”:

Asian disease is expected to kill 600 people.

A different formulation of this problem:

Asian disease is expected to kill 600 people.

Decision (i). Choose between:

Decision (ii). Choose between:

Since (i) and (ii) were presented together, respondents had

When the choices are combined into one lottery, then it

You have decided to see a play where admission is

You have decided to see a play where admission is

The difference between responses to problems 8 and 9 is

Two versions of this problem were presented to different

What happened is that people seem to evaluate the

How about you? Are you going to another shop to save

We will present some more phenomena that contradict the

(Following slides thanks to Pengfei Sun)

We present now some experimental evidence that was the

Problem 1: Choose between

With u(0) = 0, the first and second preference implies

Substitution Axiom of EUT: If B is preferred to A, then any

Choice problems illustrate Certainty effect with non-monetary

Note: Problem 7,8 is another case which violate the substitution

QEM 2 Pengfei Sun Seminar “Behavioral Decision Theory and Finance”

Preferences revert when losses instead of gains are

Implication of Reflection Effect

QEM 2 Pengfei Sun Seminar “Behavioral Decision Theory and Finance”

Problem 10: Consider the two-stage game. In the first stage,

Note: A pair of prospects can be decomposed into common and

Framing effect again:

We get A = (2, 000, 0.50; 1, 000, 0.50) = C , B = (1, 500) = D

Prospect theory models the decision process in two steps:

Culture, in particular  Economcis and Finance, i.e.

Daniel Bernoulli (1738) states: 

You have decided to see a play where admission is  

You have decided to see a play where admission is  