Causal effect of beliefs about skill on risky choices: Low (high) skill subjects are more (less) willing to take risks on gambles where the probabilities depend on relative skill

How do beliefs about skill affect risky decisions? Adrian Bruhin, Luís Santos-Pinto, David Staubli. Journal of Economic Behavior & Organization, https://doi.org/10.1016/j.jebo.2018.01.016

Highlights
•    In this paper, we use a laboratory experiment to study the causal effect of beliefs about skill on risky choices.
•    The paper offers an innovative experimental test that is free of strategic confounds and based on revealed preference.
•    Low (high) skill subjects are more (less) willing to take risks on gambles where the probabilities depend on relative skill.
•    This suggests that the wrong people may engage in risky activities V such as entering competitive markets or career paths V while the right people may be crowded out.
•    Revealed beliefs are only moderately correlated with stated beliefs and so relying only on stated beliefs may be misleading.

Abstract: Beliefs about relative skill matter for risky decisions such as market entry, career choices, and financial investments. Yet in most laboratory experiments risk is exogenously given and beliefs about relative skill play no role. We use a laboratory experiment without strategy confounds to isolate the impact of beliefs about relative skill on risky choices. We find that low (high) skill individuals are more (less) willing to take risks on gambles where the probabilities depend on relative skill than on gambles with exogenously given probabilities. This happens because low (high) skill individuals overestimate (underestimate) their relative skill. Consequently, the wrong people may engage in risky activities where performance is based on relative skill while the right people may be crowded out.

Keywords: Individual risk taking behavior; Self-confidence; Laboratory experiment