Abstract:

The literature suggests that probability weighting and choice set dependence in-uence risky choices. However, their relative importance has not been tested jointly. We present a joint test that uses binary choices between lotteries provoking Common Consequence and Common Ratio Allais Paradoxes and manipulates their correlation structure. We show non-parametrically that probability weighting and choice set dependence both play a role at describing aggregate choices. To parsimoniously account for heterogeneity, we also estimate a structural model using a nite mixture approach. The model uncovers substantial heterogeneity and classis es subjects into three types: 38% Prospect Theory types whose choices are predominantly driven by probability weighting, 34% Salience Theory types whose choices are predominantly driven by choice set dependence, and 28% Expected Utility Theory types.The model predicts type-speci_c di_erences in the frequency of preference reversals out-of-sample, i.e., in choices with a di_erent context than the ones used for estimating the model. Moreover, the out-of-sample predictions indicate that the choice context shapes the inuence of choice set dependence.