Survey_BKG_2014

Abstract

We will consider a lottery experiment that is well suited for testing the affect heuristic for both option price and risk perception. In order to elicit emotions directed at positive and negative returns, we let subjects play a binary lottery where a player randomly wins or loses with equal probability. Players enter into the lottery by paying a €5 entrance fee out of their €10 participation fee. By drawing an envelope, either €10 or €0 is awarded to subjects. Consequently, net earnings amount to either €5 or -€5. Not only does this setup represent a realistic yet simple representation of risk in financial markets, it also allows us to manipulate emotions within a context comparable to what occurs in actual financial markets. Furthermore, the setup is also sufficiently rich to price a put option on the lottery based on Cox et al. (1979), which pays €5 contingent on losing the lottery and nothing otherwise. In total 96 students participated in the experiment, which is a two-condition (win or lose the lottery) between-subject design. All subjects were enrolled in either the Master of Science (MSc) in Finance or the MSc in Financial Management at the VU University Amsterdam. Exactly 25 percent of the subjects had participated in an economics experiment before. About one third (34) of the total were female. On average, subjects earned €12.05 based on a show-up fee of €10, the result in the lottery (either +€5 if subjects won or -€5 if subjects lost), and their performance in an option valuation task (maximum of €5, minimum of €0). The minimum amount subjects earned was €5, while the maximum amount was €20. The experiment lasted 45 minutes.