[IRISK Research Seminar] Measuring Common-Ratio Effect
September 26th, 2025
2pm – 3pm in Village Building (E033) & on Zoom
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Speaker: Arnaldo NASCIMENTO, Independent Researcher and Lecturer at IAG Business School
abstract
We introduce a formal measure for the common-ratio effect (CRE). Unlike previous approaches that relied on heuristic proxies, our measure precisely captures this fundamental factor. Through a logarithmic transformation of the probability weighting function, we develop a mathematically tractable measure that illuminates the relationship between the CRE and both the curvature and elasticity of the weighting function. Our framework defines comparative CRE measures, enabling both local and global comparisons, and establishes new families of weighting functions that exhibit constant absolute (CACRE) and constant relative (CRCRE) common-ratio effects. We also provide a discrete measure suitable for nonparametric applications. We establish a fundamental connection between CRE and intertemporal choice: the degree of subproportionality directly corresponds to the degree of decreasing impatience, creating a one-to-one mapping between CACRE/CRCRE and Constant Absolute/Relative Decreasing Impatience (CADI/CRDI) discount functions. Additionally, our measurement framework extends to analyze the subproportionality of utility functions, linking it to utility elasticity and Arrow-Pratt risk aversion.