Are Criminals Loss Averse? Illegal Earnings and the Equity Premium

• In Event: Offending Decisions in Social and Legal Context:

Abstract

One of the best known anomalies in the behavioral finance is the equity premium puzzle, which describes the compensation individuals require to bear the risk of more variable stocks compared to stable bonds, justified only by unusually high levels of risk aversion. One behavioral explanation proposed is myopic loss aversion: that is, people are more sensitive to losses compared to gains and tend to evaluate losses and gains over a short time horizon. We consider the applicability of the short term loss aversion in criminal behavior by considering the compensation an individual requires to bear the hazards associated with illegal earnings, which are not only particularly volatile but are also associated with risk of incarceration. Using data from over 200 incarcerated males, the purpose of the current study is three-fold: 1) to track month-to-month income changes in both illegal and legal income over the three years prior to incarceration 2) to examine loss aversion among male offenders by calculating the premium required for making illegal earnings compared to legal income 3) to examine what factors are associated with variation in the equity premium. Results are discussed in terms of prospect theory and policy implications.

Authors

• Holly Nguyen, Pennsylvania State University

• Thomas A. Loughran, Pennsylvania State University

• Carlo Morselli, International Centre for Comparative Criminology