Investing when risk and ambiguity create opportunities for exploitation – the basic mechanism and the case of ageing investors

Jonas Fooken | Centre for the Business & Economics of Health, University of Queensland

Trust and risk preferences are widely studied, but little is known how these two interact. However, their interaction matters, for example in investment decisions in which the outcome of a probabilistic event can only be observed by an agent, but not the investor, creating opportunities for exploiting exclusive knowledge. This article studies the interaction of trust, trustworthiness and risk using an experimental trust game with and without uncertainty and varying levels of riskiness, employing both risk and ambiguity. Trustors do not only rely on trustee's trustworthiness, but their transfer is also lost with some probability. If the trustee does not return anything, the trustor cannot differentiate between a lost transfer and a selfish trustee. Results show that self-serving decisions of trustees become more common with increasing uncertainty and under ambiguity (compared to risk). This result is primarily driven by gradually increasing selfishness (moral wiggling) and less by taking advantage of the exclusive information of the trustee (hence fully opportunistic behavior). Trustors adapt their behavior with increasing uncertainty, most likely due to risk attitudes and do not anticipate decreasing trustworthiness. This effect is even more pronounced when decision makers are older, as seniors are not less risk aversion, but fail to adapt their investments to the changing incentive environment adequately.