Ruhr Economic Papers

Ruhr Economic Papers #287

Higher-Order Risk Preferences – Consequences for Test and Treatment Thresholds and Optimal Cutoffs

by Stefan Felder and Thomas Mayrhofer

University of Duisburg-Essen, 10/2011, 21 S./p., 8 Euro, ISBN 978-3-86788-333-7

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Abstract

Higher-order risk attitudes include risk aversion, prudence, and temperance. This paper analyzes the effects of such preferences on medical test and treatment decisions, represented either by test and treatment thresholds or – if the test characteristics are endogenous – by the optimal cutoff value for testing. For a risk-averse decision maker, treatment is a risk reducing strategy since it prevents the low health outcome that forgoing treatment yields in the sick state. As compared to risk neutrality, risk aversion thus reduces both the test and the treatment threshold and decreases the optimal cutoff. Prudence is relevant if a comorbidity risk applies in the sick state. It leads to even lower thresholds and a lower optimal cutoff. Finally, temperance plays a role if the comorbidity risk is left-skewed. It lowers the thresholds and the optimal cutoff even further. These findings suggest that diagnostics in low prevalence settings (e.g. screening) are considered more beneficial when higher-order risk preferences are taken into account.

JEL-Classification: D81, I10

Keywords: Medical decision making; diagnostic risk; test and treatment thresholds; optimal cutoff; risk aversion; prudence

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