Chapter 7 Great expectations: Prospect theory and oil price volatility in Iran

• DOI: https://doi.org/10.1108/S1572-8323(2010)0000014011
• Published date: 08 July 2010
• Pages: 107-122
• Date: 08 July 2010
• Author: Jennifer S. Hunt

CHAPTER 7

GREAT EXPECTATIONS:

PROSPECT THEORY AND OIL

PRICE VOLATILITY IN IRAN

Jennifer S. Hunt

ABSTRACT

Purpose – This chapter examines the impact of oil price volatility on

domestic political stability in a key supplier state.

Methodology – This chapter uses prospect theoryto analyse socio-

political instability based on signif‌icant changes in a supplier state’s largest

revenue source. Prospect theory posits that decisions are framed around a

pivotal reference point which may or may not correspond to the status quo,

but which nonetheless directly affects risk appetite. This analysis uses Iran

as a case study, and relative oil price as the reference point to analyserisk-

acceptant decision-making surrounding the 2009 Presidential election.

Findings – Dramatic economic context could be a contributing factor to

risk-acceptant behaviour in domestic politics. Specif‌ically, volatile price

swings in Iran’s main source of income, oil, which contributes over 80 per

cent in direct and indirect revenue, and perceived external declinetherein,

may have been a destabilising factor. Combined with loss aversion, this

context may have facilitated measures beyond those dictated by rational

utility calculus to secure conservative rule in the 2009 election,and in the

ensuing unrest.

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Research Limitations – Prospect theory is diff‌icult to test outside of

carefully framed laboratory experiments. Although its insights have been

applied to investment behaviour, management and domestic politics, in

conf‌lict studies, robust empirical support remains underdeveloped. More-

over, since prospect theory is an individual model of decision-making,

diff‌iculties arise when dealing with nation states with multiple centres of

power.

Implications – Prospect theory may be a useful analytic tool for

analysing risk-acceptant decision-making in the context of dynamic

economic situations.

Originality – Although this analysis complements research on rentier

state theory, prospect theory integrates recent developments in beha-

vioural economics and political psychology that may offer a new way to

conceptualise the role of expectations and choice framing in decision-

making which drives political stability.

INTRODUCTION

Political decision-making research has tended to focus on the characteristics

of individual leaders (such as personality, judgemental heuristics and

cognitive biases), structural constraints (including government type and

institutional norms) or rational choice frameworks (such as cost–benef‌it

analysis, etc.). This chapter analyses decision-making in light of a key

contextual economic factor, oil price. Although economic considerations are

part of any decision calculation, this chapter uses prospect theory to analyse

socio-political instability based on signif‌icant changes in a supplier state’s

largest revenue source, using Iran as a case study. Though analysis of

decision-making in Iran is not without its limitations, the effort is crucial in

addressing issues of international import. Though oil has been a major

source of government revenue for the past four decades, this percentage has

continued to increase and with it, vulnerability to oil price f‌luctuations. This

chapter analyses the impact of oil price volatility on decision-making in Iran

using insights from rentier state theory and prospect theory that may offer a

new way to conceptualise the role of expectations and choice framing in

decision-making.

Iran is a key supplier state in the world oil economy, but even more

crucial is the importance of oil to Iran which directly contributes 60 per cent

JENNIFER S. HUNT108