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

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 theory to 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 analyse risk-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 decline therein, 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.

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. Moreover, 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 behavioural 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.

Citation

Hunt, J.S. (2010), "Chapter 7 Great expectations: Prospect theory and oil price volatility in Iran", Goldsmith, B.E. and Brauer, J. (Ed.) Economics of War and Peace: Economic, Legal, and Political Perspectives (Contributions to Conflict Management, Peace Economics and Development, Vol. 14), Emerald Group Publishing Limited, Leeds, pp. 107-122. https://doi.org/10.1108/S1572-8323(2010)0000014011