Working Paper: CEPR ID: DP2728
Authors: Luigi Guiso; Monica Paiella
Abstract: We use household survey data to construct a direct measure of absolute risk aversion based on the maximum price a consumer is willing to pay to enter a lottery. We relate this measure to consumers' endowment and attributes and to measures of background risk. We find that risk aversion is a decreasing function of endowment - thus rejecting CARA preferences ? but that the elasticity to consumption is far below the unitary value predicted by CRRA utility. We also find that households' attributes are of little help in predicting their degree of risk aversion, which is characterized by massive unexplained heterogeneity. The consumers' environment, however, affects risk aversion. Individuals who are more likely to face income uncertainty exhibit a higher degree of absolute risk aversion, consistent with recent theories of attitudes towards risk in the presence of uninsurable risks. We also find that risk attitudes have considerable predictive power over several household decisions, including occupation and portfolio choice, moving decisions and health status.
Keywords: background risk; heterogeneous preferences; prudence; risk aversion
JEL Codes: D10; D80
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| household wealth (D14) | absolute risk aversion (D81) |
| background risk (D80) | absolute risk aversion (D81) |
| demographic factors (J11) | absolute risk aversion (D81) |
| absolute risk aversion (D81) | household decisions (D10) |