Consumption Commitments, Unemployment Durations, and Local Risk Aversion

Working Paper: NBER ID: w10211

Authors: Raj Chetty

Abstract: Studies of risk preference have empirically established two regularities that are inconsistent with the canonical expected utility model: (1) risk aversion over small gambles greatly exceeds risk aversion over larger stakes and (2) insurance buyers play the lottery. This paper characterizes risk preferences both theoretically and empirically in a world with two consumption goods, one of which involves a commitment in that an adjustment cost must be paid when the good is sold. In this model, utility over wealth is more curved locally than globally: individuals are more risk averse with respect to moderate-scale income fluctuations than they are to large income fluctuations. Commitments also create a gambling motive. The empirical importance of commitments is tested using the labor-supply method of estimating risk aversion of Chetty (2003a). Global curvature is imputed using existing labor supply elasticities, and variations in unemployment insurance laws are used to estimate local curvature in a dynamic job search model. Commitments significantly change preferences over wealth: The local coefficient of relative risk aversion is an order of magnitude larger than the global one. Implications for a broad set of questions such as optimal social insurance policies and portfolio choice are discussed.

Keywords: risk aversion; consumption commitments; unemployment insurance; labor supply

JEL Codes: D8; E21; G1; J6; R21

Causal Claims

Cause	Effect
consumption commitments (E21)	local risk aversion (D81)
consumption commitments (E21)	global risk aversion (D81)
unemployment durations (J64)	local curvature of utility (D11)
unemployment durations (J64)	risk preferences (D81)
local curvature of utility (D11)	local coefficient of relative risk aversion (D11)
global curvature of utility (D11)	global coefficient of relative risk aversion (D11)