Intertemporal substitution, risk aversion and ambiguity aversion

Summary. This paper axiomatizes a form of recursive utility on consumption processes that permits a role for ambiguity as well as risk. The model has two prominent special cases: (i) the recursive model of risk preference due to Kreps and Porteus [18]; and (ii) an intertemporal version of multiple-priors utility due to Epstein and Schneider [8]. The generalization presented here permits a three-way separation of intertemporal substitution, risk aversion and ambiguity aversion.Received: 5 August 2003, Revised: 12 March 2004, JEL Classification Numbers: D80, D81, D90.I am grateful to Larry Epstein for his guidance and invaluable advice, and to a referee for helpful comments and suggestions.     

Estimation of relative risk aversion across time

This article examines relative risk aversion in the framework of a three-moment asset pricing model that accounts for skewness. Accounting for skewness in calculating risk aversion gives a more accurate series of estimates of risk aversion and helps to reconcile the wide disparity in risk coefficients found in past literature. Risk aversion coefficients are calculated from 1926 to 2014 using stock market returns. This procedure results in a time series of data that can be related to other variables such as real interest rates and changes in demand for various asset classes.     

Parametric characterizations of risk aversion and prudence

Summary. Our first main result says that whether one decision maker is more risk averse than another can be determined from their attitudes toward a given two-parameter family of risks. When all risks belong to this family, risk aversion can be compared even when initial wealth is random. Our second main result solves a long-standing problem in mean-variance analysis: what is the interpretation of the concavity of utility as a function of mean and variance? We show that in the case of normal distributions, this utility function is concave if and only if the agent has decreasing prudence. Received: July 29, 1996; revised: October 2, 1998     

More on parametric characterizations of risk aversion and prudence

Summary. This note provides an alternative proof for the equivalence of decreasing absolute prudence (DAP) in the expected utility framework and in a two-parametric approach where utility is a function of the mean and the standard deviation. In addition, we elucidate that the equivalence of DAP and the concavity of utility as a function of mean and variance, which was shown to hold for normally distributed stochastics in Lajeri and Nielsen [4], cannot be generalized. Received: November 27, 2000; revised version: November 26, 2001 Correspondence to: T. Eichner     

Risk and risk aversion when states of nature matter

When uncertainty is associated with some intrinsically relevant states of nature, there is no reason for an agent to base his or her preferences only on probability distribution of claims. We propose a new concept of risk for state-contingent claims that, unlike the standard concept of Rothschild–Stiglitz, does not identify state-contingent claims with their probability distribution. This concept is called mean-independent risk, and we provide a simple characterization in terms of marginal utilities of (non-expected) utility functions that exhibit aversion to mean-independent risk. We study implications of aversion to mean-independent risk on agents’ choices under uncertainty. This research has been supported by the NSF under Grant SES-0099206. I have benefited from numerous conversations with Rose-Anne Dana and illuminating discussions with Tadeusz Miłosz about the theory of subgradients.     

Risk aversion, moral hazard, and the principal's loss

Summary. In their seminal paper on the principal-agent model with moral hazard, Grossman and Hart (1983) show that if the agent's utility function is , then the loss to the principal from being unable to observe the agent's action is increasing in the agent's degree of absolute risk aversion. Their proof is restricted to the case where the number of observable outcomes is equal to two, and it uses an argument that is specific to that case. In this note, we provide an alternative proof that generalizes their result to any (finite) number of outcomes. Received: March 21, 2001; revised version: June 21, 2001     

More pessimism than greediness: a characterization of monotone risk aversion in the rank-dependent expected utility model

Summary. This paper studies monotone risk aversion, the aversion to monotone, mean-preserving increase in risk (Quiggin [21]), in the Rank Dependent Expected Utility (RDEU) model. This model replaces expected utility by another functional, characterized by two functions, a utility function u in conjunction with a probability-perception function f. Monotone mean-preserving increases in risk are closely related to the notion of comparative dispersion introduced by Bickel and Lehmann [3,4] in Non-parametric Statistics. We present a characterization of the pairs (u,f) of monotone risk averse decision makers, based on an index of greediness G _u of the utility function u and an index of pessimism P _f of the probability perception function f: the decision maker is monotone risk averse if and only if . The index of greediness (non-concavity) of u is the supremum of taken over . The index of pessimism of f is the infimum of taken over 0 < v < 1. Thus, , with G _u = 1 iff u is concave. If then , i.e., f is majorized by the identity function. Since P _f = 1 for Expected Utility maximizers, forces u to be concave in this case; thus, the characterization of risk aversion as is a direct generalization from EU to RDEU. A novel element is that concavity of u is not necessary. In fact, u must be concave only if P _f = 1.Received: 10 April 2001, Revised: 18 November 2003, JEL Classification Numbers: D81. Correspondence to: Michéle CohenAlain Chateauneuf, Michéle Cohen, Isaac Meilijson: We are most grateful to Mark Machina, Peter Wakker and two anonymous referees for very helpful suggestions and comments.     

Real estate and relative risk aversion with generalized recursive preferences

This paper investigates how real estate wealth affects the household’s attitude toward risk, and derives the closed-form expressions for risk aversion with generalized recursive preferences. We find three channels through which real estate wealth affects risk aversion, and these channels are absent in the traditional measure of relative risk aversion as in Arrow (1965) and Pratt (1964). First, illiquidity and fluctuations in real estate value increase consumption risk, thereby increasing risk aversion. Second, real estate as an asset provides a cushion for absorbing negative shocks to households, reducing risk aversion. Third, an increase in real estate prices lowers the profit of the firm that uses real estate as a factor of production, induces a decline in the real wage, and causes a rise in consumption risk. This channel increases risk aversion. We study how these channels as a whole determine relative risk aversion using a basic real business cycle model with generalized recursive preferences and compare the results with the case of expected utility preferences. Finally, we explore the implications of the firm’s and the household’s real estate holdings and illiquidity of real estate on the risk premiums for equity and real estate.     

Antonelli's analytical techniques: their exploitation to derive results in duality theory

Antonelli, over a hundred years ago, pioneered techniques of economic analysis which still can be usefully employed to provide apparently new insights in duality theory. This assertion is demonstrated through the applications of these techniques to derive specific results in duality theory. These applications allow an apparently new derivation of the equality between the partial derivative of the expenditure function, with respect to the price of some good, and the compensated level of demand for this good. In addition, use of Antonelli's analytical techniques reveals links between certain results in duality theory that, apparently, have not been noticed before in the relevant literature.     

Probabilistic risk aversion with an arbitrary outcome set

This paper analyzes risk aversion when outcomes/consequences may not be measurable in monetary terms and people have fuzzy preferences over lotteries, i.e. they choose in a probabilistic manner. The paper shows that comparative risk aversion is well defined in a constant error/tremble model but not in a strong utility model.     

Religion and unproductive entrepreneurship: The role of risk aversion

Institutions can shape the reward structure in the economy and thereby influence the allocation of entrepreneurship between productive and unproductive activities. This paper investigates the effect of religion, one important component of informal institutions, on unproductive entrepreneurship. Using a nationally representative survey on private enterprises in China, we find that religious entrepreneurs devote more of their resources, both in terms of money and time, to unproductive activities such as building social relations than their nonreligious peers. We further find that religion plays a significant role only in regions with weak regulatory institutions and/or for entrepreneurs vulnerable to institutional risks. Drawing on the close link between risk-aversion and religion, our results suggest that religious entrepreneurs engage in unproductive activities so as to reduce institutional risks in their business operations.     

Risk aversion in the Eurozone

We propose a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model where a risk aversion shock enters a separable utility function. We analyze five periods from 1971 through 2011, each lasting for 20 years, to follow over time the dynamics of several parameters such as the risk aversion parameter; the Taylor rule coefficients; and the role of the risk aversion shock in output, inflation, interest rate, and real money balances in the Eurozone. Our analysis suggests that risk aversion was a more important component of output and real money balance dynamics between 2006 and 2011 than it was between 1971 and 2006, at least in the short run.     

Comorbidities and the willingness to pay for health improvements

We show that the willingness to pay for health improvements increases with the severity and probability of occurrence of comorbidities. This result, which is obtained under mild restrictions on the shape of the utility function, has important implications for cost benefit studies applied to health care. In particular it implies that the discrimination of the elderly, believed to be implicit in cost benefit analysis, is less of a problem than commonly thought.     

The power of stereotyping and confirmation bias to overwhelm accurate assessment: the case of economics,gender, and risk aversion

Behavioral research has revealed how normal human cognitive processes can tend to lead us astray. But do these affect economic researchers, ourselves? This article explores the consequences of stereotyping and confirmation bias using a sample of published articles from the economics literature on gender and risk aversion. The results demonstrate that the supposedly ‘robust’ claim that ‘women are more risk averse than men’ is far less empirically supported than has been claimed. The questions of how these cognitive biases arise and why they have such power are discussed, and methodological practices that may help to attenuate these biases are outlined.     

A Behavior‐Based Approach to the Estimation of Poverty in India

Estimates of poverty in India are crucial inputs for the understanding of world poverty, yet there is much disagreement about the numbers and the legitimacy of methods used to derive them. In this paper, we propose and justify an alternative approach to identify the poor, which uses the proportion of income spent on food. Our estimates have weaker data requirements than official methods, and they compare favorably with several validation tests. Most notably, households around our state poverty lines obtain their calories from similar sources, whereas this is not true of official poverty lines. We also find that rates of self‐reported hunger are higher in states that we classify as poor.     

The role of risk aversion in public goods dilemmas with environmental uncertainty: an experimental analysis

The purpose of this study is to extend earlier research on environmental uncertainty in public goods dilemmas. The present paper reports the results of an experiment designed to examine the effect of risk aversion on public goods provision. A von Neumann–Morgenstern utility function with constant coefficient of relative risk aversion is used to investigate the impact of risk attitudes within a threshold public goods environment. The outcome of the threshold public goods experiment shows that subjects are indifferent to the changes in environmental conditions. Additionally, the analysis indicates that risk aversion is a significant determinant of voluntary public goods contribution level.     

Risk attitudes, randomization to treatment, and self-selection into experiments

Randomization to treatment is fundamental to statistical control in the design of experiments. However randomization implies some uncertainty about treatment condition, and individuals differ in their preferences towards taking on risk. Since human subjects often volunteer for experiments or are allowed to drop out of the experiment at any time if they want to, it is possible that the sample observed in an experiment might be biased because of the risk of randomization. On the other hand, the widespread use of a guaranteed show-up fee that is non-stochastic may generate sample selection biases of the opposite direction, encouraging more risk averse samples into experiments. We directly test these hypotheses that risk attitudes play a role in sample selection. Our results suggest that randomization bias does affect the overall level of risk aversion in the sample we observe, but that it does not affect the demographic mix of risk attitudes in the sample. We show that the common use of non-stochastic show-up fees can generate samples that are more risk averse than would otherwise have been observed.     

Entrepreneurial overconfidence and ambiguity aversion: dealing with the devil you know,than the devil you don't know

Various empirical studies find that entrepreneurs are systematically overconfident in their venture's probabilistic chances of success. Yet, entrepreneurs often face an ambiguous future that precludes them from making such probabilistic judgements. A theoretical framework based on ambiguity aversion is developed to explain an entrepreneur's overconfidence under complex and novel conditions of ambiguity. Unlike optimistic explanations, this ambiguity-averse form of overconfidence offers a non-probabilistic approach to entrepreneurial judgements of uncertainty.