The missing piece: Valuing averting behavior for children's ozone exposures

Individuals can reduce their exposure to air pollution by reducing the amount of time they spend outdoors. Reducing outdoor time is an example of an averting behavior that should be measured as part of willingness to pay (WTP) for improvements in air quality. In this paper, we estimate parents’ WTP to prevent restrictions on a child's outdoor time from a stated-preference (SP) conjoint survey. We combine this WTP measure with an estimate of reductions in time spent outdoors on high-ozone days from an activity-diary study to estimate this averting behavior component of WTP for reductions in ozone pollution.     

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.     

AVERTING AND INSURANCE DECISIONS IN THE WILDLAND–URBAN INTERFACE: IMPLICATIONS OF SURVEY AND EXPERIMENTAL DATA FOR WILDFIRE RISK REDUCTION POLICY

When confronted by catastrophic wildfire risk, homeowners simultaneously allocate resources between insurance and averting activities. Expected utility theory suggests that complete insurance coverage precludes investment in averting activities. However, when potential losses include a significant nonmarket component, optimal choice includes both. To investigate this issue, the authors analyze a unique combination of contingent valuation and experimental data. Both settings include a split-sample treatment to test the influence of wildfire risk zone information. The authors find that amenity values, subjective risk, averting efficacy perception, and demographic factors influence both willingness to pay and averting share and that risk information has the predicted ordering effect. (JEL C9 , Q51 , Q54 )     

Mean-Gini analysis of stochastic externalities: The case of groundwater contamination

The mean-Gini approach is used to analyze stochastic externalities generated by agricultural production. The model addresses the problem of groundwater pollution caused by excessive fertilizer application. Inherent in the mean-Gini approach to expected utility maximization is a two-fold value: the simplicity of the two-parameter mean-variance model and satisfaction of necessary and sufficient conditions for stochastic dominance. Price and quantity policy recommendations to control externalities are formulated based upon the relative assessment of uncertainty by the regulatory authority and the farmers. Using the Gini as a measure of risk allows for the quantification of control policy measures under differentiated risk aversion and multiple sources of pollution. The model shows that when producers underestimate uncertainty, quota policies restricting fertilizer are more efficient than tax policies in reducing groundwater contamination.Work on this paper was carried out when visiting the University of Maryland. Financial aid for the work was provided by the USDA ERS-NRED under a cooperative agreement between the Department of Agricultural and Resource Economics, University of Maryland, and the USDA — Economic Research Service — Natural Resource Economics Division, I am grateful to John Miranowski and Darrell Hueth for that support. I am indebted as well to Lana Shalit, who helped me revise the paper.     

When income differences hurt or excite: The nonlinear effect of regional inequality on subjective wellbeing

Combining information from the European Union Statistics on Income and Living Conditions and the European Social Survey, we investigate the relationship between subjective well-being and income inequality using regional inequality indicators and individual data. We assume that inequality aversion and perception of social mobility affect the impact of regional inequality on subjective well-being in opposite directions. We find evidence of an inverse U-shaped effect of inequality, where inequality starts to have a positive effect on subjective well-being that becomes negative with a switch point before the average of the Gini index for the entire sample. The rationale for our nonlinear finding is that Hirschman's tunnel effect (and the positive effect of perceived social mobility) prevails for low levels of inequality, while inequality aversion and negative relative income effects are relatively stronger when inequality is higher. Robustness checks on different sample splits are consistent with the hypothesis of the two drivers.     

Application of Sample Selection Model to Double-Bounded Dichotomous Choice Contingent Valuation Studies

Modeling households' behavior with the data from a contingentvaluation (CV) survey is often complicated by samplenon-response, which can cause non-response bias and sampleselection bias, leading to inconsistent parameter estimates and adistorted mean willingness-to-pay estimate. This paper reportsthe results of empirical tests for both biases using householdsurvey data in which the double-bounded dichotomous choice CVquestion involved the benefit of a tap water quality improvementpolicy in Korea. No non-response bias, but sample selection bias,is detected in the sample. To correct for sample selection bias,a sample selection model is employed. The authors also discusshow failure to correct for bias may distort aggregate benefitestimates.     

Some Aggregate Effects of Heterogeneity in Information Processing

This paper analyzes the equilibrium of an economy where economic agents differ with respect to their information gathering and processing abilities. Our results depend on the magnitude of the relative risk aversion. We show that the unsophisticated (with respect to their information processing abilities) agents are disproportionately important in the cases of both large and small risk aversion. In the case of the relative risk aversion measure being greater than unity volatility of aggregate consumption is reduced. This supports the view that observed consumption in many countries fluctuates less than predicted by models with fully rational agents only.     

The Effect of Better Information on Income Inequality

We consider an OLG economy with endogenous investment in human capital. Heterogeneity in individual human capital levels is modelled by a distribution of innate ability across agents. This distribution is common knowledge but, at young age, no agent knows his/her ability. The production of human capital depends on each individual’s investment in education. This investment decision is taken only after observing a signal which is correlated to his/her true ability, and which is used for updating beliefs. Thus, a better information system affects the distribution of human capital in each generation. Assuming separable and identical preferences for all individuals, we derive the following results in equilibrium: (a) If the relative measure of risk aversion is less (more) than 1 then more information raises (reduces) income inequality. (b) When a risk sharing market is available better information results in higher inequality regardless of the measure risk aversion. We are grateful to Alex Cukierman, Zvi Eckstein, Yona Rubinstein and Daniel Tsiddon. An anonymous referee made extremely useful comments and suggestions. Financial support from the German-Israeli Foundation for Scientific Research and Development (GIF) is gratefully acknowledged.     

Risk Appetite,Home Bias and the Unstable Demand for Emerging Market Assets

Home bias arises when the actual portfolio of an investor consists of a smaller proportion of foreign assets than that predicted by standard portfolio theory for the observed set of risks and returns on available assets. The existence and persistence of home bias undermines the theoretical case for the efficiency of international capital markets. In this paper we use data on UK pension fund portfolios to measure home bias, and find that this is doubly acute in the case of emerging market equity—a bias against overseas assets as a whole being further magnified by a bias against emerging markets within the foreign equity class as a whole. Moreover, contrary to the conventional assumption that risk aversion is both relatively low and stable over time (canonised in neoclassical theory by the derivation of constant relative risk aversion from the utility function itself) our finding that home bias fluctuates over time suggests that risk aversion is in fact time‐variant and path‐dependent. We sketch an alternative Keynesian approach in conclusion.     

Greater downside risk aversion in the large

In this paper, we advance a definition of greater downside risk aversion that applies to both large and small changes in risk preference, and thereby complements the results for small changes reported previously. We show that a downside risk-averse transformation of a utility function results in a function that is more downside risk averse in the same manner that a risk-averse transformation increases risk aversion. Our demonstration is conducted first by using the compensated approach introduced by Diamond and Stiglitz [P. Diamond, J. Stiglitz, Increases in risk and in risk aversion, J. Econ. Theory 8 (1974) 337-360] and then by using an adaptation of the risk premium approach taken by Pratt [J. Pratt, Risk aversion in the small and in the large, Econometrica 32 (1964) 122-136].     

Estimation of the public benefits of urban water supply improvements in Ethiopia: a choice experiment

Improving existing drinking water supply services in developing countries depends crucially on available financial resources. Cost recovery rates of these services are typically low, while demand for more reliable services is high and rapidly growing. Most stated preference-based demand studies in the developing world apply the contingent valuation method and focus on rural areas. This study examines household Willingness to Pay (WTP) for improved water supply services in a choice experiment in an urban area in Ethiopia, a country with the lowest water supply coverage in Sub-Saharan Africa. The design of the choice experiment allows estimation of the value of both drinking water supply reliability and safety. The estimated economic values can be used in policy appraisals of improved supply investment decisions. Despite significant income constraints, households are willing to pay up to 80% extra for improved levels of water supply over and above their current water bill. Women and households living in the poorest part of the city with the lowest service levels value the improvement of water quality most. As expected, also averting behaviour and expenditures play an important role.     

Optimal hedge ratio under a subjective re-weighting of the original measure

In this article we study a risk-minimizing hedge ratio with futures contracts, where the risk of the hedged portfolio is measured through a spectral risk measure (SRM), thus incorporating the degree of agent’s risk aversion. We empirically estimate the optimal hedge ratio (OHR) using a long time series of UK and US equity indices, the EURUSD and EURGBP exchange rates and four liquid commodities (Brent crude oil, corn, gold and copper), to represent different asset classes. Comparing the results with common OHRs (such as the minimum variance and the minimum expected shortfall), we find that the agent’s risk aversion has a material impact, and should not be ignored in risk management.     

Auctioning Risky Conservation Contracts

Conservation auctions have the potential to increase the efficiency of payments to farmers to adopt conservation-friendly management practices by fostering competition among them. The literature considers bidders that have complete information about the costs of adoption and optimal bidding behavior reflects this information advantage. Farmers seek information rents and bids decrease when risk aversion increases because farmers are more averse to losing the auction. We contribute to the literature by allowing for cost risk. Our paper shows that farmers must balance the risk of losing the auction (thus foregoing information rent) with the risk of submitting a bid that is not high enough to pay the costs of adopting conservation practices (thus incurring losses). We design an experiment to trade off these two risks and examine how risk aversion affects bidding behavior when participants face different sources and levels of risk. Our experiment contributes to a small literature on experimental auctions with risky product valuations. We find that participants decrease their bids as risk aversion increases, even in auctions with cost risk, suggesting that the risk of losing the auction dominates. These findings uncover new challenges for the practical implementation of conservation auctions as an efficient policy instrument.     

Greater prudence and greater downside risk aversion

Variation in the degree of downside risk aversion across decision makers has implications for efficient risk sharing. However, except for small differences in risk preferences, there is no index, analogous to the Arrow-Pratt index of risk aversion, that depends only on local properties of the utility function and indicates the degree of aversion to downside risk. A measure that does depend only on local properties of the utility function u, the index of prudence p=−u^?/u^″, is related to downside risk aversion, which is indicated by a positive value for u^?. Although we show that the degree of prudence is not an accurate indicator of the degree of downside risk aversion, we nonetheless demonstrate that a uniform increase in prudence accompanied by a uniform increase (decrease) in risk aversion is sufficient to indicate greater downside risk aversion, provided prudence is greater (less) than three times the degree of risk aversion.     

Measuring Risk Attitudes in a Natural Experiment: Data from the Television Game Show Lingo

We use data from a television game show involving elementary lotteries as a natural experiment to measure risk attitudes. Unique features of our data set are the substantial monetary stakes and the large sample size. CRRA and CARA utility specifications perform approximately equally well. We find robust evidence of substantial risk aversion. Extensions of the basic model, which allow for a separate utility flow purely from playing the game or for decisions based on decision weights instead of actual probabilities, raise the estimated degree of risk aversion.     

Convex and decreasing absolute risk aversion is proper

Proper risk aversion, a pivotal concept in the study of behavioral conditions on utility functions, states that an undesirable risk can never be made desirable by the presence of an independent risk. It is well known that standard risk aversion is sufficient for this concept. We show in this short article that convex and decreasing absolute risk aversion is an alternative sufficient condition.     

First-price sealed-bid auctions when bidders exhibit different attitudes toward risk

When bidders have different risk aversion levels, we determine in a first-price auction, the asymmetric equilibrium strategies. We analyze the impact of asymmetric risk aversion levels on bidders’ markups and on the expected revenue and allocative efficiency of the auction.     

Intertemporal elasticity of substitution and risk aversion: are they related empirically?

This article examines the relationship between two types of preference: preference of intertemporal choices and preference towards risk. In the simplest form of the constant relative risk aversion utility function, the intertemporal elasticity of substitution (IES) and risk aversion have an inverse relationship. However, there is no empirical evidence that suggests this inverse relationship holds. We examine the relationship between risk aversion and IES using household consumption data from the Consumer Expenditure Survey during 1996–2010. Multiple risk domains are selected to represent risk preference, and for each domain, we consider some households to be more risk averse than others. We separately estimate IES for the more risk-averse and less risk-averse households. We find that the IES estimates are generally smaller for the more risk-averse households than for the less risk-averse households and that the difference is statistically significant in the majority of the financial domains. This finding supports the inverse relationship between the two parameters, although considerable heterogeneity is found across domains.     

Made for the job or by the job? A lab-in-the-field experiment with firefighters

A large body of evidence supports a negative association between risk aversion of workers and the level of risk they face in their occupations. This relationship could be explained by the self-selection of workers into jobs according to their risk preferences or by the effect on risk attitudes of occupations in which people face or witness dangerous situations. We use incentivized experiments to measure risk preferences among three different groups: experienced firefighters, novice firefighters, and students. We find that experienced firefighters are less risk-averse than novice firefighters, and these in turn are less risk-averse than students. The effects remain significant even after controlling for other relevant differences between these groups. Our findings suggest that the observed relationship between risk aversion and high-risk occupations is not only a result of self-selection but also of people’s preferences being shaped by their work lives.     

Background risk and the demand for state-contingent claims

Summary. We consider the demand for state-contingent claims, in the presence of an independent zero-mean, non-hedgeable background risk. An agent is defined to be generalized risk averse if he/she chooses a demand function for contingent claims with a smaller slope everywhere, given a simple increase in background risk. We show that the conditions for standard risk aversion, that is positive, declining absolute risk aversion and prudence, are necessary and sufficient for generalized risk aversion.Received: 13 February 2002, Revised: 10 February 2003, JEL Classification Numbers: D52, D81, G11. Correspondence to: Guenter FrankeWe are grateful to Louis Eeckhoudt, Christian Gollier, Harris Schlesinger and an unknown referee for valuable comments.