Risk Aversion, Wealth and Background Risk

Luigi Guiso () and Monica Paiella

No 483, Temi di discussione (Economic working papers) from Bank of Italy, Economic Research Department

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 buy a risky security. We relate this measure to consumers' endowment and attributes and to measures of background risk and liquidity constraints. We find that risk aversion is a decreasing function of endowment - thus rejecting CARA preferences - but the elasticity to consumption is far below the unitary value predicted by the 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. However, the consumers' environment affects risk aversion. Individuals who are more likely to face income uncertainty or to become liquidity constrained exhibit a higher degree of absolute risk aversion, consistent with recent theories of attitudes towards risk in the presence of uninsurable risks.

Keywords: heterogeneous preferences; risk tolerance; background risk; liquidity constraints (search for similar items in EconPapers)
JEL-codes: D10 D80 (search for similar items in EconPapers)
Date: Written
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Related works:
Working Paper: Risk Aversion, Wealth and Background Risk (2004)
Working Paper: Risk Aversion, Wealth, and Background Risk (2007)
Working Paper: Risk Aversion, Wealth and Background Risk (2001)
Journal Article: Risk Aversion, Wealth, and Background Risk (2008)
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Persistent link: http://EconPapers.repec.org/RePEc:bdi:wptemi:td_483_03

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