Risk Aversion, Wealth, and Background Risk

Luigi Guiso and Monica Paiella

No ECO2007/47, Economics Working Papers from European University Institute

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 for a risky security. We relate this measure to consumers' endowments and attributes and to measures of background risk and liquidity constraints. We find that risk aversion is a decreasing function of the endowment. thus rejecting CARA preferences. We estimate the elasticity of risk aversion to consumption at about 0.7, 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. We show that the consumer's 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 toward risk in the presence of uninsurable risks.

Keywords: Risk aversion; background risk; prudence; heterogeneous preferences (search for similar items in EconPapers)
JEL-codes: D1 D8 (search for similar items in EconPapers)
Date: 2007
New Economics Papers: this item is included in nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

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Related works:
Journal Article: Risk Aversion, Wealth, and Background Risk (2008)
Working Paper: Risk Aversion, Wealth and Background Risk (2004)
Working Paper: Risk Aversion, Wealth and Background Risk (2003)
Working Paper: Risk Aversion, Wealth and Background Risk (2001)
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Persistent link: https://EconPapers.repec.org/RePEc:eui:euiwps:eco2007/47

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