On the (Mis)Use of Wealth as a Proxy for Risk Aversion
Marc F. Bellemare
University of Minnesota - Twin Cities - Department of Applied Economics
Zachary S. Brown
OECD; Duke Global Health Institute
July 11, 2009
American Journal of Agricultural Economics, Forthcoming
Tests of risk sharing in the contracting literature often rely on wealth as a proxy for risk aversion. The intuition behind these tests is that since contract choice is monotonic in the coefficients of risk aversion, which are themselves assumed monotonic in wealth, the effect of a change in wealth on contract choice is clearly identified. We show that tests of risk sharing relying on wealth as a proxy for risk aversion are only identified insofar as the econometrician is willing to assume that (i) the principal is risk-neutral or her preferences exhibit CARA; and (ii) the agent is risk-neutral.
Number of Pages in PDF File: 29
Keywords: Contract theory, principal-agent models, risk sharing, empirical tests, risk aversion
JEL Classification: C12, D86, G32, Q19
Date posted: June 6, 2008 ; Last revised: April 26, 2010
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