Estimating Risk Preferences in the Presence of Bifurcated Wealth Dynamics: Can We Identify Static Risk Aversion Amidst Dynamic Risk Responses?

European Review of Agricultural Economics, Vol 40 (2) (2013) pp. 361–377

17 Pages Posted: 21 Jul 2015

See all articles by Travis J. Lybbert

Travis J. Lybbert

University of California, Davis - Department of Agricultural and Resource Economics

David Just

Cornell University

Christopher B. Barrett

Cornell University - Charles H. Dyson School of Applied Economics & Management

Date Written: March 2013

Abstract

Estimating risk preferences is tricky because controlling for confounding factors is difficult. Omitting or imperfectly controlling for these factors can attribute too much observable behaviour to risk aversion and bias estimated preferences. Agents often modify risky decisions in response to dynamic wealth or asset thresholds, where such thresholds exist. Ignoring this dynamic risk response introduces an attribution bias in static estimates of risk aversion. We demonstrate this pitfall using a simple model and a Monte Carlo simulation to explore the implications of this problem for empirical estimation. While an approach that jointly estimates risk preferences and wealth dynamics may remedy the problem by extracting dynamic risk responses from observed behaviour, it is likely to be challenging to implement in broader empirical settings for reasons we discuss.

Keywords: risk, uncertainty, wealth dynamics, risk aversion, risk preference estimation, poverty

Suggested Citation

Lybbert, Travis J. and Just, David and Barrett, Christopher B., Estimating Risk Preferences in the Presence of Bifurcated Wealth Dynamics: Can We Identify Static Risk Aversion Amidst Dynamic Risk Responses? (March 2013). European Review of Agricultural Economics, Vol 40 (2) (2013) pp. 361–377, Available at SSRN: https://ssrn.com/abstract=2633606

Travis J. Lybbert

University of California, Davis - Department of Agricultural and Resource Economics ( email )

One Shields Avenue
Davis, CA 95616
United States

David Just

Cornell University ( email )

Ithaca, NY 14853
United States

Christopher B. Barrett (Contact Author)

Cornell University - Charles H. Dyson School of Applied Economics & Management ( email )

315 Warren Hall
Ithaca, NY 14853-7801
United States
607-255-4489 (Phone)
607-255-9984 (Fax)

HOME PAGE: http://aem.cornell.edu/faculty_sites/cbb2/

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