Risk Aversion, Wealth and Background Risk

56 Pages Posted: 12 Apr 2001

See all articles by Luigi Guiso

Luigi Guiso

Einaudi Institute for Economics and Finance (EIEF)

Monica Paiella

University of Naples Federico II

Multiple version iconThere are 2 versions of this paper

Date Written: March 2001

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 enter a lottery. We relate this measure to consumers' endowment and attributes and to measures of background risk. We find that risk aversion is a decreasing function of endowment - thus rejecting CARA preferences - but that the elasticity to consumption is far 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. However, consumers' environment affects risk aversion. Individuals who are more likely to face income uncertainty exhibit a higher degree of absolute risk aversion, consistent with recent theories of attitudes towards risk in the presence of uninsurable risks. We also find that risk attitudes have considerable predictive power over several household decisions, including occupation and portfolio choice, moving decisions and health status.

Keywords: Background risk, heterogeneous preferences, prudence, risk aversion

JEL Classification: D10, D80

Suggested Citation

Guiso, Luigi and Paiella, Monica, Risk Aversion, Wealth and Background Risk (March 2001). CEPR Discussion Paper No. 2728. Available at SSRN: https://ssrn.com/abstract=266614

Luigi Guiso (Contact Author)

Einaudi Institute for Economics and Finance (EIEF) ( email )

Via Sallustiana 62
Rome, 00187
Italy
+39 06 4792 4858 (Phone)
+39 06 4792 4872 (Fax)

HOME PAGE: http://www.eief.it/faculty-visitors/faculty-a-z/luigi-guiso/

Monica Paiella

University of Naples Federico II ( email )

Via Amm. F. Acton, 38
80133 Naples, Caserta 80133
Italy

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