Capturing Intrinsic Risk Attitude

75 Pages Posted: 14 Oct 2019

See all articles by Christian P. Traeger

Christian P. Traeger

University of Oslo - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute) - Ifo Institute; University of Oslo - Ragnar Frisch Centre for Economic Research; University of California, Berkeley - Department of Agricultural & Resource Economics

Date Written: October 2, 2019

Abstract

This study introduces a new conceptualization of intrinsic risk attitude. In contrast to the Arrow--Pratt measure, it links directly to preferences on the multidimensional consumption space and is independent of the way in which we measure consumption, the commodity under observation, and market prices or liquidity constraints. The presented measure relies on intertemporal choice to distinguish intrinsic aversion to risk from taste or satiation. The present study characterizes risk attitude axiomatically, functionally, and numerically and compares risk attitudes across agents with differing tastes. The analysis works with a class of preference representations satisfying certainty additivity and Neumann & Morgenstern’s (1944) axioms. The underlying representation overlaps with Kreps & Porteus’s (1978) and Epstein & Zin’s (1989) models, but introduces an insightful symmetry in time and risk aggregators that helps explain the different functional manifestations of intrinsic risk attitude. An application of the concept shows that the widely employed isoelastic version of Epstein-Zin-Weil preferences implies an intrinsic risk aversion that increases in consumption for intertemporal elasticities of substitution below unity, addressing a puzzle about the difference in estimates of intertemporal substitutability in the long-run risk literature as compared to other literatures.

Keywords: risk attitude, uncertainty, interpersonal comparison, recursive utility, intertemporal substitutability, intertemporal risk aversion, Epstein–Zin preferences, asset pricing, prudence

JEL Classification: D80, D81, D90, G12

Suggested Citation

Traeger, Christian P., Capturing Intrinsic Risk Attitude (October 2, 2019). Available at SSRN: https://ssrn.com/abstract=3462905 or http://dx.doi.org/10.2139/ssrn.3462905

Christian P. Traeger (Contact Author)

University of Oslo - Department of Economics ( email )

Norway

CESifo (Center for Economic Studies and Ifo Institute) - Ifo Institute ( email )

Poschinger Str. 5
Munich, 81679
Germany

University of Oslo - Ragnar Frisch Centre for Economic Research ( email )

Gaustadalleen 21
N-0317 Oslo
Norway

University of California, Berkeley - Department of Agricultural & Resource Economics ( email )

Berkeley, CA 94720
United States

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