Capturing Intrinsic Risk Attitude
75 Pages Posted: 14 Oct 2019
Date Written: October 2, 2019
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: Suggested Citation