Risk Aversion and the Subjective Time Discount Rate: A Joint Approach

27 Pages Posted: 21 Apr 2003

See all articles by B.M.S. van Praag

B.M.S. van Praag

University of Amsterdam - Faculty of Economics and Business (FEB); IZA Institute of Labor Economics; Tinbergen Institute in Amsterdam; CESifo (Center for Economic Studies and Ifo Institute)

Adam S. Booij

Amsterdam School of Economics

Date Written: April 2003

Abstract

In this paper we analyze a large sample of individual responses to six lottery questions. We derive a simultaneous estimate of risk aversion and the time preference discount rate per individual. This can be done because the consumption of a large prize is smoothed over a larger time period. It is found that both parameters strongly vary over individuals, while they are moderately negatively correlated. Furthermore we explain the estimated relative risk aversion and time preference by income, age, gender, entrepreneurship and an obesity index. Very significant effects are found. If we explain relative risk aversion in a simple model where time discounting is ignored, we find completely different estimates for this parameter. We conclude that in the case of lotteries with big prizes a simultaneous estimate of risk aversion and time preference is needed in order to avoid misspecification.

Keywords: Expected Utility, Risk Aversion, Time Preference, Lotteries, Hypothetical Questions

JEL Classification: D12, D80, D90, E21

Suggested Citation

van Praag, Bernard and Booij, Adam S., Risk Aversion and the Subjective Time Discount Rate: A Joint Approach (April 2003). Available at SSRN: https://ssrn.com/abstract=396563 or http://dx.doi.org/10.2139/ssrn.396563

Bernard Van Praag (Contact Author)

University of Amsterdam - Faculty of Economics and Business (FEB) ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands
31 20 5256018 (Phone)
31 20 5256013 (Fax)

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Tinbergen Institute in Amsterdam

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Adam S. Booij

Amsterdam School of Economics ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

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