Comparative Risk Aversion, Comparative Prudence, and Two-Period Self-Insurance-Cum-Protection with Savings

Abstract

We investigate the effect of changes in preferences on the optimal level of effort in a two-period SICP problem with saving. We find that when the wealth deducted in the loss state is decreasing with the effort, which is a feature of self insurance, an increase in risk aversion leads to an increase in the optimal level of effort. When the wealth deducted in the loss state is increasing with the effort, which is a feature of self protection, an increase in prudence and risk aversion leads to a decrease in the optimal level of effort. The result is similar to that in a single-period model, but in contrast with that in a two-period SICP problem without saving.

Keywords: SICP, self protection, risk aversion, prudence

JEL Classification: D61, D81