Risk Aversion and Expected-Utility Theory: A Calibration Exercise

Abstract

Rabin (2000) argues that, under expected-utility, observed risk aversion over modest stakes implies extremely high risk aversion over large stakes. Cox & Sadiraj (2006) have replied that this is a problem of expected-utility of wealth, but that expected-utility of income does not share that problem. We combine experimental data on moderate-scale risky choices with survey data on income to estimate coefficients of relative risk aversion using expected-utility of consumption. Assuming individuals cannot save implies an average coefficient of relative risk aversion of 1.92. Assuming they can decide between consuming today and saving for the future, a realistic assumption, implies quadruple-digit coefficients. This gives empirical evidence for narrow bracketing.

Keywords: Risk aversion, experiment, Paraguay

JEL Classification: C93, D80, O10