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Estimating Risk Preferences from Deductible Choice

61 Pages Posted: 5 Apr 2007  

Alma Cohen

Tel Aviv University - Eitan Berglas School of Economics; Harvard Law School; National Bureau of Economic Research (NBER)

Liran Einav

Stanford University - Department of Economics; National Bureau of Economic Research (NBER)

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Abstract

We estimate the distribution of risk preferences using a large data set of deductible choices in auto insurance contracts. To do so, we develop a structural econometric model of adverse selection that allows for unobserved heterogeneity in both risk (claim rate) and risk aversion. We use data on realized claims to estimate the distribution of claim rates and data on deductible and premium choices to estimate the distribution of risk aversion and how it correlates with risk. We find large heterogeneity in risk attitudes: while the majority of individuals are almost risk neutral with respect to lotteries of 100 dollar magnitude, an important fraction of the individuals exhibit significant risk aversion even with respect to such relatively small bets. The estimates imply that women are more risk averse than men, that risk aversion exhibits a U-shape with respect to age, and that most proxies for income and wealth are positively associated with absolute risk aversion. Finally, unobserved heterogeneity in risk aversion is more important than that of risk, and risk and risk aversion are positively correlated.

Keywords: risk aversion, adverse selection, structural estimation, mixture models

JEL Classification: D82, G22

Suggested Citation

Cohen, Alma and Einav, Liran, Estimating Risk Preferences from Deductible Choice. American Economic Review, Vol. 97, pp. 745-788, 2007; Harvard Law and Economics Discussion Paper No. 582. Available at SSRN: https://ssrn.com/abstract=977586

Alma Cohen (Contact Author)

Tel Aviv University - Eitan Berglas School of Economics ( email )

Ramat Aviv, Tel Aviv, 69978
Israel

Harvard Law School ( email )

Cambridge, MA 02138
United States
(617) 496-4099 (Phone)
(617) 812-0554 (Fax)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Liran Einav

Stanford University - Department of Economics ( email )

Landau Economics Building
579 Serra Mall
Stanford, CA 94305-6072
United States
650-723-3704 (Phone)
928-223-4973 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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