Estimating Risk Preferences from Deductible Choice

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