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A New Method of Estimating Risk Aversion

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Raj Chetty

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Abstract

I show existing evidence on labor supply behavior places an upper bound on risk aversion in the expected utility model. I derive a formula for the coefficient of relative risk aversion (γ) in terms of the ratio of the income elasticity of labor supply to wage elasticity and degree of complementarity between consumption and labor. I bound the degree of complementarity using data on consumption choices when labor supply varies across states. Using labor supply elasticity estimates, I find a mean estimate of γ ≈ 1, then show generating γ > 2 requires that wage increases cause sharper labor supply reductions. (JEL D81 J22 )

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File URL: http://hdl.handle.net/10.1257/aer.96.5.1821
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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 96 (2006)
Issue (Month): 5 (December)
Pages: 1821-1834
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Handle: RePEc:aea:aecrev:v:96:y:2006:i:5:p:1821-1834

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Drazen Prelec, 1998. "The Probability Weighting Function," Econometrica, Econometric Society, vol. 66(3), pages 497-528, May.
  2. Gertner, Robert, 1993. "Game Shows and Economic Behavior: Risk-Taking on "Card Sharks."," The Quarterly Journal of Economics, MIT Press, vol. 108(2), pages 507-21, May. [Downloadable!] (restricted)
  3. Robert B. Barsky & Miles S. Kimball & F. Thomas Juster & Matthew D. Shapiro, 1997. "Preference Parameters and Behavioral Heterogeneity: An Experimental Approach in the Health and Retirement Survey," NBER Working Papers 5213, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Matthew Rabin., 2000. "Risk Aversion and Expected-Utility Theory: A Calibration Theorem," Economics Working Papers E00-279, University of California at Berkeley. [Downloadable!]
  5. Martin Feldstein, 1999. "Tax Avoidance And The Deadweight Loss Of The Income Tax," The Review of Economics and Statistics, MIT Press, vol. 81(4), pages 674-680, November. [Downloadable!] (restricted)
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  6. Wolf, Charles & Pohlman, Larry, 1983. "The Recovery of Risk Preferences from Actual Choices," Econometrica, Econometric Society, vol. 51(3), pages 843-50, May. [Downloadable!] (restricted)
  7. Hausman, Jerry A., 1985. "Taxes and labor supply," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 1, chapter 4, pages 213-263 Elsevier. [Downloadable!] (restricted)
  8. Jon Gruber & Emmanuel Saez, 2000. "The Elasticity of Taxable Income: Evidence and Implications," NBER Working Papers 7512, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  9. Nada Eissa & Hilary Williamson Hoynes, 1998. "The Earned Income Tax Credit and the Labor Supply of Married Couples," NBER Working Papers 6856, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  10. Saez, Emmanuel, 2003. "The effect of marginal tax rates on income: a panel study of 'bracket creep'," Journal of Public Economics, Elsevier, vol. 87(5-6), pages 1231-1258, May. [Downloadable!] (restricted)
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  11. Kahneman, Daniel & Wakker, Peter P & Sarin, Rakesh, 1997. "Back to Bentham? Explorations of Experienced Utility," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 375-405, May.
  12. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March. [Downloadable!] (restricted)
  13. Pencavel, John, 1987. "Labor supply of men: A survey," Handbook of Labor Economics, in: O. Ashenfelter & R. Layard (ed.), Handbook of Labor Economics, edition 1, volume 1, chapter 1, pages 3-102 Elsevier. [Downloadable!] (restricted)
  14. Szpiro, George G, 1986. "Measuring Risk Aversion: An Alternative Approach," The Review of Economics and Statistics, MIT Press, vol. 68(1), pages 156-59, February. [Downloadable!] (restricted)
  15. Machina, Mark J, 1987. "Choice under Uncertainty: Problems Solved and Unsolved," Journal of Economic Perspectives, American Economic Association, vol. 1(1), pages 121-54, Summer. [Downloadable!] (restricted)
  16. Metrick, Andrew, 1995. "A Natural Experiment in "Jeopardy!"," American Economic Review, American Economic Association, vol. 85(1), pages 240-53, March. [Downloadable!] (restricted)
  17. Jonathan Gruber, 1994. "The Consumption Smoothing Benefits of Unemployment Insurance," NBER Working Papers 4750, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  18. Martin Browning & Thomas Crossley, 1996. "Unemployment Insurance Benefit Levels and Consumption Changes," Department of Economics Working Papers 1996-01, McMaster University. [Downloadable!]
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  19. Raj Chetty, 2004. "Consumption Commitments, Unemployment Durations, and Local Risk Aversion," NBER Working Papers 10211, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  20. Blundell, Richard & Macurdy, Thomas, 1999. "Labor supply: A review of alternative approaches," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 27, pages 1559-1695 Elsevier. [Downloadable!] (restricted)
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  21. Narayana R. Kocherlakota, 1996. "The Equity Premium: It's Still a Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(1), pages 42-71, March. [Downloadable!] (restricted)
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  22. Matthew Rabin, 2000. "Risk Aversion and Expected-Utility Theory: A Calibration Theorem," Econometrica, Econometric Society, vol. 68(5), pages 1281-1292, September.
  23. Macurdy, T. & Green, D. & Paarsch, H., 1990. "Assessing Empirical Approaches For Analyzing Taxes And Labor Supply," Papers e-90-11, Stanford - Hoover Institution.
  24. Matthew Rabin, 2000. "Risk Aversion and Expected-Utility Theory: A Calibration Theorem," Department of Economics, Working Paper Series 1034, Department of Economics, Institute for Business and Economic Research, UC Berkeley. [Downloadable!]
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. David Card & Raj Chetty & Andrea Weber, 2006. "Cash-on-Hand and Competing Models of Intertemporal Behavior: New Evidence from the Labor Market," NBER Working Papers 12639, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  2. Gee, C., 2007. "Risky Choice and Type-Uncertainty in "Deal or No Deal?"," Cambridge Working Papers in Economics 0758, Faculty of Economics, University of Cambridge. [Downloadable!]
  3. Mary F. Evans & V. Kerry Smith, 2009. "Measuring How Risk Tradeoffs Adjust With Income," NBER Working Papers 15372, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Raj Chetty & Adam Looney & Kory Kroft, 2009. "Salience and taxation: theory and evidence," Finance and Economics Discussion Series 2009-11, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  5. Louis Kaplow, 2005. "The Value of a Statistical Life and the Coefficient of Relative Risk Aversion," Journal of Risk and Uncertainty, Springer, vol. 31(1), pages 23-34, July. [Downloadable!] (restricted)
    Other versions:
  6. Raj Chetty & Emmanuel Saez, 2008. "Optimal Taxation and Social Insurance with Endogenous Private Insurance," NBER Working Papers 14403, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  7. Mary F. Evans & V. Kerry Smith, 2008. "Complementarity and the Measurement of Individual Risk Tradeoffs: Accounting for Quantity and Quality of Life Effects," NBER Working Papers 13722, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. John Whalley & Ximing Yue, 2006. "Rural Income Volatility and Inequality in China," NBER Working Papers 12779, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. Stefania Albanesi, 2007. "Optimal taxation of entrepreneurial capital with private information," Discussion Papers 0607-11, Columbia University, Department of Economics. [Downloadable!]
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  10. Raj Chetty, 2008. "Moral Hazard vs. Liquidity and Optimal Unemployment Insurance," NBER Working Papers 13967, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  11. Laszlo Goerke, 2007. "Unemployment Insurance Savings Accounts and Collective Wage Determination," IZA Discussion Papers 3141, Institute for the Study of Labor (IZA). [Downloadable!]
  12. Raj Chetty, 2004. "Consumption Commitments, Unemployment Durations, and Local Risk Aversion," NBER Working Papers 10211, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  13. Raj Chetty, 2004. "Optimal Unemployment Insurance When Income Effects are Large," NBER Working Papers 10500, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  14. Ivan Vidangos, 2009. "Household welfare, precautionary saving, and social insurance under multiple sources of risk," Finance and Economics Discussion Series 2009-14, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  15. David E. Bloom & David Canning & Michael Moore, 2004. "The Effect of Improvements in Health and Longevity on Optimal Retirement and Saving," NBER Working Papers 10919, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  16. Hartley, Roger & Lanot, Gauthier & Walker, Ian, 2006. "Who really wants to be a millionaire? Estimates of risk aversion from gameshow data," The Warwick Economics Research Paper Series (TWERPS) 747, University of Warwick, Department of Economics. [Downloadable!]
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  17. Gary W. Yohe & Richard S.J. Tol, 2007. "The Stern Review: A Deconstruction," Working Papers FNU-125, Research unit Sustainability and Global Change, Hamburg University, revised Feb 2007. [Downloadable!]
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  18. Robert J. Barro, 2007. "Rare Disasters, Asset Prices, and Welfare Costs," NBER Working Papers 13690, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  19. Raj Chetty, 2009. "The Simple Economics of Salience and Taxation," NBER Working Papers 15246, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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