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Risk aversion and expected utility of consumption over time

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  • Johansson-Stenman, Olof

Abstract

The calibration theorem by Rabin [Rabin, M., 2000a. Risk aversion and expected utility theory: A calibration theorem. Econometrica 68, 1281-1292; Rabin, M., 2000b. Diminishing marginal utility of wealth cannot explain risk aversion. In: Kahneman, D., Tversky, A. (Eds.), Choices, Values and Frames. Cambridge University Press] implies that seemingly plausible small-stake choices under risk imply implausible large-stake risk aversion. This theorem is derived based on the expected utility of wealth model. However, Cox and Sadiraj [Cox, J.C., Sadiraj, V., 2006. Small- and large-stakes risk aversion: Implications of concavity calibration for decision theory. Games Econ. Behav. 56, 45-60] show that such implications do not follow from the expected utility of income model. One may then wonder about the implications for more applied consumption analysis. The present paper therefore expresses utility as a function of consumption in a standard life cycle model, and illustrates the implications of this model with experimental small- and intermediate-stake risk data from Holt and Laury [Holt, C.A., Laury, S.K., 2002. Risk aversion and incentive effects. Amer. Econ. Rev. 92, 1644-1655]. The results suggest implausible risk aversion parameters as well as unreasonable implications for long-term risky choices. Thus, the conventional intertemporal consumption model under risk appears to be inconsistent with the data.

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Bibliographic Info

Article provided by Elsevier in its journal Games and Economic Behavior.

Volume (Year): 68 (2010)
Issue (Month): 1 (January)
Pages: 208-219

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Handle: RePEc:eee:gamebe:v:68:y:2010:i:1:p:208-219

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Web page: http://www.elsevier.com/locate/inca/622836

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Keywords: Expected utility of income Expected utility of final wealth Dynamic consumption theory Asset integration Time inconsistency Narrow bracketing;

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References

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Citations

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Cited by:
  1. Treffers, T. & Koellinger, Ph.D. & Picot, A.O., 2012. "In the Mood for Risk? A Random-Assignment Experiment Addressing the Effects of Moods on Risk Preferences," ERIM Report Series Research in Management ERS-2012-014-ORG, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
  2. Marcel Fafchamps & Bereket Kebede & Daniel John Zizzo, 2014. "Keep Up With the Winners: Experimental Evidence on Risk Taking, Asset Integration, and Peer Effects," Working Paper series, University of East Anglia, Centre for Behavioural and Experimental Social Science (CBESS) 14-03, School of Economics, University of East Anglia, Norwich, UK..
  3. Johansson Stenman, Olof & Nordblom, Katarina, 2010. "Are Men Really More Overconfident than Women? - A Natural Field Experiment on Exam Behavior," Working Papers in Economics 461, University of Gothenburg, Department of Economics.
  4. Johansson-Stenman, Olof, 2010. "Risk aversion and expected utility of consumption over time," Games and Economic Behavior, Elsevier, vol. 68(1), pages 208-219, January.
  5. Kerri Brick & Martine Visser & Justine Burns, 2011. "Risk Aversion: Experimental Evidence from South African Fishing Communities," Working Papers 227, Economic Research Southern Africa.
  6. Andersson, Fredrik W., 2011. "The lambda model and "rule of thumb" consumers: An estimation problem in existing studies," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 40(4), pages 381-384, August.

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