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Is Risk Aversion Really Correlated with Wealth? How Estimated Probabilities Introduce Spurious Correlation

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  • Travis J. Lybbert
  • David R. Just

Abstract

Economists frequently focus on correlations between wealth and risk preferences but rarely observe the probabilities needed to test this relationship empirically. These unobserved probabilities are typically estimated via profit or production functions conditioned on wealth correlates, which may leave statistical fingerprints on subsequently-estimated risk aversion coefficients and confound correlations between wealth and risk preferences. Using data from an experiment with observable probabilities, we compare risk aversion coefficients based on true probabilities with those based on probabilities estimated using standard approaches and show how estimated probabilities can change risk aversion coefficients substantially and introduce spurious correlation between risk aversion and wealth. Copyright 2007, Oxford University Press.

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File URL: http://hdl.handle.net/10.1111/j.1467-8276.2007.01034.x
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Bibliographic Info

Article provided by Agricultural and Applied Economics Association in its journal American Journal of Agricultural Economics.

Volume (Year): 89 (2007)
Issue (Month): 4 ()
Pages: 964-979

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Handle: RePEc:oup:ajagec:v:89:y:2007:i:4:p:964-979

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  1. Balistreri, Edward J. & Poe, Gregory L. & McClelland, Gary H. & Schulze, William D., 1996. "Can Hypothetical Questions Reveal True Values? A Laboratory Comparison of Dichotomous Choice and Open-Ended Contingent Values with Auction Values," Working Papers 127865, Cornell University, Department of Applied Economics and Management.
  2. Rulon D. Pope, 2003. "Agricultural Risk Analysis: Adequacy of Models, Data, and Issues," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 85(5), pages 1249-1256.
  3. Bar-Shira, Z. & Just, R. E. & Zilberman, D., 1997. "Estimation of farmers' risk attitude: an econometric approach," Agricultural Economics, Blackwell, vol. 17(2-3), pages 211-222, December.
  4. Milton Friedman & L. J. Savage, 1948. "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, University of Chicago Press, vol. 56, pages 279.
  5. David R. Just & Hikaru Hanawa Peterson, 2003. "Diminishing Marginal Utility of Wealth and Calibration of Risk in Agriculture," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 85(5), pages 1234-1241.
  6. Lybbert, Travis J. & Barrett, Christopher B. & Narjisse, Hamid, 2002. "Market-based conservation and local benefits: the case of argan oil in Morocco," Ecological Economics, Elsevier, vol. 41(1), pages 125-144, April.
  7. Chavas, Jean-Paul & Holt, Matthew T, 1996. "Economic Behavior under Uncertainty: A Joint Analysis of Risk Preferences and Technology," The Review of Economics and Statistics, MIT Press, vol. 78(2), pages 329-35, May.
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Cited by:
  1. van den Berg, Marrit & Fort, Ricardo & Burger, Kees, 2009. "Natural Hazards And Risk Aversion: Experimental Evidence From Latin America," 2009 Conference, August 16-22, 2009, Beijing, China 51394, International Association of Agricultural Economists.
  2. Quiroga, Sonia & Iglesias, Ana, 2009. "A comparison of the climate risks of cereal, citrus, grapevine and olive production in Spain," Agricultural Systems, Elsevier, vol. 101(1-2), pages 91-100, June.
  3. Cardenas, Juan Camilo & Carpenter, Jeffrey, 2013. "Risk attitudes and economic well-being in Latin America," Journal of Development Economics, Elsevier, vol. 103(C), pages 52-61.
  4. Bellemare, Marc F., 2009. "The (Im)Possibility of Reverse Share Tenancy," MPRA Paper 23681, University Library of Munich, Germany.
  5. Menapace, Luisa & Colson, Gregory, 2012. "On the Validity of Gamble Tasks to Assess Farmers' Risk Attitudes," 2012 Annual Meeting, August 12-14, 2012, Seattle, Washington 124601, Agricultural and Applied Economics Association.
  6. Bellemare, Marc F., 2010. "Insecure Land Rights and Share Tenancy in Madagascar," MPRA Paper 23640, University Library of Munich, Germany.

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