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Consumption Commitments, Unemployment Durations, and Local Risk Aversion

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  • Raj Chetty

Abstract

Studies of risk preference have empirically established two regularities that are inconsistent with the canonical expected utility model: (1) risk aversion over small gambles greatly exceeds risk aversion over larger stakes and (2) insurance buyers play the lottery. This paper characterizes risk preferences both theoretically and empirically in a world with two consumption goods, one of which involves a commitment in that an adjustment cost must be paid when the good is sold. In this model, utility over wealth is more curved locally than globally: individuals are more risk averse with respect to moderate-scale income fluctuations than they are to large income fluctuations. Commitments also create a gambling motive. The empirical importance of commitments is tested using the labor-supply method of estimating risk aversion of Chetty (2003a). Global curvature is imputed using existing labor supply elasticities, and variations in unemployment insurance laws are used to estimate local curvature in a dynamic job search model. Commitments significantly change preferences over wealth: The local coefficient of relative risk aversion is an order of magnitude larger than the global one. Implications for a broad set of questions such as optimal social insurance policies and portfolio choice are discussed.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10211.

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Date of creation: Jan 2004
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Publication status: published as Raj Chetty & Adam Szeidl, 2007. "Consumption Commitments and Risk Preferences," The Quarterly Journal of Economics, MIT Press, vol. 122(2), pages 831-877, 05.
Handle: RePEc:nbr:nberwo:10211

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Cited by:
  1. David Laibson & Andrea Repetto & Jeremy Tobacman, 2005. "Estimating Discount Functions with Consumption Choices over the Lifecycle," Levine's Bibliography 784828000000000643, UCLA Department of Economics.
  2. Craig Landry & Andreas Lange & John List & Michael Price & Nicholas Rupp, 2006. "Toward an understanding of the economics of charity: Evidence from a field experiment," Natural Field Experiments 00292, The Field Experiments Website.
  3. Botond Koszegi & Matthew Rabin, 2007. "Reference-Dependent Risk Attitudes," American Economic Review, American Economic Association, vol. 97(4), pages 1047-1073, September.
  4. Raj Chetty, 2006. "A Bound on Risk Aversion Using Labor Supply Elasticities," NBER Working Papers 12067, National Bureau of Economic Research, Inc.
  5. Stephen H. Shore & Todd Sinai, 2005. "Commitment, Risk, and Consumption: Do Birds of a Feather Have Bigger Nests?," NBER Working Papers 11588, National Bureau of Economic Research, Inc.
  6. Jan Rouwendal & Peter Nijkamp, 2011. "Homeownership and Commutes," ERSA conference papers ersa10p1623, European Regional Science Association.
  7. Raj Chetty & Adam Szeidl, 2007. "Consumption Commitments and Risk Preferences," The Quarterly Journal of Economics, MIT Press, vol. 122(2), pages 831-877, 05.
  8. Raj Chetty & Adam Szeidl, 2004. "Consumption Commitments: Neoclassical Foundations for Habit Formation," NBER Working Papers 10970, National Bureau of Economic Research, Inc.
  9. Janet L. Yellen, 2004. "Stabilization policy: a reconsideration," Speech 1, Federal Reserve Bank of San Francisco.
  10. Jan Rouwendal & Peter Nijkamp, 2007. "Homeownership and Labour Market Behaviour: Interpreting the Evidence," Tinbergen Institute Discussion Papers 07-047/3, Tinbergen Institute, revised 03 Nov 2008.
  11. Nicholas Barberis & Ming Huang & Richard H. Thaler, 2006. "Individual Preferences, Monetary Gambles, and Stock Market Participation: A Case for Narrow Framing," American Economic Review, American Economic Association, vol. 96(4), pages 1069-1090, September.
  12. Raj Chetty, 2004. "Optimal Unemployment Insurance When Income Effects are Large," NBER Working Papers 10500, National Bureau of Economic Research, Inc.
  13. repec:dgr:uvatin:2007047 is not listed on IDEAS
  14. Raj Chetty, 2008. "Moral Hazard vs. Liquidity and Optimal Unemployment Insurance," NBER Working Papers 13967, National Bureau of Economic Research, Inc.

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