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Consumption Commitments, Unemployment Durations, and Local Risk Aversion

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Author Info
Raj Chetty

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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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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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Handle: RePEc:nbr:nberwo:10211

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Find related papers by JEL classification:
D8 - Microeconomics - - Information, Knowledge, and Uncertainty
E21 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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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. Raj Chetty, 2004. "Optimal Unemployment Insurance When Income Effects are Large," NBER Working Papers 10500, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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    Other versions:
  3. Matthew Rabin., 2000. "Risk Aversion and Expected-Utility Theory: A Calibration Theorem," Economics Working Papers E00-279, University of California at Berkeley. [Downloadable!]
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  20. 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!]
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  23. Raj Chetty, 2003. "A New Method of Estimating Risk Aversion," NBER Working Papers 9988, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  24. Flemming, J S, 1969. "The Utility of Wealth and the Utility of Windfalls," Review of Economic Studies, Blackwell Publishing, vol. 36(105), pages 55-66, January. [Downloadable!] (restricted)
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  26. Atkinson, Anthony B & Micklewright, John, 1991. "Unemployment Compensation and Labor Market Transitions: A Critical Review," Journal of Economic Literature, American Economic Association, vol. 29(4), pages 1679-1727, December. [Downloadable!] (restricted)
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  29. Orazio P. Attanasio, 1995. "Consumer Durables and Inertial Behavior: Estimation and Aggregation of (S,s) Rules," NBER Working Papers 5282, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  32. Adam Szeidl & Raj Chetty, 2004. "Consumption Commitments and Asset Prices," 2004 Meeting Papers 354, Society for Economic Dynamics. [Downloadable!]
  33. Cullen, Julie Berry & Gruber, Jonathan, 2000. "Does Unemployment Insurance Crowd Out Spousal Labor Supply?," Journal of Labor Economics, University of Chicago Press, vol. 18(3), pages 546-72, July. [Downloadable!] (restricted)
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  35. Matthew Rabin, 2000. "Risk Aversion and Expected-Utility Theory: A Calibration Theorem," Econometrica, Econometric Society, vol. 68(5), pages 1281-1292, September.
  36. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," Journal of Political Economy, University of Chicago Press, vol. 110(4), pages 825-853, August. [Downloadable!] (restricted)
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 Laibson & Andrea Repetto & Jeremy Tobacman, 2007. "Estimating Discount Functions with Consumption Choices over the Lifecycle," NBER Working Papers 13314, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  2. Raj Chetty & Adam Szeidl, 2004. "Consumption Commitments: Neoclassical Foundations for Habit Formation," NBER Working Papers 10970, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  3. Botond Koszegi & Matthew Rabin, 2006. "Reference-Dependent Risk Attitudes," Levine's Bibliography 122247000000001267, UCLA Department of Economics. [Downloadable!]
  4. Raj Chetty, 2003. "A New Method of Estimating Risk Aversion," NBER Working Papers 9988, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. Raj Chetty, 2006. "A Bound on Risk Aversion Using Labor Supply Elasticities," NBER Working Papers 12067, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. Raj Chetty, 2008. "Moral Hazard vs. Liquidity and Optimal Unemployment Insurance," NBER Working Papers 13967, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  7. Janet L. Yellen, 2004. "Stabilization policy: a reconsideration," Speech, Federal Reserve Bank of San Francisco, issue Jul 1. [Downloadable!]
    Other versions:
  8. Raj Chetty, 2004. "Optimal Unemployment Insurance When Income Effects are Large," NBER Working Papers 10500, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. 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. [Downloadable!]
  10. Raj Chetty & Adam Szeidl, 2006. "Consumption Commitments and Risk Preferences," NBER Working Papers 12467, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  11. 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. [Downloadable!]
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