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A New Method of Estimating Risk Aversion

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  • Raj Chetty

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 )

Suggested Citation

  • Raj Chetty, 2006. "A New Method of Estimating Risk Aversion," American Economic Review, American Economic Association, vol. 96(5), pages 1821-1834, December.
    • Handle: RePEc:aea:aecrev:v:96:y:2006:i:5:p:1821-1834
    Note: DOI: 10.1257/aer.96.5.1821
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    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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