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Is Risk Aversion Really Correlated with Wealth? How estimated probabilities introduce spurious correlation

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  • Lybbert, Travis J.
  • Just, David R.

Abstract

Economists attribute many common behaviors to risk aversion and frequently focus on how wealth moderates risk preferences. This paper highlights a problem associated with empirical tests of the relationship between wealth and risk aversion that can arise when the probabilities individuals face are unobservable to researchers. The common remedy for unobservable probabilities involves the estimation of probabilities in a profit or production that includes farmer, farm and agro-climatic variables. Unfortunately, these variables are often correlated with wealth such that estimated probabilities are likely to leave statistical fingerprints on subsequently-estimated risk aversion coefficients and may thereby introduce spurious correlations between wealth and risk preferences. In this paper, we use data from an experiment conducted among 290 Indian farmers to detect these spurious correlations. We estimate coefficients of risk aversion with known probabilities and with estimated probabilities and compare subsequent correlations with wealth and other farmer traits. We estimate 'unobservable' probabilities in conjunction with risk preferences following a standard field data approach. We explore the statistical implications of estimating probabilities by comparing correlations between wealth and these two sets of estimated risk preferences. These comparisons show how estimated probabilities can change risk aversion coefficients substantially and introduce spurious correlations between risk aversion and wealth.

Suggested Citation

  • Lybbert, Travis J. & Just, David R., 2006. "Is Risk Aversion Really Correlated with Wealth? How estimated probabilities introduce spurious correlation," 2006 Annual meeting, July 23-26, Long Beach, CA 21167, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
  • Handle: RePEc:ags:aaea06:21167
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    References listed on IDEAS

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    1. Milton Friedman & L. J. Savage, 1948. "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, University of Chicago Press, vol. 56, pages 279-279.
    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. 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.
    4. Edward Balistreri & Gary McClelland & Gregory Poe & William Schulze, 2001. "Can Hypothetical Questions Reveal True Values? A Laboratory Comparison of Dichotomous Choice and Open-Ended Contingent Values with Auction Values," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 18(3), pages 275-292, March.
    5. Bar-Shira, Ziv & Just, Richard E. & Zilberman, D., 1997. "Estimation of farmers' risk attitude: an econometric approach," Agricultural Economics of Agricultural Economists, International Association of Agricultural Economists, vol. 17(2-3), December.
    6. 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 329-335, May.
    7. 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.
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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. 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.
    3. Bellemare, Marc F., 2009. "The (Im)Possibility of Reverse Share Tenancy," MPRA Paper 23681, University Library of Munich, Germany.
    4. 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.
    5. Luisa Menapace & Gregory Colson & Roberta Raffaelli, 2016. "A comparison of hypothetical risk attitude elicitation instruments for explaining farmer crop insurance purchases," European Review of Agricultural Economics, Foundation for the European Review of Agricultural Economics, vol. 43(1), pages 113-135.
    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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    Keywords

    Risk and Uncertainty;

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