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Risk Aversion, Wealth and Background Risk

Listed author(s):
  • Luigi Guiso
  • Monica Paiella

    ()

We use household survey data to construct a direct measure of absolute risk aversion based on the maximum price a consumer is willing to pay to buy a risky security. We relate this measure to consumers' endowment and attributes and to measures of background risk and liquidity constraints. We find that risk aversion is a decreasing function of endowment - thus rejecting CARA preferences - but the elasticity to consumption is far below the unitary value predicted by the CRRA utility. We also find that households' attributes are of little help in predicting their degree of risk aversion, which is characterized by massive unexplained heterogeneity. However, the consumers' environment affects risk aversion. Individuals who are more likely to face income uncertainty or to become liquidity constrained exhibit a higher degree of absolute risk aversion, consistent with recent theories of attitudes towards risk in the presence of uninsurable risks.

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File URL: http://www.bancaditalia.it/pubblicazioni/temi-discussione/2003/2003-0483/tema_483_03.pdf
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Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 483.

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Date of creation: Sep 2003
Handle: RePEc:bdi:wptemi:td_483_03
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  25. Kihlstrom, Richard E & Romer, David & Williams, Steve, 1981. "Risk Aversion with Random Initial Wealth," Econometrica, Econometric Society, vol. 49(4), pages 911-920, June.
  26. Elizabeth Cascio & Ethan Lewis, 2005. "Schooling and the AFQT: evidence from school entry laws," Working Papers 05-1, Federal Reserve Bank of Philadelphia.
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