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Risk Aversion and Planning Horizon

  • Bommier, Antoine
  • Rochet, Jean-Charles

A number of empirical studies seem to reject the additive separability of preferences that is assumed in most theoretical models of the life cycle. We show that, when additive separability is abandoned and interactions between consumptions at different dates are taken into account, an interesting relation emerges between risk aversion and length of the planning horizon.Specifically, we show that when consumptions at different dates are specific substitutes, risk aversion increases with horizon length. This may explain the surprising empirical finding that individuals seem to increase the share of wealth held in risky assets as they become older. (JEL: D11, D91, G11) Copyright (c) 2006 by the European Economic Association.

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Paper provided by Institut d'Économie Industrielle (IDEI), Toulouse in its series IDEI Working Papers with number 204.

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Date of creation: 2003
Date of revision: Nov 2004
Publication status: Published in Journal of the European Economic Association, vol.�4, n°4, juin 2006, p.�708-734.
Handle: RePEc:ide:wpaper:3411
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  1. Karen E. Dynan, 2000. "Habit Formation in Consumer Preferences: Evidence from Panel Data," American Economic Review, American Economic Association, vol. 90(3), pages 391-406, June.
  2. John MUELLBAUER, 1988. "Habits, Rationality and Myopia in the Life Cycle Consumption Function," Annales d'Economie et de Statistique, ENSAE, issue 9, pages 47-70.
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  5. Luigi Guiso & Monica Paiella, 2003. "Risk Aversion, Wealth and Background Risk," Temi di discussione (Economic working papers) 483, Bank of Italy, Economic Research and International Relations Area.
  6. Ryder, Harl E, Jr & Heal, Geoffrey M, 1973. "Optimum Growth with Intertemporally Dependent Preferences," Review of Economic Studies, Wiley Blackwell, vol. 40(1), pages 1-33, January.
  7. Gary S. Becker & Kevin M. Murphy, 1986. "A Theory of Rational Addiction," University of Chicago - George G. Stigler Center for Study of Economy and State 41, Chicago - Center for Study of Economy and State.
  8. Browning, Martin, 1991. "A Simple Nonadditive Preference Structure for Models of Household Behavior over Time," Journal of Political Economy, University of Chicago Press, vol. 99(3), pages 607-37, June.
  9. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  10. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-57, August.
  11. Kihlstrom, Richard E. & Mirman, Leonard J., 1974. "Risk aversion with many commodities," Journal of Economic Theory, Elsevier, vol. 8(3), pages 361-388, July.
  12. Fumio Hayashi, 1982. "The Effect of Liquidity Constraints on Consumption: Cross-Sectional Analysis," Discussion Papers 516, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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  14. Guiso, Luigi & Jappelli, Tullio, 2000. "Household Portfolios in Italy," CEPR Discussion Papers 2549, C.E.P.R. Discussion Papers.
  15. Scott F. Richard, 1975. "Multivariate Risk Aversion, Utility Independence and Separable Utility Functions," Management Science, INFORMS, vol. 22(1), pages 12-21, September.
  16. Campbell, John, 1993. "Intertemporal Asset Pricing Without Consumption Data," Scholarly Articles 3221491, Harvard University Department of Economics.
  17. Raquel Carrasco & José M. Labeaga & J. David López-Salido, 2005. "Consumption and Habits: Evidence from Panel Data," Economic Journal, Royal Economic Society, vol. 115(500), pages 144-165, 01.
  18. Gollier, Christian & Zeckhauser, Richard J, 2002. " Horizon Length and Portfolio Risk," Journal of Risk and Uncertainty, Springer, vol. 24(3), pages 195-212, May.
  19. David M Kreps & Evan L Porteus, 1978. "Temporal Resolution of Uncertainty and Dynamic Choice Theory," Levine's Working Paper Archive 625018000000000009, David K. Levine.
  20. Samuelson, Paul A, 1969. "Lifetime Portfolio Selection by Dynamic Stochastic Programming," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 239-46, August.
  21. Karni, Edi, 1983. "On the correspondence between multivariate risk aversion and risk aversion with state-dependent preferences," Journal of Economic Theory, Elsevier, vol. 30(2), pages 230-242, August.
  22. Zvi Bodie & Robert C. Merton & William F. Samuelson, 1992. "Labor Supply Flexibility and Portfolio Choice in a Life-Cycle Model," NBER Working Papers 3954, National Bureau of Economic Research, Inc.
  23. MaCurdy, Thomas E, 1981. "An Empirical Model of Labor Supply in a Life-Cycle Setting," Journal of Political Economy, University of Chicago Press, vol. 89(6), pages 1059-85, December.
  24. Karni, Edi, 1979. "On Multivariate Risk Aversion," Econometrica, Econometric Society, vol. 47(6), pages 1391-1401, November.
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