Individual Risk Attitudes: New Evidence from a Large, Representative, Experimentally-Validated Survey

In this paper, expected utility, defined by a Taylor series expansion around expected wealth, is maximized. The coefficient of relative risk aversion (CRRA) that is commensurate with a 100% investment in the risky asset is simulated. The following parameters are varied: the riskless return, the market standard deviation, the market stock premium, and the skewness and the kurtosis of the risky return. Both the high extremes and the low extremes are considered. With these figures, the upper bound of the market CRRA is 3.021 and the lower bound is 0.466. Log utility, which corresponds to a CRRA of 1, is not excluded.

Consumption and portfolio choice with time-inconsistent preferences

Individuals' risk preferences are estimated and employed in a variety of settings, notably including choices in financial, labor, and product markets. Recent work, especially in financial economics, provides estimates of individuals' coefficients of relative risk aversion (CRRA's) in excess of one, and often significantly higher. However, it can be shown that high CRRA's imply equally high values for the income elasticity of the value of a statistical life. Yet estimates of this elasticity, derived from labor and product markets, are in the range of 0.5 to 0.6. Furthermore, it turns out that even a CRRA below one is difficult to reconcile with these elasticity estimates. Thus, there appears to be an important (additional) anomaly involving individuals' risk-taking behavior in different market settings.

We analyze individual investment behavior among 822 young men and women that are members of 111 formal business groups in northern Ethiopia. We collected baseline data and investment data one year later combined with incentivized field experiments to obtain dis-aggregated risk preference data. We find that businesswomen on average invest significantly less at individual level than businessmen but Cohen’s d values for the gender difference are moderate in size. Women are found to have higher Constant Relative Risk Aversion (CRRA-r) coefficients (more concave utility function), to be more loss averse, but also to be more optimistic in their expectations (lower Prelec β) than men. Women were also poorer in non-land assets, came from more land-poor parents, and had lower incomes. The gender differences in risk attitudes and baseline endowments could explain some of but not all of the gender differences in investment behavior.

PurposeThis paper seeks to reconsider the Euler equation of the Consumption Capital Asset Pricing Model (CCAPM), to derive a regression‐based model to test it, and to present evidence that the model is consistent with reasonable values for the coefficient of relative risk aversion (CRRA). This runs contrary to the findings of the literature on the equity premium puzzle, but is in agreement with the literature that estimates the CRRA for the purpose of computing the social discount rate, and is in line with the research on labor supply. Tests based on General Method of Moments (GMM) for the same sample produce results that are extremely disparate and unstable. The paper aims to check and find support for the robustness of the regression‐based tests. Habit formation models are also to be evaluated with regression‐based and GMM tests. However, the validity of the regression‐based models depends critically on their functional forms.Design/methodology/approachThe paper presents empirical evidence that the conventional use of GMM fails because of four pathological features of GMM that are referred to under the general caption of “weak identification”. In addition to GMM, the paper employs linear regression analysis to test the CCAPM, and it is found that the regression residuals follow well‐behaved distributional properties, making valid all statistical inferences, while GMM estimates are highly unstable.FindingsFour unexpected findings are reported. The first is that the regression‐based models are consistent with reasonable values for the CRRA, i.e. estimates that are below 4. The second is that the regression‐based tests are robust, while the GMM‐based tests are not. The third is that regression‐based tests with habit formation depend crucially on the specification of the model. The fourth is that there is evidence that market stock returns are sensitive to both consumption and dividends. The author calls the latter “extra sensitivity of market stock returns”, and it is described as a new puzzle.Originality/valueThe regression‐based models of the CCAPM Euler equation are novel. The comparison between GMM and regression‐based models for the same sample is original. The regression‐based models with habit formation are new. The equity premium puzzle disappears because the estimates of the CRRA are reasonable. But another puzzle is documented, which is the “extra sensitivity of market stock returns” to consumption and dividends together.

ABSTRACTFor homothetic time and state separable preferences, the coefficient of relative risk aversion (CRRA) is equal to the reciprocal of the elasticity of intertemporal substitution (EIS). This paper shows that, when the growth rate of consumption is i.i.d., asset pricing models based upon preferences in which the CRRA and the EIS are no longer linked do not have more explanatory power. Further, in these stochastic environments, estimates of the CRRA in the standard preferences are measures of the true CRRA and not the EIS. These results are fairly accurate descriptions of economies calibrated using United States annual data.

This paper builds a unifying framework that, within the theory of intertemporal consumption choices, brings together the limited participation -based explanation of the poor empirical performance of the C-CAPM and the transaction costs-based explanation of incomplete portfolios. Using the implications of the consumption model and observed household consumption and portfolio choices, we identify the preference parameters of interest and a lower bound for the costs rationalizing non-participation in financial markets, in the presence of unobserved heterogeneity in tastes for consumption and portfolio allocation. Using the US Consumer Expenditure Survey and assuming isoelastic preferences, we estimate the coefficient of relative risk aversion at 1.7 and a cost bound of 0.4 percent of non-durable consumption. Our estimate of the preference parameter is theoretically plausible and the bound sufficiently small to be likely to be exceeded by the actual total (observable and unobservable) costs of participating to financial markets.

This thesis contributes to the field of behavioral economics. Research in behavioral economics investigates whether predictions of theoretical models and their underlying assumptions hold. It thereby enhances the predictive power of economics. While the first chapter provides an introduction and overview, Chapter 2 of this thesis studies whether an intergenerational transmission of risk preferences revealed by occupational choice from parents to children can be observed. The analysis shows that different male generations of a family indeed exhibit similar risky behavior, however, the link is rather weak. Chapter 3 answers the question of whether subjects are aware of the correlation between risk preferences and sociodemographic characteristics and attach informational value to sociodemographics when assessing the risk attitudes of others. The results of the experiment show that subjects recognize the correlation between the sociodemographic variables age, gender, parenthood and family status and risk preferences. Furthermore, subjects attach informational value to sociodemographic characteristics. Chapter 4 analyzes the process of the assessment of risk preferences of others in detail. A major asset is that our sample for the experiments in Chapter 3 and 4, besides student subjects, includes individuals that professionally make decisions on behalf of others every day: senior and junior advisors with differing years of counseling experience in the financial sector. In particular, it is studied whether professional and non-professional advisors are capable of correctly assessing the risk preferences of a specific advisee given sociodemographic information. The results of the experiment show, that when forming beliefs about the risk preferences of others, a false consensus bias of the advisors is present; the advisors' own risk preferences positively correlate with their beliefs about the advisees' ones. The precision of advice increases if more information is available. Professionals outperform non-professionals significantly when forecasting the risk attitudes of others. Chapter 5 of this thesis analyses whether herding out of reputational concerns exists in financial markets. Therefore, the subjects' behavior is studied in two treatments. First, in the role of financial investors, subjects take the decision which of two assets to buy without career concerns. In a second treatment, career concerns are incorporated. While in the first treatment, according to the theory, investors should always follow their own signal and buy the respective asset, in the second treatment with career concerns, investors should engage in herd behavior and neglect their own signal. However, the experimental results indicate that a similar herd behavior can be observed in the treatment with reputational concerns as well as in the treatment without reputational concerns. Moreover, we provide further evidence for investors (irrationally) imitating predecessors.

Optimal portfolio and consumption with habit formation in a jump diffusion market

The study assesses the relation between individual risk attitudes and fear of failure. We measured risk attitudes using the risk attitude scale (Weber and Betz, 2002) and fear of failure using the Performance Failure Appraisal Inventory (Conroy et al., 2002).51 students of ages 14 - 18 years took part in the survey where they completed these two questionnaires with slight modifications. The individual scores were averaged and Cronbach's alpha test was employed to test internal reliability. Pearson's correlation and linear regression analysis was done keeping fear of failure as the independent variable. The questionnaires had good internal reliability. The correlation and regression analysis both indicated a moderate positive relation but the p - values were higher than the standard 0.05 so the relation was not considered statistically significant. The findings motivate us to conduct further research on the topic with a larger sample size to explore the relation more deeply which is imperative to human decision making.

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