Journal Article

Estimating risk preferences in the presence of bifurcated wealth dynamics: can we identify static risk aversion amidst dynamic risk responses?

Travis J. Lybbert, David R. Just and Christopher B. Barrett

in European Review of Agricultural Economics

Volume 40, issue 2, pages 361-377
Published in print March 2013 | ISSN: 0165-1587
Published online August 2012 | e-ISSN: 1464-3618 | DOI: https://dx.doi.org/10.1093/erae/jbs027
Estimating risk preferences in the presence of bifurcated wealth dynamics: can we identify static risk aversion amidst dynamic risk responses?

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  • Information, Knowledge, and Uncertainy
  • Intertemporal Choice and Growth
  • Economic Development

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Estimating risk preferences is tricky because controlling for confounding factors is difficult. Omitting or imperfectly controlling for these factors can attribute too much observable behaviour to risk aversion and bias estimated preferences. Agents often modify risky decisions in response to dynamic wealth or asset thresholds, where such thresholds exist. Ignoring this dynamic risk response introduces an attribution bias in static estimates of risk aversion. We demonstrate this pitfall using a simple model and a Monte Carlo simulation to explore the implications of this problem for empirical estimation. While an approach that jointly estimates risk preferences and wealth dynamics may remedy the problem by extracting dynamic risk responses from observed behaviour, it is likely to be challenging to implement in broader empirical settings for reasons we discuss.

Keywords: risk; uncertainty; wealth dynamics; risk aversion; risk preference estimation; poverty; D81; O12; D90

Journal Article.  6262 words.  Illustrated.

Subjects: Information, Knowledge, and Uncertainy ; Intertemporal Choice and Growth ; Economic Development

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