Risk Aversion and the Subjective Time Discount Rate: A Joint Approach
27 Pages Posted: 21 Apr 2003
Date Written: April 2003
In this paper we analyze a large sample of individual responses to six lottery questions. We derive a simultaneous estimate of risk aversion and the time preference discount rate per individual. This can be done because the consumption of a large prize is smoothed over a larger time period. It is found that both parameters strongly vary over individuals, while they are moderately negatively correlated. Furthermore we explain the estimated relative risk aversion and time preference by income, age, gender, entrepreneurship and an obesity index. Very significant effects are found. If we explain relative risk aversion in a simple model where time discounting is ignored, we find completely different estimates for this parameter. We conclude that in the case of lotteries with big prizes a simultaneous estimate of risk aversion and time preference is needed in order to avoid misspecification.
Keywords: Expected Utility, Risk Aversion, Time Preference, Lotteries, Hypothetical Questions
JEL Classification: D12, D80, D90, E21
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