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Risk aversion and expected utility of consumption over time

Johansson-Stenman, O (2010) In Games and Economic Behavior 68(1). p.208-219
Abstract
The calibration theorem by Rabin [Rabin, M., 2000a. Risk aversion and expected utility theory: A calibration theorem. Econometrica 68, 1281-1292; Rabin, M., 2000b. Diminishing marginal utility of wealth cannot explain risk aversion. In: Kahneman, D., Tversky, A. (Eds.), Choices, Values and Frames. Cambridge University Press] implies that seemingly plausible small-stake choices under risk imply implausible large-stake risk aversion. This theorem is derived based on the expected utility of wealth model. However, Cox and Sadiraj [Cox, J.C., Sadiraj, V., 2006. Small- and large-stakes risk aversion: Implications of concavity calibration for decision theory. Games Econ. Behav. 56, 45-60] show that such implications do not follow from the... (More)
The calibration theorem by Rabin [Rabin, M., 2000a. Risk aversion and expected utility theory: A calibration theorem. Econometrica 68, 1281-1292; Rabin, M., 2000b. Diminishing marginal utility of wealth cannot explain risk aversion. In: Kahneman, D., Tversky, A. (Eds.), Choices, Values and Frames. Cambridge University Press] implies that seemingly plausible small-stake choices under risk imply implausible large-stake risk aversion. This theorem is derived based on the expected utility of wealth model. However, Cox and Sadiraj [Cox, J.C., Sadiraj, V., 2006. Small- and large-stakes risk aversion: Implications of concavity calibration for decision theory. Games Econ. Behav. 56, 45-60] show that such implications do not follow from the expected utility of income model. One may then wonder about the implications for more applied consumption analysis. The present paper therefore expresses utility as a function of consumption in a standard life cycle model, and illustrates the implications of this model with experimental small- and intermediate-stake risk data from Holt and Laury [Holt, C.A., Laury, S.K., 2002. Risk aversion and incentive effects. Amer. Econ. Rev. 92, 1644-1655]. The results suggest implausible risk aversion parameters as well as unreasonable implications for long-term risky choices. Thus, the conventional intertemporal consumption model under risk appears to be inconsistent with the data. (C) 2009 Elsevier Inc. All rights reserved. (Less)
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author
publishing date
type
Contribution to journal
publication status
published
subject
keywords
Expected utility of income, Expected utility of final wealth, Dynamic consumption theory, Asset integration, Time inconsistency, Narrow bracketing
in
Games and Economic Behavior
volume
68
issue
1
pages
208 - 219
publisher
0899-8256
external identifiers
  • scopus:72049088525
ISSN
0899-8256
DOI
10.1016/j.geb.2009.07.001
project
BECC
language
English
LU publication?
no
id
054cdb02-7eac-4554-a1a7-ae7f7bcda45a (old id 4448883)
date added to LUP
2014-05-23 12:11:37
date last changed
2018-05-29 09:34:28
@article{054cdb02-7eac-4554-a1a7-ae7f7bcda45a,
  abstract     = {The calibration theorem by Rabin [Rabin, M., 2000a. Risk aversion and expected utility theory: A calibration theorem. Econometrica 68, 1281-1292; Rabin, M., 2000b. Diminishing marginal utility of wealth cannot explain risk aversion. In: Kahneman, D., Tversky, A. (Eds.), Choices, Values and Frames. Cambridge University Press] implies that seemingly plausible small-stake choices under risk imply implausible large-stake risk aversion. This theorem is derived based on the expected utility of wealth model. However, Cox and Sadiraj [Cox, J.C., Sadiraj, V., 2006. Small- and large-stakes risk aversion: Implications of concavity calibration for decision theory. Games Econ. Behav. 56, 45-60] show that such implications do not follow from the expected utility of income model. One may then wonder about the implications for more applied consumption analysis. The present paper therefore expresses utility as a function of consumption in a standard life cycle model, and illustrates the implications of this model with experimental small- and intermediate-stake risk data from Holt and Laury [Holt, C.A., Laury, S.K., 2002. Risk aversion and incentive effects. Amer. Econ. Rev. 92, 1644-1655]. The results suggest implausible risk aversion parameters as well as unreasonable implications for long-term risky choices. Thus, the conventional intertemporal consumption model under risk appears to be inconsistent with the data. (C) 2009 Elsevier Inc. All rights reserved.},
  author       = {Johansson-Stenman, O},
  issn         = {0899-8256},
  keyword      = {Expected utility of income,Expected utility of final wealth,Dynamic consumption theory,Asset integration,Time inconsistency,Narrow bracketing},
  language     = {eng},
  number       = {1},
  pages        = {208--219},
  publisher    = {0899-8256},
  series       = {Games and Economic Behavior},
  title        = {Risk aversion and expected utility of consumption over time},
  url          = {http://dx.doi.org/10.1016/j.geb.2009.07.001},
  volume       = {68},
  year         = {2010},
}