Behavior Towards Risk and Discount Rates: An Empirical Study Using the CJD Crisis as an Experiment

Abstract

This paper investigates the effect of a change in risk on households' behavior, focusing on heterogenous and endogenous discount rates. The paper circumvents traditional problems of selectivity biases when assessing the effect of risk on behavior by using the French Mad Cow crisis as a natural experiment. It exploits the suddenness of the crisis and uses a panel data set following consumers before and after the crisis. The paper shows that the response to a change in risk is a non linear function of the level of the risk. The behaviors of the consumers when learning about the risks of CJD are partly explained by heterogenous and endogenous discount rates. Both individuals who are the most and the less exposed to the risk continue to engage in risky consumption when they learn about the risk. High risk consumers displays fatalistic behaviors and self-select themselves even more into the risk. A model based on endogenous discount rates is calibrated to back out the perceived risk by the households at the date of the crisis.