Abstract
The concept of an attitude towards risk that is unique to the individual is used in predicting and prescribing preferred responses to risk. Because it is expensive and time consuming to measure attitude towards risk, one measurement or estimate of an individual’s risk attitude is often used to predict or prescribe actions in different decision contexts. However, empirical evidence shows that one of the most commonly used measures of risk attitude, the Arrow-Pratt coefficient of absolute risk aversion, varies over time, income levels and decision contexts. It can be shown that for the Arrow-Pratt coefficient to be a reliable indicator of risk attitude, individuals must exhibit (1) constant marginal utility for money, (2) homogeneous preferences, and (3) coherence of preference orderings over certainty and uncertainty. Experimental data indicate consistent violation of these conditions. As a result, the Arrow-Pratt coefficient confounds risk attitude and strength of preference for particular goods. A new measure of intrinsic risk attitude that removes the confounding influence of strength of preference for particular goods is developed and its use demonstrated.
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