Effects of Household Shocks on Risk Preferences and Loss Aversion: Evidence from Upland Smallholders of South East Asia

Abstract

Avoiding risk in financial decisions is credited to be a key contributor to persistent poverty and poverty traps. In spite of this, the methods used to measure behaviour under risk rarely reflect an adequate representation of the lives of smallholders in low income economies. We estimate risk preferences and their determinants by including two key aspects: aversion to losses and exposure to long term risk and vulnerability. We examine risk preferences of 93 smallholders in Cambodia and 91 smallholders in Lao PDR with an incentivised lottery design under the framework of Expected Utility Theory (EUT), Rank Dependent Utility Theory (RDU) and Cumulative Prospect Theory (CPT). We find that CPT best explains our data, but parameter values vary to those most commonly found in the literature. We report that the experience of household shocks have a significant effect on choice behaviour in the loss domain, even when we control for a large set of socio-economic and demographic variables.