Risk Aversion at the Country Level

Abstract

An individual’s attitude about risk underlies economic decisions about the optimal amount of retirement or precautionary savings to set aside, investment in human capital, public or private sector employment, and entrepreneurship, among other things. In the aggregate, these micro-level decisions can influence a country’s growth and development. Although there is a vast literature on measuring risk aversion, estimates of the coefficient of relative risk aversion vary widely—from as low as 0.2 to 10 and higher. Probably the most widely accepted measures lie between 1 and 3. 1 The most common approach to measuring risk aversion is based on a consumption-based capital asset pricing model (CAPM). Hansen and Singleton (1982), using the generalized method of moments (GMM) to estimate a CAPM, report that relative risk aversion is small. Hall (1988) shows that minor changes in the specifi cation and instruments cause the results to vary substantially. Neely, Roy, and Whiteman (2001), in turn, explain this difference, arguing that CAPM-based estimations fail to provide robust results because difficulties in predicting consumption growth and asset returns from available instruments lead to a near identification failure of the model. In this article, we fol low a different approach. We build on the methodology first outlined in Layard, Mayraz, and Nickell (2008). Using happiness data to estimate how fast the marginal utility of income declines as income increases, This article estimates the coefficient of relative risk aversion for 75 countries using data on self- reports of personal well-being from the 2006 Gallup World Poll. The analysis suggests that the coefficient of relative risk aversion varies closely around 1, which corresponds to a logarithmic utility function. The authors conclude that their results support the use of the log utility function in numerical simula tions of economic models. (JEL D80, D31, I31, O57)