Measure Of Risk Aversion Research Articles

Discrete choice models with q-product random utilities

While most existing closed-form discrete choice models can be regarded as special cases of McFadden's generalized extreme value model, recently, alternative frameworks of McFadden's generalized extreme value model, which maintain closed-form expressions, have been proposed; these include the weibit model, which uses the Weibull distribution for its random component. In this paper, we develop a generalized closed-form discrete choice model which include both logit and weibit models as special cases, by introducing the q-product random utility, in which the relationship between the systematic component and the random component can be either additive, multiplicative, or in-between, depending on the value of the parameter q. We show that, when imposing the Gumbel distribution on its error component (instead of assuming the additive case as the logit model), the parameter q depicts decision maker's risk attitude in the sense of the Arrow–Pratt measure of relative risk aversion, which would be a behavioral foundation of the model. We also show that the model can be straightforwardly extended to incorporate statistical dependence across alternatives. The performance of the proposed model is examined by using two case studies; one on travel-route choices and the other on transport-mode choices.

Economic efficiency adjusted for risk preferences

ABSTRACTThis study investigates the impact of risk preferences on cost and revenue efficiency for a sample of farms. Risk preference scores were used to measure risk aversion. Cost and revenue efficiency were estimated using traditional input and output measures, and then re-estimated including each farm’s risk preference score. Comparisons were made between farms with and without a change in efficiency when each farm’s risk preference was included in the analysis. As expected, risk preference plays an important role in explaining farm inefficiency. Failure to account for risk preferences overstates inefficiency, particularly for slightly risk averse and risk neutral farms.

The impact of award uncertainty on settlement negotiations

Legal disputes are often negotiated under the backdrop of an adjudicated award. While settlements are common, they are not universal. In this paper, we empirically explore how uncertainty in adjudicated awards impacts settlement negotiations. To do so, we develop an experimental design to test how increases in variance and positive skewness of the award distribution impact negotiations and settlement rates. We find increases in variance decrease settlement rates, while increases in skewness generally increases settlement rates. We also gather individual measures of risk aversion and prudence, and incorporate these measures into the analysis to test for heterogeneous treatment effects. Overall, our results suggest that highly variable adjudicated awards can contribute to the excess use of inefficient litigation, while more positively skewed awards can reduce the use of inefficient litigation.

The Impact of Variance and Skewness of Court Awards on Settlement Negotiations

Legal disputes are often negotiated under the backdrop of an adjudicated award. While settlements are common, they are not universal. In this paper, we empirically explore how uncertainty in adjudicated awards impacts settlement negotiations. To do so, we develop an experimental design to test how increases in variance and positive skewness of the award distribution impact negotiations and settlement rates. We find increases in variance decrease settlement rates, while increases in skewness generally increases settlement rates. We also gather individual measures of risk aversion and prudence, and incorporate these measures into the analysis to test for heterogeneous treatment effects. Overall, our results suggest that highly variable adjudicated awards can contribute to the excess use of inefficient litigation, while more positively skewed awards can reduce the use of inefficient litigation.

Farmers’ risk preferences and pesticide use decisions: evidence from field experiments in China

AbstractChina faces health and environmental problems associated with the use of agricultural chemicals, including pesticides. While previous studies have found that risk aversion affects pesticide use in China, they have focused primarily on commercial cotton farmers. In this study, we consider the case of smaller, semisubsistence and subsistence farmers in a poor and landlocked province of China (Yunnan). We use a field experiment to measure risk aversion and collect detailed data on farm production and input use to specifically ask whether risk aversion affects pesticide use, and whether this effect differs for subsistence farmers producing exclusively for home consumption versus semisubsistence farmers who produce both for home and the market. We find that risk aversion significantly increases pesticide use, particularly for subsistence farmers and for market plots by semisubsistence farmers. Further, this effect of risk aversion significantly decreases with farm size for subsistence farmers, but not for semisubsistence farmers, implying that pesticide use may be used to ensure sufficient food supply for home consumption. Finally, we find barriers to the use of pesticides for subsistence farmers, both in terms of financial constraints and economies of scale. This finding implies that risk‐mitigation strategies, such as crop insurance, may not target food security concerns of subsistence farmers. Given these different motivations for pesticide use, policymakers may wish to consider effective tools to support rural food security for farmers in the poorer regions of China in order to decrease pesticide use.

Local Utility and Multivariate Risk Aversion

We revisit Machina’s local utility as a tool to analyze attitudes to multivariate risks. We show that for nonexpected utility maximizers choosing between multivariate prospects, aversion to multivariate mean preserving increases in risk is equivalent to the concavity of the local utility functions, thereby generalizing Machina’s result [Machina M (1982) “Expected utility” analysis without the independence axiom. Econometrica 50:277–323]. To analyze comparative risk attitudes within the multivariate extension of rank dependent expected utility of Galichon and Henry [Galichon A, Henry M (2012) Dual theory of choice with multivariate risks. J. Econom. Theory 147:1501–1516], we extend Quiggin’s monotone mean and utility preserving increases in risk and show that the useful characterization given in Landsberger and Meilijson [Landsberger M, Meilijson I (1994) Comonotone allocations, Bickel-Lehmann dispersion and the Arrow-Pratt measure of risk aversion. Ann. Oper. Res. 52:97–106] still holds in the multivariate case.

Higher-order risk vulnerability

We add an independent unfair background risk to higher-order risk-taking models in the current literature and examine its interaction with the main risk under consideration. Parallel to the well-known concept of risk vulnerability, which is defined by Gollier and Pratt (Econometrica 64:1109–1123, 1996), an agent is said to have a type of higher-order risk vulnerability if adding an independent unfair background risk to wealth raises his level of this type of higher-order risk aversion. We derive necessary and sufficient conditions for all types of higher-order risk vulnerabilities and explain their behavioral implications. We find that as in the case of risk vulnerability, all familiar HARA utility functions have all types of higher-order risk vulnerabilities except for a type of third-order risk vulnerability corresponding to a downside risk aversion measure called the Schwarzian derivative.

Changes in Polish Farmers’ Attitudes Toward Risk After Poland’s Accession to the EU

ABSTRACTThis article presents the econometric estimation of the risk attitudes of Polish farmers. For that purpose, a model of production under risk has been employed. The research is based on data from the Polish Farm Accountancy Data Network (FADN), from the years 2004–2010. For the Polish farming sector, risk-related considerations became increasingly important after Poland’s EU accession in 2004. After the accession, Polish agriculture was affected by market liberalization, which was somewhat mitigated by CAP support. To examine the risk aversion of Polish farmers, an estimation procedure based on Antle’s (1987) approach has been applied. This study suggests that, as was the case in other countries, risk aversion decreased following EU accession, that is, the Arrow-Pratt measure of absolute risk aversion based on producers specializing in field crops systematically decreased over the analyzed period.

Micro-Foundation of ARCH Model

The Japanese version of this paper can be found at http://ssrn.com/abstract=2710516.Many macroeconomic study argued macroeconomic models should be aggregated by micro processes models (micro-foundation) and many micro-founded macroeconomic models were built. On the other hand, there are many models for price variation of a risk asset, which is macro phenomena, however, there are few studies for micro-foundation of such models. In this study we tried micro-foundation of an ARCH model using intelligence of artificial market simulation studies. That is we tried to clarify which micro processes determine each coefficient of an ARCH model. Then, we showed that the dispersion of investors' estimated prices is larger or the orders by the buy-sell imbalance taking liquidity are more, the volatility is larger. And we showed that the ration of the normal investors taking liquidity to the noise traders providing liquidity is higher or the measure of risk aversion of the normal investors is lower, the magnitude of volatility clustering is larger.

ARCHHHHHHHHHHHHHHHH (Micro-Foundation of ARCH Model)

The English version of this paper can be found at http://ssrn.com/abstract=2710457.Japanese Abstract: 経済のマクロモデルは，ミクロプロセスの積み上げによって構築する，いわいる``ミクロ的基礎付け''(micro-foundation)がなされるべきとの主張が多くなされ，ミクロ的基礎付けがなされた経済のマクロモデルが多く生まれた．一方，リスク資産の価格変動というマクロ量をモデル化したものは多く存在するが，これらのモデルをミクロ的基礎付けしようという試みは多くない．そこで本研究では人工市場研究からの知見を用いて，ARCHモデルのミクロ的基礎付け，すなわち，各係数がどのミクロプロセスから生じているのかを明らかにすることを試みた．その結果，投資家の予想価格のばらつきと需給の歪みが大きくなるとボラティリティは大きくなり，流動性を奪う投資家の存在割合が大きくなったり投資家のリスク回避度が小さくなるとボラティリティクラスタリングは大きくなることが分かった．English Abstract: Many macroeconomic study argued macroeconomic models should be aggregated by micro processes models (micro-foundation'') and many micro-founded macroeconomic models were built. On the other hand, there are many models for price variation of a risk asset, which is macro phenomena, however, there are few studies for micro-foundation of such models. In this study we tried micro-foundation of an ARCH model using intelligence of artificial market simulation studies. That is we tried to clarify which micro processes determine each coefficient of an ARCH model. Then, we showed that the dispersion of investors' estimated prices is larger or the orders by the buy-sell imbalance taking liquidity are more, the volatility is larger. And we showed that the ration of the normal investors taking liquidity to the noise traders providing liquidity is higher or the measure of risk aversion of the normal investors is lower, the magnitude of volatility clustering is larger.

Some Likelihood Based Properties in Large Samples: Utility and Risk Aversion, Second Order Prior Selection and Posterior Density Stability

The likelihood function plays a central role in statistical analysis in relation to information, from both frequentist and Bayesian perspectives. In large samples several new properties of the likelihood in relation to information are developed here. The Arrow-Pratt absolute risk aversion measure is shown to be related to the Cramer-Rao Information bound. The derivative of the log-likelihood function is seen to provide a measure of information related stability for the Bayesian posterior density. As well, information similar prior densities can be defined reflecting the central role of likelihood in the Bayes learning paradigm.

Gender differences in risk attitudes

Many experimental studies and surveys have shown that women consistently display more risk-averse behavior than men when confronted with decisions involving risk. These differences in risk preferences, when combined with gender differences in other behavioral traits, such as fondness for competition, have been used to explain important phenomena in labor and financial markets. Recent evidence has challenged this consensus, however, finding gender differences in risk attitudes to be smaller than previously thought and showing greater heterogeneity of results depending on the method used to measure risk aversion.

Anxiety, attention, and decision making: The moderating role of heart rate variability

The current exploratory research examined whether high frequency heart rate variability (HF-HRV) modulates the association between anxiety and (1) executive attentional control during situations involving neutral stimuli, in which the distractor stimuli are in conflict with the target stimulus, and (2) risk aversion in decision making. Forty-five participants (21 with low and 24 with high trait-anxiety) performed a modified version of the Attention Network Test to measure attentional control, and the Balloon Analog Risk Task to measure risk aversion. HF-HRV was recorded during a rest period before completion of the tasks. Results showed that individuals with high anxiety and low HF-HRV have worse attentional control in the face of conflicting information as well as greater risk aversion, in comparison with individuals with both high anxiety and high HF-HRV or low anxiety (regardless of HF-HRV). HF-HRV was positively associated with attentional control and negatively associated with risk aversion. Furthermore, a strong negative association was observed between attentional control and risk aversion. These results suggest that HF-HRV modulates the influence of anxiety on both attentional control to neutral stimuli, and risk aversion in decision making. Greater HF-HRV appears to fulfill a protective role in highly anxious individuals. The associations observed also suggest that executive control of attention plays a relevant role in decision making. These results support the relevance of the autonomic nervous system in sustained cognition and are in accordance with theories in which vagal-mediated heart rate variability is taken as an indicator of prefrontal cortex inhibitory influences.

Parameters measuring bank risk and their estimation

The paper develops estimation of three parameters of banking risk based on an explicit model of expected utility maximization by financial institutions subject to the classical technology restrictions of neoclassical production theory. The parameters are risk aversion, prudence or downside risk aversion and generalized risk resulting from a factor model of loan prices. The model can be estimated using standard econometric techniques, like GMM for dynamic panel data and latent factor analysis for the estimation of covariance matrices. An explicit functional form for the utility function is not needed and we show how measures of risk aversion and prudence (downside risk aversion) can be derived and estimated from the model. The model is estimated using data for Eurozone countries and we focus particularly on (i) the use of the modeling approach as a device close to an “early warning mechanism”, (ii) the bank- and country-specific estimates of risk aversion and prudence (downside risk aversion), and (iii) the derivation of a generalized measure of risk that relies on loan-price uncertainty. Moreover, the model provides estimates of loan price distortions and thus, allocative efficiency.

The Political Economy of Risk and Ideology

This paper argues for the central role of risk aversion in shaping political ideology. We develop a political economy model, which makes explicit the link between risk aversion, the labor market, government policy, and ideology. Our model distinguishes the effects of risk aversion from unemployment risk and our evidence sheds light on debates over explanations for the welfare state. We test our model using a large-scale household panel with an experimentally validated measure of risk aversion. We find that risk aversion is a systematic and important determinant of political-economic attitudes and is at least as important as, if not more so, an individual’s position in the income distribution.

A note on fourth-order risk aversion

Keenan et al. (J Risk Uncertain 24:264–277, 2002) introduced a measure of downside risk aversion (third-order risk aversion), and in Theorem 1, they showed four equivalent definitions of increased downside risk aversion. This result is thought as a higher-order extension of Theorem 3 in Diamond et al. (J Econ Theory 8:337–360, 1974). We consider fourth-order risk aversion and show four equivalent definitions of increased fourth-order risk aversion. Our result is thought as a higher-order extension of Theorem 1 in Keenan et al. (2002).

Stability of experimental and survey measures of risk, time, and social preferences: A review and some new results

Underlying preferences are often considered to be persistent, and are important inputs into economic models. We first conduct an extensive review of the disparate literature studying the stability of preferences measured in experiments. Then, we test the stability of individuals' choices in panel data from rural Paraguay over almost a decade. Answers to social preference survey questions are quite stable. Experimental measures of risk, time, and social preferences do not exhibit much stability. Correlations between experimental measures of risk aversion are a more precisely estimated zero, whereas correlations for time and social preferences are larger and noisier. We also find no systematic evidence that real world shocks influence play in games. We suggest that in a developing country context researchers should explore designing simpler experiments and including survey questions in addition to experiments to measure preferences.

Measuring risk-aversion: The challenge

Risk-aversion is advanced as a measure of the feeling guiding the person who faces a decision with uncertain outcomes, whether about money or status or happiness or anything else of importance. The concepts of utility and, implicitly, risk-aversion were used first nearly 300years ago, but risk-aversion was identified as a key dimensionless variable for explaining monetary decisions only in 1964. A single class of utility function with risk-aversion as sole parameter emerges when risk-aversion is regarded as a function of the present wealth, rather than subject to alteration through imagining possible future wealths. The adoption of a single class allows a more direct analysis of decisions, revealing shortcomings in the use of conventional, Taylor series expansions for inferring risk-aversion, over and above the obvious restrictions on perturbation size. Dimensional analysis shows that risk-aversion is a function of three dimensionless variables particular to the decision and a set of dimensionless character traits, identified later as the limiting reluctance to invest and the lower threshold on risk-aversion. The theoretical framework presented allows measurement of risk-aversion, paving the way for direct, evidence-based utility calculations.

Measuring risk aversion to guide transportation policy: Contexts, incentives, and respondents

Road pricing may provide a solution to increasing traffic congestion in metropolitan areas. Route, departure time and travel mode choices depend on risk attitudes as commuters perceive the options as having uncertain effects on travel times. We propose that Experimental Economics methods can deliver data that uses real consequences and where the context can be varied by the researcher. The approach relies on the controlled manipulation of contexts, similar to what is done in the Stated Choice approach, but builds in actual consequences, similar to the Revealed Preference approach. This paper investigates some of the trade-offs between the cost of conducting Experimental Economics studies and the behavioral responses elicited. In particular, we compare responses to traditional lottery choice tasks to the route choice tasks in simulated driving environments. We also compare students (a low cost convenient participant pool) to field participants recruited from the driving population. While we see initial differences across our treatment groups, we find that their risk taking behavior converge with minimal repetition.

The utility premium of Friedman and Savage, comparative risk aversion, and comparative prudence

We show that the utility premium of Friedman and Savage can be used to explain comparative risk aversion and comparative prudence. More precisely, we show that the greater the risk aversion measure, the greater a risk’s utility premium normalized by the marginal utility and that the greater the prudence measure, the greater the utility premium for disaggregating a certain loss of wealth and a zero-mean risk normalized by the utility function’s second derivative.