An Empirical Investigation Into the Nature of Risk Preferences

Cornell University, Ithaca NY

Investigators

Abstract

The project studies the nature of households' risk preferences. It utilizes a new data set that documents the choices made by a sample of households with respect to auto, home, and umbrella insurance. The data also include the menus from which the households' make their choices, the households' claim histories, and a rich set of demographic information for each household. The project has two parts. The first part investigates the nature of risk preferences under the assumption that households' subjective beliefs about risk are correct. It initially examines the separate influences of "standard" risk aversion (concave utility over final wealth states), loss aversion, and nonlinear probability weighting on households' deductible choices in auto and home insurance. The first part also will investigate other determinants of households' risky choices, including ambiguity aversion, as well as other policy choices, such as limit choices under liability coverages, which involve large stakes. The second part of the project will examine households' subjective beliefs about risk. A household's risky choices are jointly determined by their preferences for risk and their subjective beliefs about risk. The project will seek to estimate the joint distribution of risk preferences and subjective beliefs. Although point identification generally will not be possible, the richness of the data will allow for partial identification. Broader Impact: The project has the potential to advance the understanding of household decision making under uncertainty and to help the scientific community further the development of the theory of choice under uncertainty. The acquisition of the data set presents the opportunity to gain new and important insights into the nature of households' risk preferences and the structure of their beliefs about risk.