Publications [#141382] of Marc Bellemare
Sanford Institute Working Papers
- Marc F. Bellemare. "On the (Mis)Use of Wealth as a Proxy for Risk Aversion." (November, 2007).
(last updated on 2008/01/03)Abstract:
Empirical tests of optimal risk sharing in contracts often rely on wealth as a proxy for risk aversion. The intuition behind such tests is that since (i) optimal risk sharing is monotonic in the coefficients of risk aversion of the principal and the agent; and (ii) coefficients of risk aversion are monotonic in wealth, then wealth is a reasonable proxy for risk aversion. By showing how optimal risk sharing is not necessarily monotonic in wealth, this paper shows that such tests are misguided. For both the principal and the agent, monotonicity of optimal risk sharing in wealth depends on the trade-off between absolute risk aversion and absolute prudence. Consequently, the usual empirical test of risk sharing is at best only valid when imposing a great deal of structure on preferences.
