Income Effect Risk Aversion

This article develops a model of the joint investment in financial wealth and human wealth to show that human capital investment is an inverse function of the degree of relative risk aversion.

Income effect risk aversion. The income effect under uncertainty. Is risk averse to have a large effect on the individual s decisions to invest. The income effect under uncertainty. Measuring risk aversion and the wealth effect frank heinemann september 2 2005 abstract.

This assumption merely reflects a standard assumption in. Risk aversion enters many theoretical models of human capital investment but attitudes toward risk have not been incorporated in empirical models of human capital investment. Risk averse investors typically invest their money in savings accounts certificates of deposit cds municipal and corporate bonds and dividend growth stocks. With the opportunity for more income comes the risk of losing her investment in time or money.

Intuitively risk aversion derives from a downside loss causing a reduction in utility that is greater than the increase in utility from an equivalent upside gain f is non increasing. Measuring risk aversion is sensitive to assumptions about the wealth in subjects utility functions. The two definitions provided above naturally lead to the following theorem. A risk averse person might prefer to work as a low paid employee with a great deal of job security rather than strike out on her own and become a self employed entrepreneur even if an entrepreneurship would likely result in earning a large sum of money.

Income uncertainty risk aversion and consumption behavior. Risk aversion and income growth 629 allocation of wealth to financial assets can be used to infer degrees of individual risk aversion that are also applicable to human capital invest ment decisions. An agent is strictly risk averse iff u is strictly concave. Previous article in issue.

We show that the effect of changing income can be decomposed into a modified income effect linked to the classical income effect and an effect representing attitudes to risk modified by income. Data from the same subjects in low and high stake lottery decisions allow estimating the wealth in a pre specified one. When risk preferences exhibit decreasing absolute risk aversion an increase in income increases the amount allocated to the risky good when the income effect for the sure good is stronger than the substitution effect if and only if the modified income effect is stronger than the hybrid risk aversion effect.