Capturing Intrinsic Risk Attitude
Authors: Christian Traeger (UC Berkeley)
Title: Capturing Intrinsic Risk Attitude
Abstract: This paper introduces a concept of intrinsic risk attitude. In contrast to the Arrow-Pratt measure, it ties directly to preferences on the multidimensional consumption space and it is independent of the way we measure consumption, of the commodity under observation, and of market prices or liquidity constraints. The measure relies on intertemporal choice to distinguish intrinsic aversion to risk from taste or satiation. The paper characterizes the attitude axiomatically, functionally, and numerically, and it compares risk attitude across agents with differing tastes. The paper works with a class of preference representations satisfying certainty additivity and the von Neumann-Morgenstern axioms. The underlying representation overlaps with the models of Kreps & Porteus’s (1978) and Epstein & Zin’s (1989), but introduces an insightful symmetry in time and risk aggregation that is helpful to understand the different functional manifestations of intrinsic risk attitude. It shows that the widely employed isoelastic version of Epstein-Zin-Weil preferences implies an intrinsic risk aversion that increases in consumption for intertemporal elasticities of substitution below unity.