A New Method of Estimating Risk Aversion

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This paper develops a method of estimating the coefficient of relative risk aversion (g) from data on labor supply. The main result is that existing estimates of labor supply elasticities place a tight bound on g, without any assumptions beyond those of expected utility theory. It is shown that the curvature of the utility function is directly related to the ratio of the income elasticity of labor supply to the wage elasticity, holding fixed the degree of complementarity between consumption and leisure. The degree of complementarity can in turn be inferred from data on consumption choices when employment is stochastic. Using a large set of existing estimates of wage and income elasticities, I find a mean estimate of g = 1. I also give a calibration argument showing that a positive uncompensated wage elasticity, as found in most studies of labor supply, implies g < 1.25. The estimate of g changes by at most 0.25 over the range of plausible values for the complementarity parameter.

Published: Raj Chetty, 2006. "A New Method of Estimating Risk Aversion," American Economic Review, American Economic Association, vol. 96(5), pages 1821-1834, December.

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