Structural Estimation of Higher Order Risk Preferences

Abstract

Structural measures of higher order risk attitudes have well-developed foundations in Expected Utility Theory (EUT), but little is known about their empirical magnitudes. We introduce a novel experimental design and a companion econometric model that allows us to structurally estimate indices of risk aversion, prudence, and temperance under EUT without imposing restrictions on their interdependence. We find that indices of absolute risk aversion, prudence, and temperance exhibit distinct patterns of variation over income, and that predicted risk premia under EUT and Rank-Dependent Utility Theory gradually converge as the order of risk increases. These findings are obscured by regular parametric utility functions, which inherently bias results toward prudence and temperance when subjects are risk averse. The results remain robust in subsamples of moderate size, which suggests that our approach can be adopted in broader studies that link higher order risk attitudes to other domains of latent individual preferences and economic behavior.