Abstract
Although many economic decisions involve choices between uncertain outcomes occurring at different times, most theoretical and empirical work restricts attention to one dimension or another. In this paper, we investigate whether both risk and time preferences can be represented by a single parameter. We collect experimental data to estimate models which allows for a disentanglement of risk and time preferences. Results reveal that the discounted expected utility model assumption, that risk and time preferences can be explained by a single parameter, is not supported by the data. The model estimates imply people prefer to delay the resolution of risky outcomes.
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Notes
This roughly inverse relationship does have some empirical support. For example, Anderhub et al. (2001) found a negative correlation between risk and time preferences, in that more risk averse individuals tended to discount the future more heavily. Other psychologists have gone so far as to suggest that time and risk preferences both arise from a common underlying dimension, equating the discounting of future outcomes to the discounting of uncertain outcomes (e.g., Rachlin et al. 2000; Weber and Chapman 2005).
Two individuals demonstrated a preference reversal and were excluded from the analysis.
We have also considered a more flexible functional form for the μ t and V functions. In particular, we investigated a parameterization in which both functions were specified according to Holt and Laury’s (2002) power-expo form (see also Saha 1993). The power-expo form nests the CRRA form as a special case when one of the parameters is equal to zero. For both the μ t and V functions, we cannot reject the hypothesis that the parameter in question is different than zero, suggesting that the CRRA form is the preferred specification.
The analysis in Holt and Laury (2002) does not consider the panel nature of their choice data. When we ignore the repeated nature of our data and omit the random effect in our likelihood function, we find an estimated value for α of about 0.45 which is very similar to the Holt and Laury (2002) estimate when one notes that the dollar amounts used in this study are about 5x the baseline values in Holt and Laury (2002). This suggests, at least in our data, that ignoring individual heterogeneity leads to an inflated estimate of the degree of relative risk aversion.
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Authors are Giles Distinguished Professor in the department of agricultural economics at Mississippi State University and professor and Willard Sparks Endowed Chair in the department of agricultural economics at Oklahoma State University, respectively.
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Coble, K.H., Lusk, J.L. At the nexus of risk and time preferences: An experimental investigation. J Risk Uncertain 41, 67–79 (2010). https://doi.org/10.1007/s11166-010-9096-7
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DOI: https://doi.org/10.1007/s11166-010-9096-7