A Non-Parametric Test of Risk Aversion

TL;DR

This paper critically tests the expected utility model of risk aversion using a non-parametric approach, revealing limited support for the model and highlighting issues with common elicitation methods.

Contribution

It introduces a simple non-parametric test for expected utility and concavity, challenging the validity of prevalent risk aversion measurement techniques.

Findings

Only 30% choices align with concave utility

Few subjects are consistent with expected utility

Popular methods overestimate risk aversion due to misspecification

Abstract

In economics, risk aversion is modeled via a concave Bernoulli utility within the expected-utility paradigm. We propose a simple test of expected utility and concavity. We find little support for either: only 30 percent of the choices are consistent with a concave utility, only two out of 72 subjects are consistent with expected utility, and only one of them fits the economic model of risk aversion. Our findings contrast with the preponderance of seemingly "risk-averse" choices that have been elicited using the popular multiple-price list methodology, a result we replicate in this paper. We demonstrate that this methodology is unfit to measure risk aversion, and that the high prevalence of risk aversion it produces is due to parametric misspecification.