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Identifying Preferences under Risk from Discrete Choices

Chiappori, Pierre A.; Gandhi, Amit; Salanie, Bernard; Salanie, Francois

When studying consumption choices, economists have often relied on the abstraction of a representative agent. Such an agent can indeed be shown to exist and to replicate the aggregate consumers’ demand, but only under very strong (and actually quite unrealistic) assumptions (Alan P. Kirman 1992). There was also a justifiable reluctance to introduce heterogeneous preferences, as such a step might seem ad hoc when trying to explain different consumption behaviors. The rise of empirical studies based on microdata has opened new perspectives. The microeconomic importance of uninsurable risks is now recognized, and threatens the foundations of the representative agent hypothesis often used in macroeconomics. The continuing controversies surrounding the question of individual attitudes toward risk have motivated many empirical studies and observations; most of them find a bewildering diversity of individual preferences (Robert B. Barsky et al. 1997; Alma Cohen and Liran Einav 2002; Luigi Guiso and Monica Paiella 2008; Syngjoo Choi et al. 2007; Chiappori and Paiella 2007). Clearly, the identifiability of the heterogeneous distribution of preferences becomes a crucial issue in this perspective. This paper proposes conditions under which heterogeneous individual attitudes toward risk can be nonparametrically identified from individual- or market-level data on the choices made by agents over risk prospects. Our main result establishes that given data that is usually available (essentially market shares of the different risky prospects present within a market, plus the realizations of the final outcomes of agents), the analyst can recover the whole distribution of individual preferences so long as preferences can be indexed by a one-dimensional parameter that satisfies a fairly weak single-crossing condition. We then discuss several applications of our general methodology.

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Title
American Economic Review
DOI
https://doi.org/10.1257/aer.99.2.356

More About This Work

Academic Units
Economics
Published Here
March 3, 2015