RESEARCH TOPIC AND PAPERS

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  MEASURING UTILITY: AN APPLICATION TO HIGHER ORDER RISK PREFERENCES
  
  
  
  
  
  
  
  

  
  
  
  Sebastian O. Schneider, Marcela Ibanez and Gerhard Riener
  
  

  Measuring utility is at the heart of microeconomics and has critical applications in many areas of economics. Here we present a new experimental method to elicit utility functions and associated measures of (higher-order) risk preferences. The method we propose builds on a non-parametric estimation technique called P-spline regression in order to obtain continuous and differentiable estimations of utility functions from any mapping of experimental income to utility levels.

  
  

  Using this method, we can compute well-known theoretically derived measures of the intensities of risk aversion, prudence, and temperance. We apply this method to study precautionary saving with a sample of poor households in Bogota: Leland (1968) suggests that prudent individuals increase savings as a precautionary measure under risky income.We obtain results comparable to those of earlier studies concerning the classification of individuals as prudent or imprudent. In addition, our results strongly support the theoretical prediction that income risk leads to increases in savings for prudent individuals. An accompanying laboratory experiment validates our method: We find significant relations to other methods and can replicate our finding with respect to precautionary saving.
  

  
  
  

  
  
  
  
  
  
  
  






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  INCOME RISK, PRECAUTIONARY SAVING, AND LOSS AVERSION – AN EMPIRICAL TEST
  
  
  
  
  
  
  
  

  
  
  
  Hanna Freudenreich, Marcela Ibanez, Stephan Dietrich, Oliver Musshoff
  
  

  We empirically investigate whether future income uncertainty causes an increase in saving associated with loss aversion. We study this loss-aversion based precautionary savings hypothesis in a lab-in-the-field and a lab experiment with over 800 participants, using experimentally measured loss aversion, and observed as well as exogenously induced income risk. Confirming theory, we find that precautionary savings increase with the degree of loss aversion. Thus, consistent with a loss-aversion based precautionary savings hypothesis, but in contrast to common assumptions, our findings establish that loss aversion is not necessarily an obstacle to saving, and thus identify new approaches of increasing saving.