Higher order risk preferences and economic decisions

In theory, individuals’ higher order risk attitudes of prudence and temperance influence saving and investment decisions. Prudent individuals save more when their future income becomes more uncertain, and temperate individuals prefer less risky investments in the presence of greater background risks. In a laboratory experiment, we measure individuals’ higher order risk attitudes directly, using two different elicitation methods. Participants then make saving and investment decisions under varying levels of background risk. We find strong evidence for background risk effects on saving and investment. Moreover, individual prudence measures correlate with the strength of precautionary saving, while individual temperance measures do not do so with investment. The risk attitudes acquired with the two elicitation methods are strongly correlated with each other. The representative individual is risk averse, prudent, and neutral towards temperance.

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