Journal
JOURNAL OF DEVELOPMENT ECONOMICS
Volume 97, Issue 2, Pages 415-426Publisher
ELSEVIER SCIENCE BV
DOI: 10.1016/j.jdeveco.2011.06.004
Keywords
Elasticity of intertemporal substitution; Risk aversion; Recursive utility; Asset dynamics; Poverty
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Most decisions involve variability in two dimensions: uncertainty across states of nature and fluctuations over time. The stakes involved in tradeoffs between these variability dimensions are especially high for the poor who have difficulty managing and recovering from shocks. We assume Epstein and Zin recursive preferences and estimate risk aversion and intertemporal substitution as distinct preferences using data from Kenyan herders. Results suggest that the assumption implicit in additive expected utility models that relative risk aversion (RRA) is the inverse of the elasticity of intertemporal substitution (EIS) is flawed. Specifically, our RRA and EIS estimates are consistent with a preference for the early resolution of uncertainty, which we believe is driven importantly by the instrumental value of early uncertainty resolution. This same preference pattern is consistent with asset smoothing in response to a dynamic asset threshold. (C) 2011 Elsevier B.V. All rights reserved.
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