Inequality aversion
and risk attitudes
Ada Ferrer-i-Carbonell
ICREA & IAE-CSIC
&
Xavier Ramos
Universitat Autònoma de Barcelona & IZA
Inequality aversion
 Empirical evidence
 Subjective measures: GINI has a negative
effect on self-reported well-being.
Alesina, Di Tella, MacCulloch (2004) & Schwarze, Harpfer (2007)
 To what is it related?
 Risk aversion: only experimental evidence
shows that risk aversion & inequality aversion
are related concepts (Carlsson, Daruvala, JohanssonStenman, 2005 ).
 Mobility
Our contribution
 Empirical test on whether inequality
aversion found in Western Europe is
related to risk aversion.
 Uses direct measures of utility and risk
 Large representative panel data set with
about 20.000 individuals.
Measuring subjective well-being
In conclusion, we would like to ask you about your
satisfaction with your life in general.
Please, answer according to the following scale: 0 means
´completely dissatisfied´, 10 ´completely satisfied´.
How satisfied are you with your life, all things
considered?
0___1___2___3___4___5___6___7___8___9___10
completely
dissatisfied
completely
satisfied
Assumptions: empirical evidence
 Interpersonal comparability:
 Individuals able to recognize and predict
satisfaction level of others (pictures,videos) .
 Common understanding of how to translate
internal feelings into a number scale.
 Measurability:
 Strong positive correlation between emotional
expressions (smiling, frowning, brain activity) &
self-reported happiness.
 Individuals will not choose to continue activities
which yield low satisfaction levels.
Our satisfaction equation
U it    1 I ft   2 I ft Ri  3 Ri   X it  1T   2 F  i   it
 Individual risk attitudes (Ri)  assumed constant
 Inequality at the federal/time level (I) (GINI)
 Other explanatory variables (Xit).
 Individual effects (about 80%) (i).
E.g. intelligence, and capacity to adapt to adversities.
 Time (T) and federal (F) dummy variables .
Empirical testing
 Risk attitudes constant over time
 “β3Rt” can only be included with individual
random effects.
 We present results with FE and RE
 RE: Mundlack specification for those
variables that may correlate with individual
time persistent traits
 Cardinal/ordinal assumption makes no
difference in terms of trade-offs
Ferrer-i-Carbonell & Frijters (2004)
Measuring risk attitudes
How do you see yourself:
Are you generally a person who is fully prepared to
take risks or do you try to avoid taking risks?
Please tick a box on the scale, where the value 0 means: 'risk averse' and
the value 10 means: 'fully prepared to take risks'. You can use the
values in between to make your estimate.
0___1___2___3___4___5___6___7___8___9___10
risk
averse
fully prepared
to take risks
Willingness to take risks (WTR)
 Validity of WTR question:
 Correlation between reported WTR & individual
behavior in an experimental setting
 Correlation between reported WTR & reported
behavior (e.g. holding stocks, smoking, & occupational
choice)
 Correlation between reported WTR & individual
characteristics (e.g. women are more risk averse,
and years of education and income correlate negatively
with risk aversion).
Data
 The German Socio-Economic Panel
 1997-2004 = about 20000 individuals &
115000 observations.
 Sample means
 Mean risk attitude = 4.42. Most individuals
(22%) report 5 and 46% of them report a 4 or
less.
 Mean life satisfaction = 7
 Household income = 2535 (euros/month/net)
 Equivalent household income =1374
Risk attit. & inequality aversion
Gini (year/federal)
Fixed effects
Spec 1 Spec 2
Est.
Est.
Random effects
Spec 1 Spec 2 Spec 3
Est.
Est.
Est.
-0.614
(-1.86)
-0.762
(-2.34)
-0.580
(-1.76)
-0.758
(-2.33)
Willingness to take risk
Willing. to take risk * Gini
0.818
(6.25)
0.305
(9.10)
-0.746
(-2.29)
-0.141
(-4.16)
0.785
(6.54)
 Individuals are inequality averse
 The more risk averse, the larger the effect
of inequality on well-being
 Similar effects when introducing Ri with RE
The effects explained
 The FE results: (all results are very similar)
 For the most risk averse individuals, the effect
of inequality = -2.07
 For the average person, the GINI coeff = -0.58
 The effect of GINI is positive for 21% of the
sample (7 or more WTR)
 RE: inequality coefficient positive for WTR = 10
Is it risk attitudes?
 Risk attitudes correlated with other characteristics:
 may it be something else than risk?
 E.g. lower educated or women are more risk
averse & face larger income fluctuations.
 To test for this
 We introduce an interaction term between GINI
and (gender, years of education, & household
income).
 Only significant interaction:
 GINI & household income, which is negative
 It does not change the relationship between
GINI & risk attitudes
Conclusions
 Inequality aversion has been often proxied
with estimates of risk aversion.
 This paper employs two direct measures of
utility and risk
 To identify & estimate inequality aversion and
risk aversion separately.
and
 To explore the relationship between the two.
Summary of results
 Risk attitudes & inequality aversion are
related
 Risk attitudes determine the effect that
inequality has on life satisfaction.
 Most risk averse individuals are also the ones
who are more inequality averse.
 Consistent with the results in experimental
setups.