A test of risk vulnerability in the wider population

Abstract

Panel data from the German SOEP is used to test for risk vulnerability (RV) in the wider population. Two different survey responses are analysed: the response to the question about willingness-to-take risk in general and the chosen investment in a hypothetical lottery. A convenient indicator of background risk is the VDAX index, an established measure of volatility in the German stock market. This is used as an explanatory variable in conjunction with HDAX, the stock market index, which proxies wealth. The impacts of these measures on risk attitude are identifiable by exploiting the time dimension of the panel and matching survey months with corresponding observations from these time-varying factors. Both of the survey responses allow us to test for decreasing absolute risk aversion (DARA); in one case, we find strong evidence of DARA, while in the other, we do not. Both survey responses also allow us to test for RV, and in both cases we find strong evidence. In the case of the hypothetical lottery response, we are also able to estimate a “coefficient of risk vulnerability” (CRV). This is defined as the absolute amount by which absolute risk aversion rises in response to a doubling of background risk. We estimate CRV to be between 1.03 and 1.27.