What do you prefer:
- Option A: Toss a coin, if heads you win $20, tails you win $0
- option B: Sure win $10
If you prefer option A, you are risk-averse; if you prefer option B, you are risk-averse. If you are indifferent to these options, you are risk neutral. A key question is how many individuals have these preferences and how strong are those preferences. For example, a risk-neutral person might prefer option B until the certainty equivalent is $8, then they might switch to option A. Very A risk-averse person might prefer option B until it gets down to $5, and then prefer option A.
One way to measure the strength of these preferences is to use a measure called relative risk aversion.
A paper by A Foreign Land (2014) An overview of some papers is provided and is not intended to empirically estimate relative risk aversion. We found a wide range of RRA estimates.
We see that some methods produce higher estimates of relative risk aversion than others. Data collected from surveys and game shows yielded similar estimates of risk aversion; estimates of relative risk aversion based on financial choices and insurance purchases showed higher levels of risk aversion.
The paper provides more details on how relative risk aversion varies across individual characteristics (e.g. education, wealth, gender) and is worth reading.
