Risk Preferences and the Consumption of Luxuries

Consumer risk preferences over income are derived from the optimal consumption bundle purchased at each income, via the construction of an indirect uility function. The paper shows that, even though an individual may exhibit risk averse preferences over a wide income range, consumer theory predicts that the opportunity to acquire high-priced luxury goods can induce a convexity in the indirect utility function at higher income levels. Thus, instead of being an anomaly, variations in risk preferences over income (which can give rise to concurrent insurance and gambling behaviour) appear to stem from straightforward rational utility maximising behaviour when individuals consume the luxuries of life. JEL Classi…cation: D11, D81