Does the Risk Aversion Vary with Different Background Risk of Households?

The concept of risk aversion is important in understanding individual behavior as well as many other theoretical issues in finance and economics. This study uses life insurance expenditure data of Survey of Family Income and Expenditure (SFIE) in Taiwan to estimate the Arrow-Pratt risk aversion coefficient of households empirically by using the reduced form equation derived by Halek and Eisenhauer (2001). The another aim of this paper is to provide empirical evidence on the nature of the relationship between the risk aversion and background risk which is not under the control of the agent, and that is independent of endogenous risks. Using the coefficient variation of household income as the proxy for background risk, after controlling other factors including household income and wealth, the characteristics of the head of the household and other demographic variables, the author finds that households which are more likely to face income risk exhibit a higher coefficient of risk aversion. This result is consistent with theories of optimal risk taking behavior in the presence of background risk.