Virtually all current theories of choice under risk or uncertainty are cognitive and consequentialist. They assume that people assess the desirability and likelihood of possible outcomes of choice alternatives and integrate this information through some type of expectation-based calculus to arrive at a decision. The authors propose an alternative theoretical perspective, the risk-as-feelings hypothesis, that highlights the role of affect experienced at the moment of decision making. Drawing on research from clinical, physiological, and other subfields of psychology, they show that emotional reactions to risky situations often diverge from cognitive assessments of those risks. When such divergence occurs, emotional reactions often drive behavior. The risk-as-feelings hypothesis is shown to explain a wide range of phenomena that have resisted interpretation in cognitive-consequentialist terms.

This paper employs a synthetic cohort technique and Consumer Expenditure Survey data to construct average age-profiles of consumption and income over the working lives of typical households across different education and occupation groups. Even after controlling for family and cohort effects, typical consumption profiles are not flat, and seem to track income at young ages. Using these profiles, we estimate a structural model of optimal life-cycle consumption expenditures in the presence of realistic income uncertainty. The model fits the profiles quite well. In addition to providing tight estimates of the discount rate and risk aversion, we find that consumer behavior changes strikingly over the life-cycle. Young consumers behave as "buffer-stock" agents. Around age 43, the typical household starts accumulating liquid assets for retirement and its behavior mimics more closely that of a certainty equivalent consumer. This change in behavior is mostly driven by the life-cycle profile of expected income. Our methodology provides a natural decomposition of saving into its precautionary and retirement components.

Theoretical models predict that overconfident investors trade excessively. We test this prediction by partitioning investors on gender. Psychological research demonstrates that, in areas such as finance, men are more overconfident than women. Thus, theory predicts that men will trade more excessively than women. Using account data for over 35,000 households from a large discount brokerage, we analyze the common stock investments of men and women from February 1991 through January 1997. We document that men trade 45 percent more than women. Trading reduces men’s net returns by 2.65 percentage points a year as opposed to 1.72 percentage points for women.

We extend expected utility theory to situations in which agents experience feelings of anticipation prior to the resolution of uncertainty. We show how these anticipatory feelings may result in time inconsistency. We provide an example from portfolio theory to illustrate the potential impact of anticipation on asset prices. I.

We propose that stock-market participation is influenced by social interaction. In our model, any given “social ” investor finds the market more attractive when more of his peers participate. We test this theory using data from the Health and Retirement Study, and find that social households—those who interact with their neighbors, or attend church—are substantially more likely to invest in the market than non-social households, controlling for wealth, race, education, and risk tolerance. Moreover, consistent with a peer-effects story, the impact of sociability is stronger in states where stock-market participation rates are higher. IN 1998, 48.9 PERCENT OF AMERICAN HOUSEHOLDS owned stock, either directly, or through mutual funds or various retirement vehicles such as 401(k) plans or IRAs. 1 While this number may appear low in an absolute sense—particularly in light of the historically high returns to investing in the stock market—it actually represents an all-time peak in the United States, and a dramatic increase from prior years. For example, less than a decade earlier, in 1989, the

In this paper we study the asset pricing implications of a parsimonious two-agent macroeconomic model with two key features: limited participation in the stock market and heterogeneity in the elasticity of intertemporal substitution. The parameter values for the model are taken from the business cycle literature and are not calibrated to match any financial statistic. Yet, with a risk aversion of two, the model is able to explain a large number of asset pricing phenomena including all the facts matched by the external habit model of Campbell and Cochrane (1999). Examples in this list include a high equity premium and a low risk-free rate; a counter-cyclical risk premium, volatility and Sharpe ratio; predictable stock returns with coefficients and R2 values of long-horizon regressions matching their empirical counterparts, among others. In addition the model generates a risk-free rate with low volatility (5.7 percent annually) and with high persistence. We also show that the similarity of our results to those from an external habit model is not a coincidence: the model has a reduced form representation which is remarkably similar to Campbell and Cochrane’s framework for asset pricing. However,themacroeconomic implications of the two models are quite different, favoring the limited participation model. Moreover, we show that policy analysis yields dramatically different conclusions in each framework.

This paper attempts to reconcile two opposing views about the elasticity of intertemporal substitution in consumption (EIS), a parameter that plays a key role in macroeconomic analysis. On the one hand, empirical studies using aggregate consumption data typically find that the EIS is close to zero (Hall, 1988). On the other hand, calibrated macroeconomic models designed to match growth and business cycle facts typically require that the EIS be close to one (Weil, 1989; Lucas, 1990). We show that this apparent contradiction arises from ignoring two kinds of heterogeneity across individuals.

This paper utilizes the Asset and Health Dynamics of the Oldest Old (AHEAD) Panel to test for the absence of causal links from socio-economic status (SES) to health innovations and mortality, and from health conditions to innovations in wealth. We conclude that there is no direct causal link from SES to mortality or to incidence of most sudden onset health conditions (accidents and some acute conditions), but there is an association of SES with incidence of gradual onset health conditions (mental conditions, and some degenerative and chronic conditions), due either to causal links or to persistent unobserved behavioral or genetic factors that have a common influence on both SES and innovations in health. We conclude that there is no direct causal link from health status to innovations in wealth.

This paper assesses the similarity in net worth between parents and their children, and explores alternative explanations for this similarity. Using a standard life cycle model, we show that, depending on the extent to which preferences for saving are correlated across generations, the relative magnitudes of the intergenerational wealth and income correlations are a priori indeterminate. We document substantial intergenerational persistence in wealth: the age adjusted correlation is between 0.23 and 0.50, similar in magnitude to the documented intergenerational income correlation. These intergenerational relationships are large, especially since we only focus on households who have not yet received bequests from their parents. Permanent income measures explain less than one-half of the raw intergenerational wealth correlation. Controlling for the receipt of large gifts, expected bequests and interfamily risk sharing explains a small amount of the remaining wealth correlation. Our model suggests that such a finding implies a sizeable intergenerational persistence in preferences for saving. We provide direct evidence for this claim. Using measures of preferences from the Panel Study of Income Dynamics, we show that the responses to survey questions designed to measure risk aversion are highly correlated between parents and their children. We thank Heidi Shierholz for excellent research assistance and participants at the NBER 2000 summer consumption workshop, the University of Chicago’s Graduate School of Business macro lunch, the University of Michigan’s labor seminar, Dartmouth’s economic workshop and Purdue University’s macro/international workshop for helpful comments. Additionally, we would like to thank Mark Aguiar,

We develop and evaluate a simple gamble-choice task to measure attitudes toward risk, and apply this measure to examine differences in risk attitudes of male and female university students. In addition, we ask whether a person's sex is read as a signal of risk preference. Subjects choose which of five 50/50 gambles they wish to play. The gambles include one sure thing; the remaining four increase (linearly) in expected payoff and risk. Each subject also must guess which of the five gambles each of the other subjects chose. The experiment is conducted under three different frames: an abstract frame where the two highest-payoff gambles carry the possibility of losses, an abstract frame with no losses, and an investment frame that mirrors the payoff structure of the former. We find that women are significantly more risk averse than men in all three settings, and predictions of both women and men tend to confirm this difference. While average guesses reflect the average difference in choices, only 27 percent of guesses are accurate.