A Bound on Risk Aversion Using Labor Supply Elasticities

Raj Chetty

NBER Working Paper No. 12067
Issued in March 2006
NBER Program(s):   AP   EFG   LS   PE

This paper shows that existing evidence on labor supply behavior places an upper bound on risk aversion in the expected utility model. I derive a formula for the coefficient of relative risk aversion (g) in terms of (1) the ratio of the income elasticity of labor supply to the wage elasticity and (2) the degree of complementarity between consumption and labor. I bound the degree of complementarity using data on consumption choices when labor supply varies randomly across states. Using labor supply elasticity estimates from thirty-three studies, I find a mean estimate of g = 1. I then show that generating g > 2 would require that wage increases cause sharper reductions in labor supply than estimated in any of the studies.

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