The Risk-Loving Decisions of Low-Income Households (2009)

Undergraduate: Sarah Whitley

Faculty Advisor: Saraswata Chaudhuri
Department: Economics

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The general theory of risk aversion promotes the idea of a decreasing aversion to risk as income increases, yet this is not always an accurate reflection of reality. For instance, low-income individuals spend more money in lottery systems than any other income group in the United States. Judging by their participation in lotteries, risky gambles, and credit use relative to accompanying wealth level, low-income individuals conflict with this general theory on risk in their tendencies to exhibit more risk-loving preferences. This thesis explores the idea of adverse risk behavior among low-income individuals by examining the housing expenditure decisions of a cross-sectional survey of American households. Empirical results calculating a negative effect of increases in income and positive effect of low-income status upon risk support the theoretical explanation of this contrary behavior, concluding that individuals tend to be Decreasingly Relative Risk Averse until reaching an income threshold where they then act with Increasing Relative Risk Aversion. While increases in income and a designation of low-income status have distinct effects on the amount of housing expenditure risk one is willing to take, other factors like education, age, marital status, employment, and future economic outlook affect risk preference as well.