Are Risk Aversion and Impatience Related to Cognitive Ability?
“We find that lower cognitive ability is associated with greater risk aversion, and more pronounced impatience”
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Abstract (Via Unimaas)
This paper investigates whether risk aversion and impatience are correlated with cognitive ability. We conduct incentive compatible choice experiments measuring risk aversion, and impatience over an annual time horizon, for a representative sample of roughly 1,000 German adults. A measure of cognitive ability is provided by two submodules of one of the most widely used IQ tests. Interviews are conducted in subjects’ own homes. We find that lower cognitive ability is associated with greater risk aversion, and more pronounced impatience. These relationships are statistically and economically significant, and robust to controlling for personal characteristics, educational attainment, income, and measures of liquidity constraints. We perform a series of additional robustness checks, which help rule out other possible confounds.
Introduction (Via Unimass)
Preferences and cognitive ability are fundamental determinants of decision-making in economic models. Their importance is con¯rmed empirically by studies showing that individual measures of risk aversion and impatience predict a wide range of important economic outcomes (e.g., Luigi Guiso and Monica Paiella, 2005; Catherine Eckel et al., 2005), and by the literature showing that higher cognitive ability is associated with better labor market outcomes (e.g., James J. Heckman et al., 2006).1 In economic models and applications, cognitive ability is typically assumed to be independent of both risk aversion and impatience. This assumption, however, has received relatively little attention in the empirical literature.
This paper tests whether risk aversion and impatience are related to cognitive ability. We use a sample of more than 1,000 adults living in Germany, randomly drawn to be representative of the population, which enhances the generalizability and economic relevance of our ¯ndings.2 In particular, relying on student subjects only would involve limiting the analysis to only a limited part of the distribution of cognitive ability, and would not allow us to investigate the relationship between cognitive ability and risk aversion and ability for a heterogeneous population. Subjects made choices in paid experiments, which provide incentive compatible and controlled measures of risk aversion and impatience. The measure of risk aversion involved choices over real-stakes lotteries, and the measure of impatience involved making tradeo®s between payments available immediately and payments available in one year. Subjects also took two different sub-modules of a widely used IQ test, providing a measure of cognitive ability. A questionnaire collected information on various personal and background characteristics. The questionnaire and experiments were conducted in subjects’ own homes.
Findings (Via Unimass)
Our main finding is that risk aversion and impatience both vary systematically with cognitive ability. Individuals with higher cognitive ability are significantly more willing to take risks in the lottery experiments, and are significantly more patient over the year-long time horizon studied in the intertemporal choice experiment. The correlation between cognitive ability and risk aversion is present for both young and old, and for males and females, although the relationship is somewhat weaker for females and younger individuals. We find that the correlation of both traits with cognitive ability remains strong and significant even after removing variation due to personal characteristics such as gender, age, and height, as well as important economic variables including education, income, and liquidity constraints. We rule out that various aspects of the experiment or cognitive ability tests explain the correlations, including confusion about incentives in the choice experiments, different propensities to engage in arbitrage, differences in test-taking style for people who are more risk averse or more impatient, and the potential role for personality type, or noncognitive skills, to influence performance on the cognitive ability tests.
Click Here To Read: Are Risk Aversion and Impatience Related to Cognitive Ability?
