Temporal Instability of Risk Preference among the Poor: Evidence from Payday Cycles

Abstract

The poor live paycheck to paycheck and are repeatedly exposed to strong cyclical income fluctuations. We investigate whether such income fluctuations affect their risk preference. If risk preference temporarily changes around payday, optimal decisions made before payday may no longer be optimal afterward, which could reinforce poverty. By exploiting social security payday cycles in the United States, we find that the poor relying heavily on social security become more risk tolerant before payday. More than cognitive decline before payday, the deterioration of mental health and relative deprivation are likely to play a role. We find similar evidence among the Japanese elderly. (JEL D81, D91, G51, I12, I32, J14, J31)

Poverty is associated with both risk avoidance and risk taking: an empirical test of the desperation threshold model.

“…Consistent with the desperation threshold, the poorest and the richest quintiles were the most risk tolerant, both for income and wealth. Recently, (47) documented in the same dataset that those who strongly depended on social security -those with the fewer resources -were significantly more risk-tolerant the day before receiving welfare checks, when they are most likely to be below the threshold, than at other times.…”