The Subsistence Constraint and Endogenous Risk Aversion

This paper contributes to the literature on endogenous preferences by showing that, when income is close to the minimum required for subsistence, individuals rationally will behave as if they were risk averse. It is suggested that observed risk aversion in empirical studies can be explained by the fact that, in the distant past, most people lived close to the subsistence constraint. It is shown that this approach can account for a number of empirical phenomena, including increasing income equality over time, decreasing risk aversion as income increases, and the economic role of insurance companies.