Staying the Course or Rolling the Dice: Time Horizon’s Effect on the Propensity to Take Risk

Abstract

Is the old adage that states that the young take more risk than the old correct? In PERC Working Paper 1902, authors Liqun Liu, Andrew J. Rettenmaier and Thomas R. Saving investigate this conventional wisdom in the context of non-financial risk taking. The paper analyzes a model of dynamic decision making under uncertainty, where in each period the decision maker is faced with a choice between accepting a known level of benefit inherited from the last period - “staying the course�- and drawing from a random benefit distribution, or “rolling the dice.� Results show that the decision maker’s propensity to roll the dice decreases as it gets closer to the ending period, therefore providing a justification for the conventional wisdom that the young would take more risk than the old. Additional results show that it is possible for a risk averse decision maker with an inherited benefit level greater than the mean of the random benefit distribution to prefer rolling the dice to staying the course, and that it is also possible for a risk averse decision maker to be more prone to risk taking as the underlying benefit distribution becomes riskier.