The Dynamic Properties of Economic Preferences
Melbourne Institute Working Paper No. 04/18
Date: April 2018
Author(s):
Abstract
The time-stability of preferences is a crucial and ubiquitous assumption in economics, yet to date there is no method to test its validity. Based on a model of the dynamics of individual preferences, I develop a simple method to test this assumption. Time-persistance in preferences is captured via an autoregressive parameter that accounts for observable characteristics and is unattenuated by measurement error, which forms the basis of the test. The method also estimates the variance of persistent shocks to latent preferences, which measures unobserved heterogeneity, and preference measurement error. I illustrate the use of this method by testing the stability of risk aversion and patience using micro-level data, and find that patience is time-stable but risk aversion is not. However, change very slowly over time. This method provides researchers with a simple tool to properly test the assumption on preference stability, and to measure the degree of preference changes due to observable and unobservable factors.