Consumption commitments, risk preferences, and optimal unemployment insurance

Studies of risk preference have empirically established two regularities that are inconsistent with the canonical expected utility model: (1) risk aversion over small gambles greatly exceeds risk aversion over larger stakes and (2) insurance buyers play the lottery. These puzzles are of central importance for analyzing a wide set of policy questions, including optimal social insurance and tax policies.; This dissertation characterizes risk preferences both theoretically and empirically in a world with two consumption goods, one of which involves a commitment in that an adjustment cost must be paid when the good is sold. In this model, utility over wealth is more curved locally than globally: individuals are more risk averse with respect to moderate-scale income fluctuations than they are to large income fluctuations. Commitments also create a gambling motive.; To test the empirical importance of commitments, I develop a method of estimating risk aversion using data on labor supply. I show that the curvature of the utility function can be inferred from labor supply wage and income elasticities for a given degree of complementarity between consumption and leisure. The degree of complementarity can in turn be inferred from data on consumption choices when employment is stochastic.; I test the model by estimating local (γl) and global (γg) curvature using the labor supply method. First, using a large set of existing estimates of wage and income elasticities, I find a mean estimate of γ g = 1. I also give a calibration argument showing that a positive uncompensated wage elasticity, as found in most studies of labor supply, implies γg < 1.25. The estimate of γg changes by at most 0.25 over the range of plausible values for the complementarity parameter.; I then estimate γl by estimating price and income effects for unemployed individuals, who are likely to retain commitments while making search decisions. Cross-state and time variation in unemployment insurance laws is used to estimate local curvature using both reduced-form hazard models and structural estimation of a dynamic job search model. I find that commitments significantly change preferences over wealth. The local coefficient of relative risk aversion is an order of magnitude larger than the global coefficient of relative risk aversion. In addition, cross-sectional evidence confirms two auxiliary predictions of the model: more committed agents find jobs more quickly and are more risk averse.; The effects of commitments on preferences over wealth can help shed light on several issues, including intertemporal substitution, optimal punishment strategies for criminals, the labor supply of secondary earners, deadweight cost of income taxation, and optimal social insurance policies. The dissertation concludes with an analysis of optimal unemployment insurance (UI) with commitments. When commitments are taken into account, the optimal rate of insurance rises from zero to 44% of pre-unemployment wages. The value of UI is augmented because households are forced to bear the full impact of an income shock on a small portion of their budget, with rapidly diminishing marginal utility over wealth.