Evaluating the magnitudes of financial transactions costs on risk behavior

The model presented in this paper relies on financial constraints and transactions costs to operationalize model of behavior akin to safety rules. The decision maker is taken to maximize long term (40 period) expected wealth in the presence of financial transactions costs. The model allows exploration of the implications of these constraints and transactions costs for measurable choice patterns over risk. The optimization analysis demonstrates very rich behavior despite the restrictive assumption of risk neutral preferences. The optimal decisions show instances of “risk aversion” with willingness to pay less than a risky option's expected value, and of “risk preference” or plunging with willingness to pay greater than a risky option's expected value. These varied behavioral patterns in the presence of risk depend on the individual's financial standing, the magnitude of the random outcomes, the underlying distribution, and the farm policy environment.