DP15373 How do People Respond to Small Probability Events with Large, Negative Consequences?

Author(s): Martin Eichenbaum, Miguel Godinho de Matos, Francisco Lima, Sérgio Rebelo, Mathias Trabandt
Publication Date: October 2020
Date Revised: October 2020
Keyword(s): COVID-19, risk
JEL(s): E21, I10
Programme Areas: Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15373

We study how people react to small probability events with large negative consequences using the outbreak of the COVID-19 epidemic as a natural experiment. Our analysis is based on a unique administrative data set with anonymized monthly expenditures at the individual level. We find that older consumers reduced their spending by more than younger consumers in a way that mirrors the age dependency in COVID-19 case-fatality rates. This differential expenditure reduction is much more prominent for high-contact goods than for low-contact goods and more pronounced in periods with high COVID-19 cases. Our results are consistent with the hypothesis that people react to the risk of contracting COVID-19 in a way that is consistent with a canonical model of risk taking.