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Working Paper 311 - Risk, Returns, and Welfare
A positive correlation between the riskiness and returns of households’ asset portfolios and their initial asset endowments is often taken for granted in development economics, especially in settings where financial market failures are likely (Barrett et al. 2016). The relationship among risk, returns, and welfare has important implications for the reproduction of inequality and persistent poverty and therefore is critical to understand for effective anti-poverty policy making. If a household with a low initial asset endowment is constrained to low return economic activities (or, similarily, if higher return activities come with greater risk and household risk preferences induce the household to chose the low risk, low return activities), then not only will that household remain poor, but the gap between those with a low endowment and those with a high endowment will only grow overtime, meaning growing inequality.