Law and economic behaviour

Abstract

Preferences play a key role in economic models as drivers of behaviour. Recent contributions have started to model preferences as endogenously determined. This creates two fundamental issues for empirical research. The first concerns the determinants of preferences. The second concerns the effect of preferences on economic outcomes, which become difficult to quantify once preferences are endogenous. We explore the extent to which the prevalence of risk tolerance across countries is endogenously determined by the legal and institutional environment of a country, and whether this behavioural trait in turn contributes to shaping the aggregate entrepreneurship rate. To do so, we rely on structural equation modelling, where the direction of causality arises from the underlying model assumed to construct the equations. Data fit to the model serve to determine whether the underlying causal model presents a plausible representation of the empirical facts. We find that legal origins exert a strong effect on risk tolerance. We further document an indirect effect of legal origins on entrepreneurship rates passing through risk preferences. These findings illustrate the pervasiveness of the effect of legal origins on economic behaviour.