The Probability Premium Approach to Comparative Risk Aversion
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Date
2015-04-23
Authors
Journal Title
Journal ISSN
Volume Title
Publisher
Private Enterprise Research Center, Texas A&M University
Abstract
In the framework of expected utility, nth-degree risk aversion/loving is unequivocally characterized by the sign of the nth-order derivative of the utility function, but there exist different notions of one decision maker being nth-degree more risk averse than another. This paper first reformulates Pratt’s (1964) probability premium approach to comparative (2nd-degree) risk aversion with a nonrandom starting wealth, and then shows that the reformulated probability premium approach can be easily extended to deal with random starting wealth and comparative nth-degree risk aversion. The paper shows that interpersonal comparisons of various versions of probability premia for nth-degree risk aversion are characterized by the (n/m)th-degree Ross more risk aversion of Liu and Meyer (2013), where n > m >1. Besides the original Pratt setting, the same comparative nth-degree risk aversion extends to probability premia derived from the risk apportionment setting of Eeckhoudt and Schlesinger (2006) and the comparative statics setting of Jindapon and Neilson (2007).
Description
Retirement_Savings
Keywords
1504, Risk Aversion, Comparative risk aversion, Probability premium, Downside risk aversion, Risk Apportionment, Retirement_Savings