AbstractIn searching for an appropriate utility function in the expected utility framework, we formulate four properties that we want the utility function to satisfy. We conduct a search for such a function, and we identify Pareto utility as a function satisfying all four desired properties. Pareto utility is a flexible yet simple and parsimonious two-parameter family. It exhibits decreasing absolute risk aversion and increasing but bounded relative risk aversion. It is applicable irrespective of the probability distribution relevant to the prospect to be evaluated. Pareto utility is therefore particularly suited for catastrophic risk analysis. A new and related class of generalized exponential (gexpo) utility functions is also studied. This class is particularly relevant in situations where absolute risk tolerance is thought to be concave rather than linear. Copyright The Author(s) 2013
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Bibliographic InfoArticle provided by Springer in its journal Theory and Decision.
Volume (Year): 75 (2013)
Issue (Month): 1 (July)
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Web page: http://www.springerlink.com/link.asp?id=100341
Parametric utility; Hyperbolic absolute risk aversion (HARA); Exponential utility; Power utility; D81;
Find related papers by JEL classification:
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
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