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Improving the Risk Concept: A Revision of Arrow-Pratt Theory in the Context of Controlled Dynamic Stochastic Environments

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Author Info
DAN PROTOPOPESCU ()
Abstract

In the literature on risk, one generally assume that uncertainty is uniformly distributed over the entire working horizon, when the absolute risk-aversion index is negative and constant. From this perspective, the risk is totally exogenous, and thus independent of endogenous risks. The traditional measures of risk-aversion are generally too weak for making comparisons between risky situations. This can be highlighted in concrete problems in ?nance and insurance, context for which the Arrow-Pratt measures (in the small) give ambiguous results (Ross 1981). We improve the Arrow-Pratt approach (1964, 1971a, 1971b), which takes into account only attitudes towards small exogenous risks, by integrating in the analysis potentially high endogenous risks which are under the control of the agent. Based on multiple theoretical and empirical arguments, this new approach offers an elegant study of the close relationship between behavior, attitude and perceived risk.

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Paper provided by Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC) in its series UFAE and IAE Working Papers with number 727.08.

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Length: 44
Date of creation: 15 Dec 2007
Date of revision: 08 Jan 2009
Handle: RePEc:aub:autbar:727.08

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Related research
Keywords: Endogenous risk-aversion; adaptive risk management; optimal risk-aversion threshold; excessive risk-averse behavior; risk perception; changing risk behavior.;

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Find related papers by JEL classification:
C61 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Optimization Techniques; Programming Models; Dynamic Analysis
D78 - Microeconomics - - Analysis of Collective Decision-Making - - - Positive Analysis of Policy-Making and Implementation
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Protopopescu Dan, 2008. "Improving the Effort Concept: A Revision of the Traditional Approach in the Context of Controlled Dynamic Stochastic Environments," UFAE and IAE Working Papers 739.08, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC), revised 08 Jan 2009. [Downloadable!]
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