The Behavioural Components of Risk Aversion
AbstractThe risk premium is affected by loss aversion and probability distortions as well as utility curvature. We introduce two variants - the total risk premium relative to objective expected value, and the subjective risk premium relative to perceived expected value. Approximate solutions for each provide analogies to the Pratt-Arrow coefficient of risk aversion (showing how risk attitude depends on each behavioural component), and sufficient conditions for risk aversion. Earlier results of Levy and Levy (2002) which examined decision weights in isolation are revised and extended to show how the curvature and loss aversion conditions are affected by probability distortions.
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Bibliographic InfoPaper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0458.
Date of creation: Oct 2004
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Risk-Premium; Cumulative Prospect Theory; Loss Aversion; Decision Weights; Utility Curvature;
Find related papers by JEL classification:
- D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
This paper has been announced in the following NEP Reports:
- NEP-CBE-2004-11-07 (Cognitive & Behavioural Economics)
- NEP-EVO-2004-11-07 (Evolutionary Economics)
- NEP-FIN-2004-11-07 (Finance)
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