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Putting Risk in its Proper Place

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  • Louis Eeckhoudt
  • Harris Schlesinger

Abstract

This paper examines preferences towards particular classes of lottery pairs. We show how concepts such as prudence and temperance can be fully characterized by a preference relation over these lotteries. If preferences are defined in an expected-utility framework with differentiable utility, the direction of preference for a particular class of lottery pairs is equivalent to signing the nth derivative of the utility function. What makes our characterization appealing is its simplicity, which seems particularly amenable to experimentation.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2005/wp-cesifo-2005-05/cesifo1_wp1462.pdf
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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 1462.

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Date of creation: 2005
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Handle: RePEc:ces:ceswps:_1462

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Keywords: properness; prudence; risk apportionment; risk aversion; stochastic dominance; temperance; utility premium;

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References

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  1. Pratt, John W & Zeckhauser, Richard J, 1987. "Proper Risk Aversion," Econometrica, Econometric Society, Econometric Society, vol. 55(1), pages 143-54, January.
  2. Miles S. Kimball, 1991. "Precautionary Motives for Holding Assets," NBER Working Papers 3586, National Bureau of Economic Research, Inc.
  3. Lajeri-Chaherli, Fatma, 2004. "Proper prudence, standard prudence and precautionary vulnerability," Economics Letters, Elsevier, Elsevier, vol. 82(1), pages 29-34, January.
  4. Caballé, Jordi & Pomansky, Alexey, 1995. "Mixed Risk Aversion," Working Paper Series, Research Institute of Industrial Economics 444, Research Institute of Industrial Economics.
  5. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
  6. Eeckhoudt, Louis & Gollier, Christian & Schlesinger, Harris, 1996. "Changes in Background Risk and Risk-Taking Behavior," Econometrica, Econometric Society, Econometric Society, vol. 64(3), pages 683-89, May.
  7. Christian Gollier, 2004. "The Economics of Risk and Time," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262572249, December.
  8. Bigelow, John P & Menezes, Carmen F, 1995. "Outside Risk Aversion and the Comparative Statics of Increasing Risk in Quasi-linear Decision Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(3), pages 643-73, August.
  9. X. Henry Wang & Carmen F. Menezes, 2004. "Increasing Outer Risk," Working Papers, Department of Economics, University of Missouri 0413, Department of Economics, University of Missouri, revised 23 Dec 2004.
  10. Ekern, Steinar, 1980. "Increasing Nth degree risk," Economics Letters, Elsevier, Elsevier, vol. 6(4), pages 329-333.
  11. repec:fth:iniesr:444 is not listed on IDEAS
  12. Atkinson, Anthony B., 1970. "On the measurement of inequality," Journal of Economic Theory, Elsevier, Elsevier, vol. 2(3), pages 244-263, September.
  13. Milton Friedman & L. J. Savage, 1948. "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 56, pages 279.
  14. Kimball, Miles S, 1993. "Standard Risk Aversion," Econometrica, Econometric Society, Econometric Society, vol. 61(3), pages 589-611, May.
  15. Menezes, C & Geiss, C & Tressler, J, 1980. "Increasing Downside Risk," American Economic Review, American Economic Association, American Economic Association, vol. 70(5), pages 921-32, December.
  16. Gollier, Christian & Pratt, John W, 1996. "Risk Vulnerability and the Tempering Effect of Background Risk," Econometrica, Econometric Society, Econometric Society, vol. 64(5), pages 1109-23, September.
  17. Segal, Uzi & Spivak, Avia, 1990. "First order versus second order risk aversion," Journal of Economic Theory, Elsevier, Elsevier, vol. 51(1), pages 111-125, June.
  18. Eeckhoudt, Louis & Gollier, Christian & Schneider, Thierry, 1995. "Risk-aversion, prudence and temperance: A unified approach," Economics Letters, Elsevier, Elsevier, vol. 48(3-4), pages 331-336, June.
  19. Patrick L. Brockett & Linda L. Golden, 1987. "A Class of Utility Functions Containing all the Common Utility Functions," Management Science, INFORMS, INFORMS, vol. 33(8), pages 955-964, August.
  20. Shorrocks, Anthony F & Foster, James E, 1987. "Transfer Sensitive Inequality Measures," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 54(3), pages 485-97, July.
  21. Nachman, David C., 1982. "Preservation of "more risk averse" under expectations," Journal of Economic Theory, Elsevier, Elsevier, vol. 28(2), pages 361-368, December.
  22. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, Elsevier, vol. 2(3), pages 225-243, September.
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