Apportioning of Risks via Stochastic Dominance
AbstractConsider a simple two-state risk with equal probabilities for the two states. In particular, assume that the random wealth variable Xi dominates Yi via ith-order stochastic dominance for i = M,N. We show that the 50-50 lottery [XN + YM, YN + XM] dominates the lottery [XN + XM, YN + YM] via (N + M)th-order stochastic dominance. The basic idea is that a decision maker exhibiting (N + M)th-order stochastic dominance preference will allocate the state-contingent lotteries in such a way as not to group the two "bad" lotteries in the same state, where "bad" is defined via ith-order stochastic dominance. In this way, we can extend and generalize existing results about risk attitudes. This lottery preference includes behavior exhibiting higher order risk effects, such as precautionary effects and tempering effects.
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Bibliographic InfoPaper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2467.
Date of creation: 2008
Date of revision:
downside risk; precautionary effects; prudence; risk apportionment; risk aversion; stochastic dominance; temperance;
Other versions of this item:
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
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