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Apportioning of Risks via Stochastic Dominance

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Author Info
Louis Eeckhoudt ()
Harris Schlesinger ()
Ilia Tsetlin

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Abstract

Consider 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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Publisher Info
Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number CESifo Working Paper No. 2467.

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Date of creation: 2008
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Handle: RePEc:ces:ceswps:_2467

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Related research
Keywords: downside risk; precautionary effects; prudence; risk apportionment; risk aversion; stochastic dominance; temperance;

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Find related papers by JEL classification:
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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    Other versions:
  15. Louis Eeckhoudt & Harris Schlesinger, 2006. "Putting Risk in Its Proper Place," American Economic Review, American Economic Association, vol. 96(1), pages 280-289, March. [Downloadable!]
    Other versions:
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