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A simple measure of risk aversion in the large and an application

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Author Info
CHANDER, Parkash

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Abstract

We introduce a simple measure of risk aversion in the large. Besides satisfying properties which are conceptually analogous to the usual properties of the Arrow-Pratt measure, the index of risk aversion in the large leads to a stronger concept of decreasing risk aversion, which necessarily implies decreasing absolute risk aversion but not necessarily non-increasing relative risk aversion. The index also leads to a recursive procedure for refining the set of vN - M utility functions. We show that the majority of refinements considered in the theory of multiple risk bearing including that of mixed risk aversion can be obtained from this procedure. Finally, as an illustration, we apply the measure to characterize individual behaviour under uncertainty in the principal-agent model of optimal income tax enforcement in which the risks involved are indeed large.

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Paper provided by Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) in its series CORE Discussion Papers with number 2000041.

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Date of creation: 01 Aug 2000
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Handle: RePEc:cor:louvco:2000041

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Related research
Keywords: expected utility; risk aversion; certainty equivalent; multiple risk bearing; principal-agent; audit probability.;

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
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

References listed on IDEAS
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  1. Carroll, Christopher D & Kimball, Miles S, 1996. "On the Concavity of the Consumption Function," Econometrica, Econometric Society, vol. 64(4), pages 981-92, July. [Downloadable!] (restricted)
    Other versions:
  2. Machina, Mark J, 1982. "A Stronger Characterization of Declining Risk Aversion," Econometrica, Econometric Society, vol. 50(4), pages 1069-79, July. [Downloadable!] (restricted)
  3. Gollier, Christian & Pratt, John W, 1996. "Risk Vulnerability and the Tempering Effect of Background Risk," Econometrica, Econometric Society, vol. 64(5), pages 1109-23, September. [Downloadable!] (restricted)
  4. Ross, Stephen A, 1981. "Some Stronger Measures of Risk Aversion in the Small and the Large with Applications," Econometrica, Econometric Society, vol. 49(3), pages 621-38, May. [Downloadable!] (restricted)
  5. Reinganum, Jennifer F. & Wilde, Louis L., 1985. "Income tax compliance in a principal-agent framework," Journal of Public Economics, Elsevier, vol. 26(1), pages 1-18, February. [Downloadable!] (restricted)
  6. Kimball, Miles S, 1993. "Standard Risk Aversion," Econometrica, Econometric Society, vol. 61(3), pages 589-611, May. [Downloadable!] (restricted)
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  7. Chander, Parkash & Wilde, Louis L, 1998. "A General Characterization of Optimal Income Tax Enforcement," Review of Economic Studies, Blackwell Publishing, vol. 65(1), pages 165-83, January. [Downloadable!] (restricted)
  8. Mookherjee, Dilip & Png, Ivan, 1989. "Optimal Auditing, Insurance, and Redistribution," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 399-415, May. [Downloadable!] (restricted)
  9. Pratt, John W & Zeckhauser, Richard J, 1987. "Proper Risk Aversion," Econometrica, Econometric Society, vol. 55(1), pages 143-54, January. [Downloadable!] (restricted)
  10. Caballe, Jordi & Pomansky, Alexey, 1996. "Mixed Risk Aversion," Journal of Economic Theory, Elsevier, vol. 71(2), pages 485-513, November. [Downloadable!] (restricted)
  11. Sinclair-Desgagne, Bernard & Gabel, H. Landis, 1997. "Environmental Auditing in Management Systems and Public Policy," Journal of Environmental Economics and Management, Elsevier, vol. 33(3), pages 331-346, July. [Downloadable!] (restricted)
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  12. Parkash Chander, 1998. "A Stronger Measure of Risk Aversion and a General Characterization of Optimal Income Tax Enforcement," Economics Working Paper Archive 399, The Johns Hopkins University,Department of Economics.
  13. Dreze, Jacques H. & Modigliani, Franco, 1972. "Consumption decisions under uncertainty," Journal of Economic Theory, Elsevier, vol. 5(3), pages 308-335, December. [Downloadable!] (restricted)
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Cited by:
(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. Parkash Chander, 2004. "Risk Aversion and Income Tax Enforcement," Econometric Society 2004 Far Eastern Meetings 531, Econometric Society. [Downloadable!]
  2. CHANDER, Parkash, 2005. "Repetitive risk aversion," CORE Discussion Papers 2005022, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE). [Downloadable!]
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