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Putting risk in its proper place

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  • EECKHOUDT, Louis
  • SCHLESINGER, Harris

Abstract

This paper examines preferences toward particular classes of lottery pairs. We show how such concepts 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://dx.doi.org/10.1257/000282806776157777
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Bibliographic Info

Paper provided by Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) in its series CORE Discussion Papers RP with number -1871.

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Handle: RePEc:cor:louvrp:-1871

Note: In : American Economic Review, 96(1), 280-289, 2006
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  1. EECKHOUDT, Louis & Christian GOLLIER & Harris SCHLESINGER, 1994. "Changes in Background Risk and Risk Taking Behavior," Working Papers 005, Risk and Insurance Archive.
  2. X. Henry Wang & Carmen F. Menezes, 2004. "Increasing Outer Risk," Working Papers 0413, Department of Economics, University of Missouri, revised 23 Dec 2004.
  3. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
  4. Shorrocks, Anthony F & Foster, James E, 1987. "Transfer Sensitive Inequality Measures," Review of Economic Studies, Wiley Blackwell, vol. 54(3), pages 485-97, July.
  5. Lajeri-Chaherli, Fatma, 2004. "Proper prudence, standard prudence and precautionary vulnerability," Economics Letters, Elsevier, vol. 82(1), pages 29-34, January.
  6. Segal, Uzi & Spivak, Avia, 1990. "First order versus second order risk aversion," Journal of Economic Theory, Elsevier, vol. 51(1), pages 111-125, June.
  7. Patrick L. Brockett & Linda L. Golden, 1987. "A Class of Utility Functions Containing all the Common Utility Functions," Management Science, INFORMS, vol. 33(8), pages 955-964, August.
  8. Miles S. Kimball, 1991. "Standard Risk Aversion," NBER Technical Working Papers 0099, National Bureau of Economic Research, Inc.
  9. Menezes, C & Geiss, C & Tressler, J, 1980. "Increasing Downside Risk," American Economic Review, American Economic Association, vol. 70(5), pages 921-32, December.
  10. Christian Gollier, 2004. "The Economics of Risk and Time," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262572249, January.
  11. Eeckhoudt, Louis & Gollier, Christian & Schneider, Thierry, 1995. "Risk-aversion, prudence and temperance: A unified approach," Economics Letters, Elsevier, vol. 48(3-4), pages 331-336, June.
  12. Milton Friedman & L. J. Savage, 1948. "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, University of Chicago Press, vol. 56, pages 279.
  13. Miles S. Kimball, 1991. "Precautionary Motives for Holding Assets," NBER Working Papers 3586, National Bureau of Economic Research, Inc.
  14. Nachman, David C., 1982. "Preservation of "more risk averse" under expectations," Journal of Economic Theory, Elsevier, vol. 28(2), pages 361-368, December.
  15. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January.
  16. Ekern, Steinar, 1980. "Increasing Nth degree risk," Economics Letters, Elsevier, vol. 6(4), pages 329-333.
  17. Pratt, John W & Zeckhauser, Richard J, 1987. "Proper Risk Aversion," Econometrica, Econometric Society, vol. 55(1), pages 143-54, January.
  18. 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, vol. 36(3), pages 643-73, August.
  19. 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.
  20. Atkinson, Anthony B., 1970. "On the measurement of inequality," Journal of Economic Theory, Elsevier, vol. 2(3), pages 244-263, September.
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