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An Alternative Explanation for the Variation in Reported Estimates of Risk Aversion

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  • Conniffe, Denis

    ()
    (National University of Ireland, Maynooth)

  • O'Neill, Donal

    ()
    (National University of Ireland, Maynooth)

Abstract

There is a large literature estimating Arrow-Pratt coefficients of absolute and relative risk aversion. A striking feature of this literature is the very wide variation in the reported estimates of the coefficients. While there are often legitimate reasons for these differences in the estimates, there is another source of variation that has not been considered to date. The Arrow-Pratt coefficients are properties of the utility functions, but a number of estimates are obtained by equating these to risk aversion measures defined in a mean-variance framework. This paper shows that while the legitimacy of the mean-variance approach may hold under general conditions the additional assumptions invoked when estimating the risk aversion parameter hold only in very restricted circumstances and that serious under or over estimation can easily arise as a result.

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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 6877.

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Length: 19 pages
Date of creation: Sep 2012
Date of revision:
Publication status: published in: Journal of Risk, 2013, 15 (4), 91-102
Handle: RePEc:iza:izadps:dp6877

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Related research

Keywords: location scale; mean-variance estimation; variability in risk aversion estimation;

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  1. Donald Meyer & Jack Meyer, 2005. "Relative Risk Aversion: What Do We Know?," Journal of Risk and Uncertainty, Springer, Springer, vol. 31(3), pages 243-262, December.
  2. Meyer, Jack, 1987. "Two-moment Decision Models and Expected Utility Maximization," American Economic Review, American Economic Association, American Economic Association, vol. 77(3), pages 421-30, June.
  3. Friend, Irwin & Blume, Marshall E, 1975. "The Demand for Risky Assets," American Economic Review, American Economic Association, American Economic Association, vol. 65(5), pages 900-922, December.
  4. Levy, H & Markowtiz, H M, 1979. "Approximating Expected Utility by a Function of Mean and Variance," American Economic Review, American Economic Association, American Economic Association, vol. 69(3), pages 308-17, June.
  5. Salem, A B Z & Mount, T D, 1974. "A Convenient Descriptive Model of Income Distribution: The Gamma Density," Econometrica, Econometric Society, Econometric Society, vol. 42(6), pages 1115-27, November.
  6. Thomas Flavin, 2006. "How risk averse are fund managers? Evidence from Irish mutual funds," Applied Financial Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 16(18), pages 1355-1363.
  7. Engel, Charles & Rodrigues, Anthony P, 1989. "Tests of International CAPM with Time-Varying Covariances," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 4(2), pages 119-38, April-Jun.
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