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First-order (Conditional) Risk Aversion, Background Risk and Risk Diversification

Author

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  • Georges Dionne
  • Jingyuan Li

Abstract

In the literature, utility functions in the expected utility class are generically limited to second-order (conditional) risk aversion, while non-expected utility functions can exhibit either first-order or second-order (conditional) risk aversion. This paper extends the concepts of order of conditional risk aversion to orders of conditional dependent risk aversion. We show that first-order conditional dependent risk aversion is consistent with the framework of the expected utility hypothesis. We relate our results to risk diversification and provide additional insights into its application in different economic and finance examples.

Suggested Citation

  • Georges Dionne & Jingyuan Li, 2011. "First-order (Conditional) Risk Aversion, Background Risk and Risk Diversification," Cahiers de recherche 1111, CIRPEE.
    • Handle: RePEc:lvl:lacicr:1111
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    File URL: http://www.cirpee.org/fileadmin/documents/Cahiers_2011/CIRPEE11-11.pdf
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    Cited by:

    1. Dionne, Georges & Li, Jingyuan, 2014. "When can expected utility handle first-order risk aversion?," Journal of Economic Theory, Elsevier, vol. 154(C), pages 403-422.

    More about this item

    Keywords

    Expected utility theory; first-order conditional dependent risk aversion; background risk; risk diversification;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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