First-order (Conditional) Risk Aversion, Background Risk and Risk Diversification
AbstractIn 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.
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Bibliographic InfoPaper provided by CIRPEE in its series Cahiers de recherche with number 1111.
Date of creation: 2011
Date of revision:
Expected utility theory; first-order conditional dependent risk aversion; background risk; risk diversification;
Find related papers by JEL classification:
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-04-16 (All new papers)
- NEP-RMG-2011-04-16 (Risk Management)
- NEP-UPT-2011-04-16 (Utility Models & Prospect Theory)
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