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On Risk Aversion, Classical Demand Theory, and KM Preferences

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  • Leonard J. Mirman
  • Marc Santugini

Abstract

Building on Kihlstrom and Mirman (1974)’s formulation of risk aversion in the case of multidimensional utility functions, we study the effect of risk aversion on optimal behavior in a general consumer’s maximization problem under uncertainty. We completely characterize the relationship between changes in risk aversion and classical demand theory. We show that the effect of risk aversion on optimal behavior depends on the income and substitution effects. Moreover, the effect of risk aversion is determined not by the riskiness of the risky good, but rather the riskiness of the utility gamble associated with each decision.

Suggested Citation

  • Leonard J. Mirman & Marc Santugini, 2011. "On Risk Aversion, Classical Demand Theory, and KM Preferences," Cahiers de recherche 1132, CIRPEE.
    • Handle: RePEc:lvl:lacicr:1132
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    References listed on IDEAS

    as
    1. Bommier, Antoine & Chassagnon, Arnold & Le Grand, François, 2012. "Comparative risk aversion: A formal approach with applications to saving behavior," Journal of Economic Theory, Elsevier, vol. 147(4), pages 1614-1641.
    2. Diamond, Peter A. & Stiglitz, Joseph E., 1974. "Increases in risk and in risk aversion," Journal of Economic Theory, Elsevier, vol. 8(3), pages 337-360, July.
    3. Kihlstrom, Richard E. & Mirman, Leonard J., 1974. "Risk aversion with many commodities," Journal of Economic Theory, Elsevier, vol. 8(3), pages 361-388, July.
    4. Kraus, Marvin, 1979. "A comparative statics theorem for choice under risk," Journal of Economic Theory, Elsevier, vol. 21(3), pages 510-517, December.
    5. Larry G. Epstein & Stanley E. Zin, 2013. "Substitution, risk aversion and the temporal behavior of consumption and asset returns: A theoretical framework," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 12, pages 207-239, World Scientific Publishing Co. Pte. Ltd..
    6. Katz, Eliakim, 1981. "A note on a comparative statics theorem for choice under risk," Journal of Economic Theory, Elsevier, vol. 25(2), pages 318-319, October.
    7. 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 621-638, May.
    8. Selden, Larry, 1978. "A New Representation of Preferences over "Certain A Uncertain" Consumption Pairs: The "Ordinal Certainty Equivalent" Hypothesis," Econometrica, Econometric Society, vol. 46(5), pages 1045-1060, September.
    9. Kreps, David M & Porteus, Evan L, 1978. "Temporal Resolution of Uncertainty and Dynamic Choice Theory," Econometrica, Econometric Society, vol. 46(1), pages 185-200, January.
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    Cited by:

    1. Antoniadou, Elena & Mirman, Leonard J. & Santugini, Marc, 2016. "The income effect under uncertainty: A Slutsky-like decomposition with risk aversion," Economic Modelling, Elsevier, vol. 55(C), pages 169-178.

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    More about this item

    Keywords

    Classical Demand Theory; Consumer Choice; Income and Substition Effects; Risk Aversion;
    All these keywords.

    JEL classification:

    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

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