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Apportioning of risks via stochastic dominance

  • Eeckhoudt, Louis
  • Schlesinger, Harris
  • Tsetlin, Ilia

Consider a simple two-state risk with equal probabilities for the two states. In particular, assume that the random wealth variable dominates via ith-order stochastic dominance for i=M,N. We show that the 50-50 lottery dominates the lottery via (N+M)th-order stochastic dominance. The basic idea is that a decision maker exhibiting (N+M)th-order stochastic dominance preference will allocate the state-contingent lotteries in such a way as not to group the two "bad" lotteries in the same state, where "bad" is defined via ith-order stochastic dominance. In this way, we can extend and generalize existing results about risk attitudes. This lottery preference includes behavior exhibiting higher-order risk effects, such as precautionary effects and tempering effects.

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Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 144 (2009)
Issue (Month): 3 (May)
Pages: 994-1003

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Handle: RePEc:eee:jetheo:v:144:y:2009:i:3:p:994-1003
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622869

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