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Approximating Risk Aversion in Decision Analysis Applications

Author

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  • Craig W. Kirkwood

    () (Department of Supply Chain Management, Arizona State University Tempe, Arizona 85287-4706)

Abstract

This paper investigates the impact of risk aversion in decision analyses under uncertainty with a single evaluation measure and presents a simple procedure for approximately addressing risk aversion in a way that is defensible for many decisions. Specifically, a simulation study is presented that leads to guidelines for determining when an expected utility analysis should be conducted for a decision, rather than simply an expected value analysis, and what form of utility function should be used for this expected utility analysis. The simulation study shows that a sensitivity analysis using an exponential utility function should be conducted for most decision analyses, but that this sensitivity analysis can often establish, without requiring utility information from the decision maker , that no further utility analysis is required. In addition, when further utility analysis is required, the simulation study shows that this can be done in a simple way using an exponential utility function that will be accurate for many decision analyses. However, in situations where there is equal or greater downside risk than upside potential, a more detailed study of the decision maker's utility function may be necessary.

Suggested Citation

  • Craig W. Kirkwood, 2004. "Approximating Risk Aversion in Decision Analysis Applications," Decision Analysis, INFORMS, vol. 1(1), pages 51-67, March.
  • Handle: RePEc:inm:ordeca:v:1:y:2004:i:1:p:51-67
    DOI: 10.1287/deca.1030.0007
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    File URL: http://dx.doi.org/10.1287/deca.1030.0007
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Sascha Hokamp & Michael Pickhardt, 2010. "Income Tax Evasion in a Society of Heterogeneous Agents - Evidence from an Agent-based Model," International Economic Journal, Taylor & Francis Journals, vol. 24(4), pages 541-553.
    2. J. Eric Bickel, 2008. "The Relationship Between Perfect and Imperfect Information in a Two-Action Risk-Sensitive Problem," Decision Analysis, INFORMS, vol. 5(3), pages 116-128, September.
    3. Xin Chen & Melvyn Sim & David Simchi-Levi & Peng Sun, 2007. "Risk Aversion in Inventory Management," Operations Research, INFORMS, vol. 55(5), pages 828-842, October.
    4. L. Robin Keller & Ali Abbas & J. Eric Bickel & Vicki M. Bier & David V. Budescu & John C. Butler & Enrico Diecidue & Robin L. Dillon-Merrill & Raimo P. Hämäläinen & Kenneth C. Lichtendahl & Jason R. W, 2012. "From the Editors ---Brainstorming, Multiplicative Utilities, Partial Information on Probabilities or Outcomes, and Regulatory Focus," Decision Analysis, INFORMS, vol. 9(4), pages 297-302, December.
    5. Steven A. Lippman & Kevin F. McCardle, 2012. "Embedded Nash Bargaining: Risk Aversion and Impatience," Decision Analysis, INFORMS, vol. 9(1), pages 31-40, March.
    6. J. Eric Bickel, 2007. "Some Comparisons among Quadratic, Spherical, and Logarithmic Scoring Rules," Decision Analysis, INFORMS, vol. 4(2), pages 49-65, June.
    7. Doumpos, Michael & Hasan, Iftekhar & Pasiouras, Fotios, 2017. "Bank overall financial strength: Islamic versus conventional banks," Economic Modelling, Elsevier, vol. 64(C), pages 513-523.
    8. L. Robin Keller, 2008. "From the Editor..," Decision Analysis, INFORMS, vol. 5(1), pages 1-4, March.
    9. Philippe Delquié, 2008. "Interpretation of the Risk Tolerance Coefficient in Terms of Maximum Acceptable Loss," Decision Analysis, INFORMS, vol. 5(1), pages 5-9, March.
    10. L. Robin Keller, 2010. "From the Editor..," Decision Analysis, INFORMS, vol. 7(3), pages 235-237, September.
    11. Schosser, Josef, 2019. "Consistency between principal and agent with differing time horizons: Computing incentives under risk," European Journal of Operational Research, Elsevier, vol. 277(3), pages 1113-1123.
    12. Philippe Delquié, 2008. "The Value of Information and Intensity of Preference," Decision Analysis, INFORMS, vol. 5(3), pages 129-139, September.
    13. Ender Su & John Bilson, 2011. "Trading asymmetric trend and volatility by leverage trend GARCH in Taiwan stock index," Applied Economics, Taylor & Francis Journals, vol. 43(26), pages 3891-3905.
    14. Michael Doumpos & Chrysovalantis Gaganis & Fotios Pasiouras, 2016. "Bank Diversification and Overall Financial Strength: International Evidence," Working Papers 1602, University of Crete, Department of Economics.

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