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Improving the Risk Concept: A Revision of Arrow-Pratt Theory in the Context of Controlled Dynamic Stochastic Environments

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  • DAN PROTOPOPESCU

Abstract

In the literature on risk, one generally assume that uncertainty is uniformly distributed over the entire working horizon, when the absolute risk-aversion index is negative and constant. From this perspective, the risk is totally exogenous, and thus independent of endogenous risks. The traditional measures of risk-aversion are generally too weak for making comparisons between risky situations. This can be highlighted in concrete problems in finance and insurance, context for which the Arrow-Pratt measures of risk-aversion give ambiguous results (Ross 1981). We improve the Arrow-Pratt approach (1964, 1971a, 1971b), which takes into account only attitudes towards small exogenous risks, by integrating in the analysis potentially high endogenous risks that are under the control of the agent. Based on multiple theoretical and empirical arguments, this new approach offers an elegant study of the close relationship between behavior, attitude and perceived risk.

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  • Dan Protopopescu, 2007. "Improving the Risk Concept: A Revision of Arrow-Pratt Theory in the Context of Controlled Dynamic Stochastic Environments," UFAE and IAE Working Papers 727.08, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC), revised 03 Dec 2009.
    • Handle: RePEc:aub:autbar:727.08
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    1. Protopopescu Dan, 2008. "Improving the Effort Concept: A Revision of the Traditional Approach in the Context of Controlled Dynamic Stochastic Environments," UFAE and IAE Working Papers 739.08, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC), revised 03 Dec 2009.

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    More about this item

    Keywords

    Endogenous risk-aversion; adaptive risk management; optimal risk-aversion threshold; excessive risk-averse behavior; risk perception; changing risk behavior.;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D78 - Microeconomics - - Analysis of Collective Decision-Making - - - Positive Analysis of Policy Formulation and Implementation
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness

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