Risk Aversion in the Not-So-Small: Beyond Mean and Variance
The Pratt-Arrow coefficient of risk aversion, r(w), describes decision behavior of individuals under uncertainty, when small amounts of money are involved. In this paper a two-parameter measure is proposed which also takes into account the utility function’s third derivative: by thus incorporating a risk’s skewness, one receives a better approximation for amounts which are not necessarily very small. The model provides new theoretical results and also predicts unexpected behavior under certain conditions; this permits the model’s empirical verification.
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