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Arrow-Pratt-Type Measure of Ambiguity Aversion

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  • Chiaki Hara

    (Institute of Economic Research, Kyoto University)

Abstract

We define a measure of ambiguity aversion for ambiguity-averse utility functions in a way analogous to the Arrow-Pratt measure of risk aversion. The measure is determined by the second Peano derivative, which exists even for non-differentiable functions, such as maximin and Choquet expected utility functions. Unlike the standard notion of comparative ambiguity aversion, it allows us to compare ambiguity aversion between two utility functions exhibiting different risk attitudes. We introduce a notion of ambiguity premium and show that our measure is related to the second-order, as opposed to the first-order, ambiguity premium. We also show that it is related to the first-order impact on matching probabilities of the size of prizes.

Suggested Citation

  • Chiaki Hara, 2023. "Arrow-Pratt-Type Measure of Ambiguity Aversion," KIER Working Papers 1097, Kyoto University, Institute of Economic Research.
    • Handle: RePEc:kyo:wpaper:1097
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    References listed on IDEAS

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    More about this item

    Keywords

    Expected utility functions; risk aversion; ambiguity aversion; ambiguity premium; matching probabilities; Peano derivative;
    All these keywords.

    JEL classification:

    • C38 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Classification Methdos; Cluster Analysis; Principal Components; Factor Analysis
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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