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Utility Functions whose Parameters depend on Initial Wealth

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  • Christian S. Pedersen
  • S. E. Satchell

Abstract

Conventional one‐period utility functions in Economics assume that initial wealth only enters preferences through the definition of final wealth. Consequently, those utility functions most utilized (i.e., exponential and quadratic) have implausible risk characteristics. The authors characterize a new class of utility function whose risk parameters depend upon initial wealth and obtain several desirable results. In particular, investors with quadratic and exponential utility functions can have decreasing risk aversion, and risky assets in a quadratic utility multi‐asset environment do not have to be inferior as implied by the traditional framework.

Suggested Citation

  • Christian S. Pedersen & S. E. Satchell, 2003. "Utility Functions whose Parameters depend on Initial Wealth," Bulletin of Economic Research, Wiley Blackwell, vol. 55(4), pages 357-371, October.
    • Handle: RePEc:bla:buecrs:v:55:y:2003:i:4:p:357-371
    DOI: 10.1111/1467-8586.00181
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    References listed on IDEAS

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    Cited by:

    1. Elena Krasnokutskaya, 2009. "Choice of product under government regulation: The case of Chile's privatized pension system," 2009 Meeting Papers 230, Society for Economic Dynamics.

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