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Allocative downside risk aversion

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  • Richard Watt
  • Francisco J. Vazquez

Abstract

Traditionally, downside risk aversion is the study of the placement of a pure risk (a secondary risk) on either the upside or the downside of a primary two-state risk. When the decision maker prefers to have the secondary risk placed on the upside rather than the downside of the primary lottery, he is said to display downside risk aversion. The literature on the intensity of downside risk aversion has been clear on the point that greater prudence is not equivalent to greater downside risk aversion, although the two concepts are linked. In the present paper we present a new, and we argue equally natural, concept of the downside risk aversion of a decision maker, namely the fraction of a zero mean risk that the decision maker would optimally place on the upside. We then consider how this measure can be used to identify the intensity of downside risk aversion. Specifically, we show that greater downside risk aversion in our model can be accurately measured by a relationship that is very similar to, although somewhat stronger than, greater prudence.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Richard Watt & Francisco J. Vazquez, 2013. "Allocative downside risk aversion," International Journal of Economic Theory, The International Society for Economic Theory, vol. 9(4), pages 267-277, December.
    • Handle: RePEc:bla:ijethy:v:9:y:2013:i:4:p:267-277
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    File URL: http://hdl.handle.net/10.1111/j.1742-7363.2013.12019.x
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    References listed on IDEAS

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    1. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January.
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    5. Keenan, Donald C. & Snow, Arthur, 2009. "Greater downside risk aversion in the large," Journal of Economic Theory, Elsevier, vol. 144(3), pages 1092-1101, May.
    6. Menezes, C & Geiss, C & Tressler, J, 1980. "Increasing Downside Risk," American Economic Review, American Economic Association, vol. 70(5), pages 921-932, December.
    7. Jindapon, Paan & Neilson, William S., 2007. "Higher-order generalizations of Arrow-Pratt and Ross risk aversion: A comparative statics approach," Journal of Economic Theory, Elsevier, vol. 136(1), pages 719-728, September.
    8. Keenan, Donald C. & Snow, Arthur, 2010. "Greater prudence and greater downside risk aversion," Journal of Economic Theory, Elsevier, vol. 145(5), pages 2018-2026, September.
    9. Gollier, Christian & Pratt, John W, 1996. "Risk Vulnerability and the Tempering Effect of Background Risk," Econometrica, Econometric Society, vol. 64(5), pages 1109-1123, September.
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    Cited by:

    1. Liqun Liu & William S. Neilson, 2019. "Alternative Approaches to Comparative n th-Degree Risk Aversion," Management Science, INFORMS, vol. 65(8), pages 3824-3834, August.

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    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty

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